1. Between a rock and a hard place

Between a rock and a hard place

A sharp drop in steel prices along with cheap imports and low demand is hurting the industry

By: and | Updated: April 20, 2015 1:20 AM

Last week rating agency Fitch lowered the outlook for Steel Authority of India (SAIL)’s long-term foreign currency issuer default rating to negative. In its commentary, Fitch noted that continued weak steel demand growth in India or high steel imports or a further softening in global steel prices could derail SAIL’s efforts to de-leverage; the company’s net leverage increased 5.5 times in FY14 while the Ebitda/interest cover fell to 4.3. Indeed, with demand at an anaemic 3% and more supply coming in, the country’s steel makers are staring at tough times. The 28% drop in global prices over the past six months has seen imports rise by 71% to 9.3 million tonnes last year and local prices come off by 10-14%.

“The China slowdown and the steep decline in iron ore prices will continue to weigh on already depressed global steel prices. The global price decline and surge of cheap imports have led to sharp cut in domestic steel prices over the past six months,” Kotak Institutional Equities (KIE) observed in a recent report.

While the larger companies are unlikely to default, their margins could be badly dented. Analysts estimate that the average realisation per tonne for JSW Steel is likely to fall to R35,660 in FY16 from R38,028 in FY15; for Tata Steel (India) the average prices of HRC are estimated to fall from $526 in FY14 to $485 in FY15 and further to $410 in FY16. However, both companies are likely to be able to improve volumes at the cost of other players.

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But that’s only if the flood of imports from China, Japan, South Korea and Russia, where production costs have come down significantly due to the fall in the prices of iron ore and the depreciation of their currencies against the dollar, subsides. As Anjani Agrawal, national leader (mining and metals), E&Y points out, the rupee has remained stable or even appreciated against most currencies save the dollar against which it has fallen by 1.6% over the last six months.

Meanwhile, as Jayant Acharya, director, commercial and marketing, JSW Steel, points out, the cost of iron ore in the local market remains higher than that in the international markets. “Prices globally have corrected by about 58% over the last 12 months but prices locally have fallen by just 12%,” Acharya said. While the industry is lobbying for a hike in import duties, that may not be of too much help.

In a recent report brokerage HSBC observed that although Russia/CIS has not exported a lot into India, interactions with the steel mills suggested that buyers may have used the low bids from that region to drive down prices during negotiations. “Although the Budget for 2016 increased the maximum permissible limit of import duty that can be levied, it stopped short of raising the duty itself, implying status quo.

Rising imports amid weak domestic demand, relative loss of competitiveness due to currency appreciation and export benefits offered by some countries to their steel exporters are some of the reasons used by the steel mills to persuade India’s finance ministry to raise the duty protection,” the report noted. “In the absence of duty protection, the situation will remain dire for Indian steel mills,” HSBC observed.

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Firdose Vandrevala, executive vice-chairman, Essar Steel, however, points out that given the lower import duties from Japan and Korea, which are protected by the free trade agreements, the effectiveness of such a duty hike may be diluted. Vandrevala adds that with NMDC’s iron ore prices on the higher side margins could be under pressure.

Unless demand picks up quickly, the industry could see a prolonged period of weakness since supply is rising. Even as the situation continues to be grim, Indian steelmakers exude confidence, in the belief that the incipient economic recovery would stand them in good stead. “I am expecting that in the new fiscal 2015-16, the growth in steel demand should not be less than 8-9 %, SAIL chairman CS Verma said. Asked whether that was an over-optimitsic projection given the tepid demand scenario that prevailed in the previous two years (0.6% in 2013-14 and 3.1% in 2014-15), he said the steps taken by the Modi government such as the proposed changes to the Land Acquisition Act and the renewed focus on infrastructure and manufacturing would aid the recovery.

SAIL recently commissioned its 4.5 mtpa Rourkela steel plant and expects production capacity to rise to 23 mtpa in September. Tata Steel’s Kalinganagar plant will contribute another three mtpa in the next couple of years. By March 2016, the country’s steel making capacity is expected to go up by 10% with 10 million tpa being added to the existing capacity of approximately 100 million tpa.

SAIL’s Verma, who pins hopes on a smart recovery in domestic demand, however is concerned about the slump in export markets. “With global steel industry operating at less than 75% capacity, exporting steel is indeed challenging,” he said. According to him, since steel prices have plunged to a historic low, it could only start firming up now.

Integrated players are also expected to see an erosion in their respective earnings per share (EPS) numbers owing to higher royalties imposed by the new mines bill. Existing miners’ contribution to the district mineral foundation (DMF) under Mines and Minerals (Development and Regulation) Amendment Bill, 2015, will now increase to 100% of the royalty amount against 33% in the earlier MMDR Ordinance approved in January 2015.

Kotak Institutional equities has lowered its EPS estimate for Tata Steel of R18.6 for 2014-15 to R18.2 as royalty costs are estimated to rise to R2,600-2,700 crore in 2016-17 compared to R1,100 crore in 2013-14; in 2013-14, Tata Steel posted an EPS of R37.3.  While Tata Steel is highly leveraged, the company should be able to service its loans comfortable. Other firms may find it difficult. Vandrevala told FE recently that Essar Steel, is looking to get $2  billion worth of loans refinanced under the Reserve Bank of India’s 5/25 scheme. Bankers to Bhushan Steel have lent the firm an additional R7,000 crore even though the company owes them R35,000 crore and has reported losses for the last five quarters.

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