Analysts cautious as steel stocks rise

Chinese capacity cut is unlikely to help, though a continuing trend of declining coal prices

The news of a cut in Chinese capacities and falling coal prices led to a rally in steel stocks on Wednesday. There was a gain on the bourses of four to 11 per cent for JSW Steel, Tata Steel, Steel Authority of India (SAIL) and Bhushan Steel.

The Chinese government has decided to close all medium frequency furnaces, about nine per cent of total capacity in that country of 1.13 billion tonnes, with annual production of about 50 million tonnes (mt).

Analysts are cautious. For one, the capacities being cut are of low quality. Also, China had cut about 45 mt capacity in 2016 but this did not lead to a decline in overall output.

“A cap on exports by China would be a more appropriate move to curtail global oversupply. Then, production there will automatically adjust to local (China) demand,” said an analyst with Motilal Oswal Securities.

Goutam Chakraborty at Emkay Global has a similar view, adding that benefits can accrue only if a demand-supply balance is achieved.

“Stock prices of domestic steel companies are up today on sentiment but at a business level, no material change is expected due to China capacity closure,” said Abhisar Jain, senior analyst with Centrum Brokerage.

Observers will watch for the impact after the Chinese new year (January 28), when the peak production season starts. In the near future, no big impact is expected on prices and margins.

The other news that could help is a decline in coal prices. Premium hard coking coal’s Australian export prices on January 11 came down to $185.2 a tonne, from $308.8 a tonne on November 30. If prices sustain at lower levels, input costs for steel makers could fall.

Coal prices had risen in the recent past and contracted coking coal costs during the December ’16 quarter are estimated to have gone up to $200 a tonne, from $92 a tonne in the September quarter. Though companies have been raising prices, average long and flat steel prices should be higher by only five to 10 per cent, as the hikes were only in the initial part of the December quarter, before demonetisation played spoilsport. There have been some price increases in January.

The good news now is that the impact of demonetisation seems to be reversing. An Elara Capital report suggests demand had slumped 14 per cent in November, after demonetisation. However, December steel consumption reflects growth of 17 per cent month-on-month and 5.2 per cent year-on-year. Also, finished steel production grew 12 per cent year-on-year to 8.4 mt in December, with most majors reporting healthy growth. 

For now, most analysts are cautious. Those at Ambit Capital say they expect Ebitda (earnings before interest, taxes, depreciation and amortisation) growth in the second half of FY17 to be lower than the first half, on rising coal prices and poor pricing power, due to worsening demand-supply dynamics. Analysts at Elara say margin pressure is likely to ease in the March quarter but they do not expect an earnings upgrade for these companies.

For the December quarter, Tata Steel India sales volumes are expected to increase 11 per cent over a year before; European sales growth might remain flat. The Ebitda per tonne at Rs 7,783 is to increase from Rs 7,308 a tonne in a seasonally weak September quarter and Rs 6,375 in the December quarter. For European operations, Ebitda is factored in at $35 a tonne by analysts at Ambit, compared to $67 a tonne earlier, due to decline in spreads.

For SAIL, while sales volumes are expected to increase 24 per cent due to capacity ramp-up, Ambit expects Ebitda loss of Rs 311 a tonne. The company will feel the biggest pinch of the rise in coal prices. 

JSW Steel remains the best pick and could see a boost from increased exports. Analysts at Emkay expect the operating profit to increase 177 per cent from a year before, though down 16 per cent sequentially due to rising coal costs.