CLSA downgrades prompt selling in Tata Steel, JSW Steel after 3-day rally

Tata Steel had made a new record high of Rs 156 in Saturday's special session on March 2. In the last three days, prior to today's losses, the stock had rallied 8 per cent

Shares of steel majors Tata Steel and JSW Steel snapped their three-day rally on Monday after global brokerage CLSA downgraded its ratings and target prices on the two stocks, reiterating a cautious stance on the Indian steel sector citing high valuations in relation to price/spread compression. 

CLSA downgraded Tata Steel and JSW Steel to 'Sell' from outperform and underperform, respectively, cutting target prices from Rs 145 on the former to Rs 135 and from Rs 810 on JSW Steel to Rs 730. 

The share prices of JSW Steel and Tata Steel fell nearly 3 per cent each to their intra-day lows of Rs 819 and Rs 151, respectively, on BSE. In the last three days, prior to today's losses, the two had rallied 8 per cent and 3 per cent, respectively.

Tata Steel had made a new record high of Rs 156 in Saturday's special session on March 2. 

In calendar year 2024, the Nifty Metal index is up 5 per cent, while since September 4, 2023 that is in past 6 months, the index has rallied nearly 20 per cent. The Nifty50, in comparison, is up 15 per cent during this period. Tata Steel is up 17 per cent in last six months, while JSW Steel is up just 5 per cent.   

Noting three key factors behind its cautious stance on Indian steel companies, CLSA said it expects the profit pool to incrementally move towards miners (iron ore/coking coal players) from steel mills or converters as steel capacity addition picks up pace.

"The sharp ramp-up of blast furnace-based steel capacity in India over the next three years will likely weigh on spreads and shift incremental margins from steel conversion to raw materials. As supply outstrips demand growth, and reliance on exports rise, domestic steel prices are unlikely to trade above import parity," it said in a note. 

The brokerage thus expects steady state spreads below the past average (in $ terms) going ahead. It sees FY25/26CL spread at $360/ton against the10-year average of $410/ton. 

Besides, it noted that unlike the past, valuation multiples (price to book) for Indian steel companies have risen in the past 18 months while steel prices/spreads have corrected.

This, it says, is likely driven by a better demand outlook, expectation of a China stimulus and overall elevated valuations in Indian markets.

In its weekly update on Feb 21, Prabhudas Lilladher (PL) noted that Indian benchmark hot-rolled coil (HRC) price slumped below the Rs 54,000 per tonne mark to Rs 53,800, down 0.4 per cent on a weekly basis.

The spot spreads declined 1 per cent week-on-week to Rs 19,980 per tonne led by a fall in HRC prices as raw material prices remained stable

As per the PL analysts, domestic steel demand improved in January as imports subsided, however, pricing still remains muted.

"Primary steel players are expected to take calibrated price hikes in near term in order to push rising cost curve. Steel companies are eyeing export markets as Indian HRC continues to trade at discount on import parity basis," they said. 

CLSA further believes that consensus estimates too are not factoring in spread compression.

"Consensus estimates are implying FY25/26 profitability in line with or above Q3FY24 levels, which we find unjustified. While spreads have compressed further in the past two months, Q3 numbers had been insulated due to the lag effect of cost inflation," it said. 

Hence, the brokerage has changed FY24-26CL Ebitda estimates for steel companies by -6 per cent to +5 per cent on lower spread assumptions, thus giving a double downgrade to both JSW Steel and Tata Steel.

However, it has raised its target price for Jindal Steel and Power (JSPL) from Rs 820 to Rs 840, while holding its 'underperform' rating, as "it is relatively better off because weaker industry spreads will be more than offset by the margin expansion projects".

The brokerage has also flagged China stimulus as a key risk to its thesis as a sustained higher demand in China driving up spreads, will be most favorable for Indian mills given the self-sufficiency of iron ore in the country.

However, if China production remains elevated with weak demand, spreads could remain lower for longer, it said.