Steel makers find little reason to cheer as profits dip on high input costs, low demand

Written by Debabrata Das | Pradip Kumar Dey | Mumbai | Updated: Jan 2 2012, 07:16am hrs
Rising raw material costs and lower offtake from auto and realty sectors hit steel companies hard in 2011, making them less profitable.

Steel demand traditionally grows at 1.5 times the pace of the economy, but between April and November 2011, demand growth slipped to 3.9%, lower than the gross domestic product (GDP) growth rate.

This eroded companies profits and factories cut down steel production. By December, steel makers ran their plants at just around 70-75% capacity, according to an official of a public sector steel company.

Policy paralysis, global uncertainties and high interest rates hit new investments, pulling down steel demand.

In the current fiscal, steel demand has suffered on account of low investment activity and even slowdown in infrastructure spending, equity research firm Nomura said in a report on December 7.

We expect a modest recovery in the next fiscal.

The September 2011 quarter saw new investments worth only R2.6 lakh crore, a nine-quarter low, data from the Centre for Monitoring Indian Economy or CMIE showed. This is about 64% below the peak of R7.2 lakh crore achieved in the June 2010 quarter.

2011 was a year that the steel industry in India would like to forget, Linus Lobo from mjunctionedge, the knowledge division of Sail and Tata Steel-promoted website mjunction, said. On the one hand, demand started cooling from the consumer segment real estate and auto and the worrying sign in the slightly longer term is the slowdown in capital expenditure from the private sector and public spending on infrastructure.

New steel capacities that came on stream during the fiscal created excess supply, preventing steel makers from raising prices to make up for higher input costs.

Some Indian majors had ramped up capacity, which is why there was a supply demand mismatch in the domestic market this year, said Anjani Agrawal, partner and national leader, metals and mining with consultant Ernst & Young India. But our view is that demand will bounce back.

To add to the woes of steel makers, especially those in the South, was the Supreme Court order in August banning mining of iron ore in Karnataka.

The low point for the industry was the ban on iron ore mining in Karnataka because it has curtailed availability and pushed up prices of this crucial input for the steel sector, says mjunctionedges Lobo. Iron ore availability continues to be a pain point.

The negative effect of the move is expected to continue in the first quarter of the calendar year 2012.

Steel makers in the southern states had to source iron ore from NMDC via an e-auction or electronic auction. The e-auctions were far from successful as steelmakers complained of delays in deliveries and low-grade quality of the ore.

The effect of the e-auction system would reflect in lower profitability during Q3 and Q4 of FY 2012, which would have a significant impact on the industry volumes, said the Frost & Sullivan 2012 outlook.

Next year, however, demand for steel is expected to improve. Consultants expect steel demand to revive once investments in infrastructure projects begin again.

The increase in public and private investments in the countrys infrastructure, core and allied industries will help in sustaining the steel sector growth in the near future, says the yearly sectoral report from the Metals & Minerals Practice of consultancy firm Frost & Sullivan.

Most Indian steel producers would continue to pursue both organic and inorganic capacity expansion opportunities to cater to the anticipated demand, the report adds.

Nomura, however, warns that if demand doesnt improve, prices will have to drop. However, if the demand scenario doesnt improve, we could see a surplus which may lead to an erosion of the premium that domestic prices had over landed cost of imports (close to 3-5%), the research firm says in its report.

Now that the alarm bells have begun to ring on the economic slowdown and concerns on inflation seem to be waning, it is expected that the government and RBI will step in with the right policy measures to stimulate growth in the economy, said Lobo.

With the rupee having depreciated significantly, imports are currently not a concern and, therefore, domestic demand will be satisfied with local supplies rather than imports, he added.

Steel companies will also need to keep a check on their debt. In 2011, 97 steel companies saw their total debt increase by about 22.5% over the year, while equity or net worth increased by 25.2%, a study conducted by FE revealed.

The steel industry in India is going through a difficult phase due to higher raw material cost, while reduced demand and declining steel prices globally threatens to put domestic steel prices under pressure, said an analyst from a brokerage house.

This could result in a reduction in internal accruals for FY12, forcing steel companies to increase their reliance on debt to meet the ever-growing capex requirement. This could lead to an increase of the debt/equity ratio for the steel industry going forward, he added.

The increase in debt for FY11 is mainly on account of the increase in working capital requirements for these companies, said Hitesh M Avachat, an analyst with Care Research.

However, improvement in steel prices and increase in volumes helped steel companies to improve their net worth also.