Domestic steel makers struggle with sluggish demand growth: ICRA

Profitability may recover somewhat in Q3, with a sharp fall in coking coal prices in August 2019 and expectation of better demand from the construction sector during that quarter.
Domestic steel makers struggle with sluggish demand growth: ICRA

The domestic steel consumption growth is expected to decelerate to around 5-6 per cent in FY2020 as compared to 7.9 per cent in FY2019 due to the unprecedented slowdown in economic activity, as reflected by GDP growth tapering down to 5 per cent in Q1 FY2020.

Consequently, margin outlook for steelmakers has weakened in Q2 due to a sharp fall in steel prices and firm raw material costs, though some recovery is expected in Q3 FY2020. As per ICRA, the demand environment is expected to improve somewhat in the second half of FY2020 following a likely pick-up in infra spending.

Jayanta Roy, Senior VP & Group Head-Corporate Ratings, ICRA said, “Industry operating environment remains challenging in FY2020 thus far. Our analysis of prevailing trends of 22 companies comprising 60 per cent of industry size indicates that reduced demand and steel prices amidst firm raw material costs have restricted the revenues and operating margins of the industry in Q1FY2020. The decline in steel prices and seasonally weak demand are also likely to keep Q2 financial performance muted for the domestic steelmakers. However, a likely pick-up in infra spending in the second half and softer coking coal prices could benefit steelmakers for the remainder of the year.”

Roy also believed that the profitability may recover somewhat in Q3, with a sharp fall in coking coal prices in August 2019 and expectation of better demand from the construction sector during that quarter.

Dragged by the significant correction in steel prices, the operating profit margin of an ICRA sample of steel companies accounting for around 60 per cent of the domestic installed capacity has declined by around 450 basis points year-on-year in the first quarter of the current fiscal.

Given the challenging operating environment prevailing at present, ICRA estimates the industry’s operating margin to decline to around 18 per cent in FY2020, compared to 23 per cent in the previous fiscal. In line with the deterioration in profitability, the industry’s debt protection metrics have also weakened.

The interest coverage ratio for the ICRA sample declined to around thrice in the first quarter of FY2020, down from the intermediate peak level of 3.5 times recorded in Q2 FY2019. With steel spreads steadily gravitating to lower levels, the industry’s total debt to OPBITDA is poised to deteriorate to around 4.5 times in FY2020 as against 3.5 times in FY2019. Bulk of the domestic steel industry’s ongoing capacity expansion projects are being undertaken by the larger integrated steel players who have the benefit of a stronger balance sheet.

In FY2019, the industry operated at a capacity utilisation rate of around 84 per cent. With fresh capacity addition of only around three mn tonne per annum being planned in the current fiscal, the industry’s capacity utilisation rates are expected to remain at a healthy level of 85 per cent in the current year as well, notwithstanding a slower demand growth.

“Demand worries will continue to keep steel prices under pressure, which are at present trading at a discount to imported offers. Domestic HRC prices have dropped 13 per cent since March 2019, whereas domestic rebar prices have dropped 14 per cent in the same period. In FY2020, domestic iron ore prices are expected to remain range-bound and there is a possibility of an ore supply deficit in the next fiscal, if mine auctions are delayed. On the other hand, blast furnace players would benefit in H2 from a steep correction in coking coal prices in recent months,” added Roy.

Globally, steel production growth remained healthy at 4.6 per cent in 7M CY2019 on the back of a high output growth in China in H1 CY2019. However, due to rising trade tensions, slowing Chinese demand, and increasing concerns on the global macroeconomic health, steel production growth is expected to soften in H2 CY2019. China’s steel exports have remained low due to its healthy domestic consumption, providing a respite to other economies including India. While the steel imports by India de-grew by six per cent in 4M FY2020, even steeper fall of 23 per cent in steel exports and unrelenting imports from free trade agreement (FTA) countries including Japan and Korea, are likely to keep India a net importer of steel in the near term. Nevertheless, given the fact that domestic steel prices are currently trading at a significant discount of 16 per cent to landed cost of Chinese HRC and at a discount of 8 per cent to landed cost of Japanese HRC, India’s steel imports would remain low at an absolute level in the coming months.

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