In the steel grip of oversupply

Updated: Nov 20 2005, 05:30am hrs
Analysts are worked up. Recent data shows that the global demand-supply situation is certainly not in favour of Indian steel companies. Some are even scared that this could be the start of a downward spiral. After all, steel is an important parameter for any growing economy. It also happens to be the raw material for the entire range of core sectors of the economy, which includes housing and automobiles.

In spite of its woes, the steel industry is optimistic. Says BN Singh, JMD & CEO, JSW Steel, "On account of the government and private development programmes, one can expect consumption to grow by 7-8% annually and it can reach 150 million tonne by the end of 2010 from the current level of 34 million tonne."

For the quarter ended September 30, 2005, large steel companies saw marginal growth in sales. The impact of falling steel prices and rising energy cost, coupled with the slowdown in global demand, has dampened the revenue growth of steel companies. The top 25 companies have registered a net sales growth of 3.02% for the quarter ended September 2005, whereas the operating profits and net profits have shown a negative growth at 6.40% and 17.94%, respectively.

Companies during the quarter have operated on thin margins due to the rise in prices of coking coal, gas and iron ore. The raw material cost has gone up by 7.76% and given the demand-supply scenario in the domestic and international markets, companies could not pass on the rise in raw material cost fully to their customers.

Production

During January-July 2005, world crude steel production has registered a 6.9% growth at 636.2 million tonnes, while for the same period India's production went up 18.7% to 22.1 million tonnes. China's production has gone up by 28.1% to 193.8 million tonnes. Interestingly, China, which has so far remained the world's largest consumer, has also started exporting with aggressive pricing, thus impacting the domestic steel producers in India.

In the last couple of years, driven by global demand especially in Asia, the steel industry the world over has witnessed exceptional times, as a result of which one can see massive additional capacities. India is the largest producer of sponge iron and the ninth largest producer of steel in the world. Today, when global demand is easing, and China is exporting its steel produce, there is a consequent fall in prices.

Based on the last nine-month production data, China accounts for 31% of the total world production and 61% of the total production in Asia. The same figures work out to 3.35% and 6.58% for India. For the last nine-month period, the total world production worked out to 818946 metric tonnes.

Now, with an oversupply of the metal, Indian steel companies are occupied with massive capacity expansion plans. About 80 million metric tons of new steel capacity is planned in India, and this is considered almost three times the nation's current need.

Jindal Steel and Power is set to sign an MoU with the Orissa government for increasing the size of its proposed steel plant in the state from two million tonnes to six million tonnes.

For the quarter ended September 30, 2005, Tata Steel achieved an all-time production of hot metal, crude steel and saleable steel.

Driven by infrastructure growth and Chinese demand in the last couple of years, Indian steel companies were in the radar of every investor and fund manager. The share prices of steel companies were soaring, however, today as a result of declining prices and a lacklustre performance , the industry scenario is different. Investors are increasingly worried about the outlook of these companies.

Demand-supply

The domestic consumption of finished steel has gone up from 14.84 million tonnes in 1991-92 to 34 million tonnes (estimated) in the year 2004-05 and by 6.3% at 107 lakh tonnes during April-July 2005. However, exports have come down by 12% to 12 lakh tonnes as compared to 13.6 lakh tonnes in the corresponding period last year. Analysts believe that the fall in exports can be contributed by a decline in imports from China, and lower demand from the EU.

According to the International Iron and Steel Institute, world crude steel production has gone up by 4.5% to 90.3 million metric tonnes (mmt) in July 2005 and the same was estimated to be 92.1 mmt in September. This is 3.5% higher than for the same month of 2004, whereas India was estimated to grow by 34% to 3.6 million tonnes.

Price move

Steel prices went down during the quarter-ended September 2005 following cheap imports from China and Ukraine. China, which was earlier importing steel, has turned a net exporter. The country produces 290 million tonnes of steel while the consumption level is at 250 million tonnes. The domestic steel companies reduced the steel prices in the month of July 2005, across the products by around Rs 500-3000 per tonne, considering the slump in international demand and build-up of inventory. Again, in August 2005, there was a cut announced by companies in the range of Rs 1500- 2500 per tonne. Says Ashutosh Satsangi, head, research, Crisil, "The recent decline in steel prices can be attributed to falling international prices, lower Chinese imports and surplus world production."

However, in the month of September 2005, domestic prices were raised by Rs 500-3000, which is believed to have been a result of firm international prices and falling inventory levels.

Markets

In the recent market rally, most of the industries performed well and touched new highs, while, on the other hand, the share prices of most steel companies have been a cause for concern. At current market levels, the BSE Sensex has moved up by almost 44% in the last one year, whereas the BSE Metal index has gone up merely by 16.10%, and the share prices of some steel majors such as Tata Steel and Sail have moved up by a modest 18% and 3% respectively. Considering the Sensex PE of 16.58, today, most steel companies are trading at considerably low valuations. Share prices of Tata Steel and Sail are trading at PE multiples of 5.5 and 3.4 respectively, and the price to book value (PBV) works out to 2.86 and 2 respectively, which is considered very low compared to some of the other industries.

Outlook

The world economy is moving at its fastest pace in the last 15 years. This is mainly attributed to the growth in Asia. The International Iron and Steel Institute (IISI) expects the world economy to expand by 3.4% in 2005. But escalating crude oil and other commodity prices can dent the projected economic growth. Currently, world steel production is growing at around 6%, which is much higher than the world economy. This might just be a temporary phase of euphoria. The Indian economy is growing at a healthy rate but still might not be able to make up for the oversupply of steel production.