 "Why rally in steel stocks is far from over")
Steel companies that survived dumping by China are all trading near their 52-week high levels. Some others have tried to keep pace but have not yet touched their 52 week highs, but they are trading well above their lows. However, there is a general apprehension in the market that the rally in the steel sector is over. Especially since demand has not really picked up.
An ICICI Securities report points out that steel demand has increased by 3 per cent in the second quarter of the current fiscal over the last year. A Crisil report points out that benefits of the introduction of import restrictions has not percolated down to the weakest companies in the sector. The Crisil rating report says that minimum import price (MIP) and the anti-dumping measures will lend only a marginal fillip to the profit margins over the medium term, but companies’ debt-servicing abilities will remain weak given the indebtedness levels.
To add to the trouble of steel companies is the increasing raw material prices. ICICI Securities points out that despite a steady pickup in demand realisations, a drop of 3-5% over previous quarter will impact margins.
Credit Suisse in a report on the steel sector says coking coal prices have doubled in the past two months and are at a four-year high, raising concerns of a drop in margins for Indian steel players that rely mostly on imported coal. However, the broking firm says they are quite enthused by the hike in RM costs as it provides support to the cost curve.
Rise in coking coal prices was on account of several supply-side factors such as lower production in China, lower exports from the US on account of miner bankruptcies and floods in Australia. Credit Suisse points out that these events coincided with a seasonally strong buying season globally.
A Deutsche Bank report on Indian steel says that historical data indicates that Indian steelmakers have been able to preserve margins by passing a significant portion of the higher coal costs on to end users. The research firm believes the cost pass-through should also happen this time, supported by strong regulatory support, with the domestic benchmark HRC (hot rolled coil) price at a 10 per cent discount to the landed cost of imports and an expected pick-up in domestic steel demand in a seasonally strong second half.
There is a further scope of hike in steel prices which can fuel the stock rally in the markets. Deutsche Bank says the domestic HRC coils are still trading at a 10% discount to the landed price, despite taking into account a 9% rise in steel prices from their August 2016 lows. This implies that there is sufficient scope to raise prices, even without factoring in any cost-driven global steel price recovery. With coking coal inventory of 2-2.5 months, Deutsche Bank expects the full impact of higher coking coal prices to be reflected only from December 2016, with the full impact in 4Q, when scope for domestic price increases is high, being a seasonally strong quarter for India steel with a pick-up in domestic demand.