The sharp increase in coking coal prices can adversely impact the profits of Indian steel firms, Fitch Ratings said today.
"Risk will increase if high coking coal prices persist and domestic steel demand growth remains weak," Fitch said in a statement.
The full impact of the recent jump in coking coal prices on steelmakers will be felt from the later part of Q3 2016-17, as volumes are mostly traded on a contractual basis and priced using monthly or quarterly averages and companies generally keep two to three months' worth of inventories, it added.
"JSW Steel relies solely on imported coking coal and is therefore exposed to the cost rises. Tata Steel's Indian operations are less susceptible to the rise in coking coal prices as its own production caters to roughly 45 per cent of its requirements, but its overseas units are at higher risk as they rely on imports," Fitch said.
Quoting Steel Index data, the ratings agency said prices for hard coking coal for export by Australia as of September 30, 2016 were 125 per cent (USD 100/tonne) higher than the average in the quarter ended June 2016 (Q1 2016-17).
Prices rallied following China's decision to limit coal mines' operating days to 276 a year, from 330 before, to restructure the industry and improve its profitability.
Other issues such as flooding in China's Shanxi province, which reduced supply, and a number of unplanned mine outages in Australia also supported the price rise, it said.
"Increase in raw material costs for Indian steel producers could shrink margins, if the cost rise is not passed on to consumers. For example, we estimate that a USD 50/tonne increase in Tata Steel's coking coal cost in Q1 2016-17 would have reduced consolidated EBITDA by around 35 per cent, if all else stayed the same," Fitch said.
Similarly, JSW Steel's Q1 2016-17 consolidated EBITDA would have fallen by around 25 per cent. The impact of higher coal costs would be offset if we assume price realisations for the two companies were 5-10 per cent higher, it added.
"However, the ability of steelmakers in India to raise prices to counter any sustained cost increase is likely to be constrained if weak domestic demand growth persists amid increased capacity," it said.
Domestic consumption in April-September 2016 rose by just 2.5 per cent y-o-y, compared with 5.9 per cent in 2015-16. Meanwhile, producers, including Tata Steel and JSW Steel, aim to increase sales volume after recent capacity expansions, it added.
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