Steel firms get back pricing power

Healthy demand, better realisations and benign input prices indicate good prospects.

The outlook for domestic steel manufacturers is improving on the back of strong demand in the country and companies hiking steel prices. Companies including JSW Steel, SAIL and Essar Steel have hiked steel prices in the range of Rs 1,000-1,500 per tonne (or 3-4 per cent) in the last one week, which analysts believe could rise further. In totality, domestic HRC (hot rolled coil) prices are up 13 per cent since July this year, at about Rs 38,700-39,200 ($880-890) per tonne. In the light of the healthy demand, better realisations and benign input prices, the prospects of steel manufacturers look good.

Strong demand, better pricing
The hike in domestic steel prices is the result of strong demand post-monsoon and beginning of the festival season. According to estimates, steel demand in the country grew 14.4 per cent in 2009-10 and about 10-12 per cent in the quarter ended June 2010. The higher demand is led by construction, automobile and white-good sectors, which has seen companies ramp up production. According to World Steel Association (WSA) data, the domestic steel production in the three months ended August 2010 has grown about 20 per cent.
 

GAINING STRENGTH
In Rs crore	FY11E		PE (x)		CMP (Rs)
	Sales	PAT	FY11E	FY12E
Tata Steel	111,556	6,018	10.5	8.5	670
JSW Steel	24,051	1,886	16.0	10.7	1,378
SAIL	48,149	7,848	12.7	10.9	228
E: Estimates                                             Source: Bloomberg concensus estimates

WSA estimates India’s steel demand could grow by 13.6 per cent in 2011, which would be 32 per cent above its 2007 level. In addition to the domestic triggers, production cuts in China and lower international prices of raw materials such as coal and iron ore have added to the sector’s positive outlook.

The strong demand, higher steel prices and lower input costs suggest that steel companies will not only report better sales numbers but also report better profitability in the coming quarters. “However, a large part of its impact will be seen in the December 2010 quarter, wherein the margins will improve and the average realisations could go up by Rs 2,000-2,500 per tonne,” says Ravindra Deshpande, who tracks the metal sector at Elara Capital. We look at the country’s top steel producers and their medium-term outlook.

Tata Steel
The impact of higher domestic prices will be relatively marginal for Tata Steel, which generates most of its revenue from the international market (mainly Europe; Tata Steel Europe), where prices and demand have not seen much improvement. The international operations have seen a positive turnaround in the current year after huge losses last year. This along with the strong pick-up in the domestic business, which accounts for a reasonable chunk of its profits, should lead to an improvement in overall margins and good growth in earnings in the current year and the next. Also, in the near-term, Tata Steel Europe’s outlook may not improve dramatically. But over the next two-three quarters, the company should be cash positive, with the margins stabilising. Additionally, following the refinancing of a £3.67-billion bank loan, the liquidity pressure on Tata Steel Europe has also eased. For now, analysts are divided due to the uncertainties pertaining to the global economic growth and the upturn in Tata Steel’s stock price. The stock could be bought on dips with a two-year perspective.

Sail
The company, which is a pure domestic play, will benefit on account of higher selling prices and lower input cost, which will reflect on its realisations and margins. The company’s average realisations for 2010-11 could improve to about Rs 36,500-37,000 per tonne compared to Rs 34,350 per tonne in the previous year. However, in the near term, owing to the absence of any volume growth, analysts expect steel prices to drive the company’s revenue growth.

Sail is doubling its capacity to 25 million tonnes. But, the impact of new capacity will be seen only in the financial years 2013 and 2014. This will also be accompanied by the reduction in operating costs as a result of higher integration, modernisation and economies of scale. Meanwhile, though its earnings growth could be in the range of 12-15 per cent over the next two years, the stock looks fully priced for now.

JSW Steel
JSW Steel is the key beneficiary of strong domestic demand as well as its expanded capacities. During 2009-10, the company reported a whopping 61 per cent growth in production. Now, with higher steel prices, its average realisations too are expected to improve to Rs 35,500-36,000 per tonne in 2010-11 as against the Rs 31,900 per tonne in 2009-10. On the back of these, expect the company to report a volume growth of 10-11 per cent in the current financial year, while the earnings growth is estimated to be 47 per cent annually over the next two years. While the near-term upside looks limited, the stock could be bought with a one-year perspective.