Commodity and metal prices overall have seen a strong rally since mid-2020 and there seemed to be no respite from the run-up till recently, when various factors came together to halt the rally.
“Steel prices in the domestic market are expected to correct in the coming months, as current domestic prices are at a premium to import parity,” said Jatin Damania, vice-president, fundamental research, Kotak Securities. He attributes this premium in domestic prices to the fact that the Chinese hot-rolled coil (HRC) prices have softened by about 20% in the past four weeks and are now back at levels seen at the start of the calendar year.
Chinese correction
Chinese HRC prices have witnessed a correction due to an energy crisis the country faced due to low coal stocks at generating stations in the last couple of months which led to power usage restrictions and lowered demand from its strong manufacturing sector. Demand for steel was lower from the real estate sector as well due to the ongoing saga at debt-laden property developer Evergrande and concerns arising from the leverage the sector faces. International iron ore prices have corrected sharply as well, dropping from near $140 per tonne in August-September to below $100 a tonne in November.
“Over the last few weeks, there were weaker data points from China and a sustained upmove in the Dollar Index which were capping gains for industrial metals and energy,” said Navneet Damani, vice-president, commodity and currency research, Motilal Oswal Financial Services.
Chinese production cuts
Chinese exports are likely to remain in check with large production cuts across provinces. The output reductions have been sharp and have continued into November since the start of the energy crisis in March. Chinese crude steel production declined 22 percent year-on-year (y-o-y) in October, however, while crude steel production in the calendar year so far was flat on a yearly basis.
“Winter restrictions further extend curtailments into Q1CY22 with at least a 30 percent y-o-y cut for ~40 percent of production in China over 1 Jan to 15 Mar 2022. While an intermittent rise is possible, we believe the cuts will keep exports in check,” said a report from brokerage firm BOBCaps.
These production cuts have, however, helped offset demand weakness and kept inventory levels low.
Domestic scenario
The decline in steel shipments from China has meant HRC prices in the domestic market are at a 10-12 percent premium compared over imports when historically they used to trade at a discount of 3-5 percent. Weak demand from overseas is also contributing to the woes of Indian steelmakers.
“Export orders of Indian mills have dried up whereas domestic demand is yet to see any meaningful recovery. We expect HRC prices to correct by 5-10% over the next 2-3 months in India, partially helped by longer lead times for import orders,” said a report from Kotak Institutional Equities.
Domestic HRC prices have fallen in the traders market by around 2 percent week-over-week to Rs 70,000 per tonne. “This is still at ~6 percent premium compared to imports from China,” said a report from Edelweiss. However, there still are no major import bookings even though Chinese export prices have declined 10 percent on a weekly basis to $795 a tonne (at the lowest level since March).
The Edelweiss report added, “In the case of Indian players, export realization is at a discount of 11% to domestic prices for HRC, hence we expect the exports proportion to reduce, further exacerbating the pressure in traders’ market.”
Iron ore and coking coal prices
While international iron ore prices have softened and appear to be stabilising around $90-100 per tonne, the import parity between domestic iron ore prices has reduced to 10 percent from the historic levels of 20–25 percent.
The prices of coking coal from Australia have declined from $400 a tonne in October to $364 a tonne in November. Prices of coking coal in China are also seen easing from $540 to $440 per tonne due to contraction in demand and better supply post plant maintenance.
“Though the upcoming wet season in Australia poses a near-term risk, we expect prices to revert to mean over 6-12 months,” BOBCaps added in its report.
Though coking coal prices have peaked, given the inventory lag, cost pressures are likely to ease only towards the end of 4QFY22E, added Damania from Kotak.
Margins in the domestic market
The domestic industry was able to partially offset the higher costs with higher realizations in the second quarter of this financial year. However, EBITDA (earnings before interest, tax, depreciation and amortisation) margins took a hit of about Rs 4,000 a tonne across the sector. Higher coking coal costs and the softness in prices are expected to continue and have a similar sequential impact on EBITDA margins in the third quarter.
The latest guidance from Tata Steel implies a Rs 4,000-5,000-per-tonne quarterly decline from its Q2FY22 EBITDA margin of Rs 30,700 a ton for standalone operations.
“4QFY22E is likely to see further margin correction due to lower prices,” said Kotak.
BOB Caps concurred with Kotak, saying, “We believe steel margins will soften over the next 6-12 months as prices ease to an estimated $650 per tonne by FY23.”
Steel stocks
Most brokerages expect profitability of domestic steel players to be under pressure due to higher coking coal prices. Edelweiss expects Tata Steel and Jindal Steel and Power Ltd to perform relatively well owing to improving prospects of their European operations (high contract prices and low iron ore prices) and lower reliance on imported coking coal.
“Steel companies would continue to deleverage in FY2023-24E after a sharp debt reduction in FY2021-22E,” expects Kotak. “Steel stocks are likely to remain under pressure amid steel price weakness in the near term; however, we see attractive risk-reward from a one-year perspective, it added while recommending a ‘Buy’ on JSP and Tata on dips.”
BOBCaps prioritises capital discipline over expansion projects. It is positive on Tata Steel and Jindal Steel which are now focusing on responsible growth, in its view.
Source:financialexpress.com