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September 25, 2019 location Mumbai

Falling Ebitda spreads to weigh on steel sector capex

Elusive price recovery despite run-up in raw material cost

Global steel prices dropped 13% in the first eight months of 2019 due to weak demand, unseasonal jump in global inventory levels (up ~35% through August) and trade tensions. This was despite a whopping 56% run-up in global iron ore prices during the same period.

 

Steel prices in India mirrored the trend, falling 10% from Rs 42,000 per tonne in January to Rs 38,000 per tonne in August 2019.

 

Not surprisingly, Indian steel manufacturers’ earnings before interest, tax, depreciation and amortisation (Ebitda) spreads contracted 420 basis points (bps) on-year in the first quarter of fiscal 2020. The contraction was more for large non-integrated players, at 470 bps.

 

What’s worse, subdued domestic demand and weak export markets cloud the industry’s prospects in the rest of this fiscal as well. After a robust 7.5-8% growth in the last two fiscals, the domestic steel industry is expected to witness a mid-cycle slowdown at 4-5% this fiscal, given muted construction investments and weak automotive market.

 

CRISIL expects some improvement in global market sentiment and domestic demand growth in the second half, however, a weak first half will still see to a 5-6% contraction in realisations this fiscal.

 

Says Prasad Koparkar, Senior Director, CRISIL Research, “Steel prices have not been able to recover despite a cost push, and hopes of a rally are fading now. We therefore believe weak realisations will shear 350-370 bps off the sector’s Ebitda margins for the first half and 200-250 bps for the fiscal as a whole, reversing a three-year climb. Large non-integrated players will see their margins shrink more, by 300-350 bps this fiscal, given weak flat steel market and a 3-5% rise in iron ore prices amidst weak realizations.”

 

All this will be a drag on the sector’s aggregate operating profit1, which is expected to fall 12-13% in fiscal 2020.

 

What’s more, large brownfield expansion plans, capacity acquisitions under the National Company Law Tribunal (NCLT) process, and high leverage of global assets will weigh on return ratio in the near to medium term.

 

Says Hetal Gandhi, Director, CRISIL Research, “The industry plans to add 28-30 million tonne (MT) steel capacity in the next 5 years, entailing a capital expenditure of Rs 1.4-1.5 lakh crore. Of this, nearly threefourth of capacity will be added by large players2 apart from the assets being acquired under NCLT by these companies. Falling spreads amidst high leverage will potentially slow down the investment plans in the near term.”

 

While in the near term the sector shall witness rising leverage, however, support in the form of prevailing antidumping duty across steel products (for period of five years) will help avoid the freefall of prices and profit as seen back in fiscal 2016

 

Recovery in global market, domestic demand growth, and upcoming iron ore auctions will be key determinants of the sector’s performance in the near term. On the iron ore front supply resumption at Karnataka’s Donimalai mine (that has impacted one-fifth of the state’s production), uncertainty around upcoming iron ore auctions in Odisha (which would account for half of the state’s production), and high premiums in the mines recently auctioned in Karnataka would be key determinants of iron ore cost structures and thereby steel players profit spreads in medium term.

 

Note:
Includes sample set of 42 steel companies including large players, re-rollers, long steel players, sponge / pig iron players, and alloy steel players.
Large players includes Tata Steel, JSW Steel, JSPL, and SAIL

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    Saman Khan
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    Prasad Koparkar
    Senior Director
    CRISIL Limited
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  • Hetal Gandhi
    Director
    CRISIL Limited
    B: +91 22 3342 3000
    hetal.gandhi@crisil.com