Credit profiles of steel pipe makers will benefit from healthy demand outlook, resilient margins and moderate capex intensity over the medium term.
CRISIL has analysed the sector by categorising the steel pipe industry into two segments – first, electric resistance welded (ERW), and second, submerged arc welded (SAW) and seamless, together referred to as S&S.
Demand growth for steel pipes overall is expected to accelerate to 7-8% over the next five fiscals, compared with 4.5% in the last five. Growth would be higher for ERW at 8-10% as against 5-6% for S&S.
Demand drivers for ERW pipes include higher investments in water supply and sanitation, irrigation, and increased usage of structural pipes in infrastructure projects and other newer applications. Organised ERW pipe makers will continue to benefit from formalisation of the economy post implementation of the Goods and Services Tax (GST).
For S&S pipes, on the other hand, the main growth driver is the oil and gas sector.
The implementation of recently awarded city gas distribution (CGD) licences will be a big boost for both ERW and S&S segments. CGD orders will require at least 10,000-15,000 km per annum of pipes through fiscal 2029, entailing an opportunity of over Rs 5,000 crore per annum over 10 years.
Steel prices are inherently volatilite, which leads to high variability in the operating profitability of steel producers. However, steel pipe manufacturers have exhibited higher resilience as their business model is different from steel producers. Generally, steel pipe makers work on conversion margins, which insulates them from price risk to a large extent. However, any sharp change in steel prices could expose pipe makers and will result in inventory losses as seen in Q3 of fiscal 2019 for some ERW manufacturers.
Most of the pipe makers have completed capital expenditure programmes in fiscal 2019 and have enough headroom in capacity utilisation.
In the ERW segment, the utilisation level is expected to be 63% for fiscal 2019, compared with 59% in fiscal 2018. We believe the next cycle of capex will start only when the exisiting capacities reach utilisation levels of 80-90%, which may take two more years.
For S&S, there is scope of capex of Rs 600-800 crore in fiscal 2020 for balancing requirements and in value-added segments. Despite the capex, utilisation levels are expected to increase to around 50% in fiscal 2020, compared with 46% in fiscal 2019.
Operating performance of steel pipe players will remain susceptible to any slowdown in end-user industries. For ERW players, any sharp movement in hot rolled (HR) coil prices will also be a key monitorable.