Indian steel stocks have remained buoyant due to recent spurt in regional prices and with our investor interactions post our note ‘India Steels: Curb Your Enthusiasm’ suggesting that most investors are hopeful of domestic steel prices firming up supported by ADD and hopes of better domestic demand supply. We stay cautious as we think this may be too optimistic, leading to earnings disappointment. This should also negate investors’ hope of a valuation re- rating.
Iron ore prices are up 14% and Chinese steel prices up 4% in the last two weeks led by restocking post inventory draw down, better Chinese PMI data and news flow around induction furnace closures. Most investors concur with our view that iron ore prices should weaken as restocking ends and due to higher supply. This should drag regional steel prices lower again.
We believe supply reforms should support better spreads, but regional steel price levels rather than spreads are more important for Indian steel cos. Chinese steel spreads are already near peak levels and could possibly correct. Also, closure of IF capacities have mainly affected longs rather than flat products and longs account for ~85% of fall in Chinese exports.
Many investors view the fall in domestic steel prices as seasonal weakness and expect prices to improve post monsoon. Note, domestic steel prices softened even in April/May (before monsoon). We believe domestic steel prices would be driven by import parity and unless regional prices rally, domestic steel prices should sustain at lower levels as prices (ex mill) are 5-7% premium to Anti dumping duty (ADD) based import parity (FTA).
Investors appear to be focusing on Chinese import parity, but import parity based on FTA countries is more relevant as a large proportion of flat product imports (45% of imports) are from FTA countries. Recent rise in regional prices and de-stocking ahead of GST have led a few mills to announce price hikes, but we doubt this would sustain.