Tuesday, May 11, 2010

Steel Industry - Buy Tata Steel & Jindal Steel Power

With input prices on the rise, non-integrated steel producers may find it difficult to sustain margins if steel prices do not rise in proportion

To produce a tonne of steel it requires about 1.6 tonne of iron ore and about 0.7 tonne of coking coal. And, these raw materials put together account for almost 70-75 per cent of the total cost to produce a tonne of steel. This is also precisely a reason that whenever there is an increase in the raw material cost, steel companies have little option but to increase steel prices so that they can make reasonable profits. In the current scenario, when steel prices are trading at relatively lower levels and there is less appetite for any price rise among the customers, Indian non-integrated steel companies might see an impact on their profitability given the recent increase in raw material prices.

Input prices on the rise…

In January 2010, NMDC had raised its domestic iron ore prices by about 15 per cent. Very recently, NMDC intimated to the industry that it has further increased iron ore prices by about 30-50 per cent on a provisional basis effective April 1. NMDC’s iron ore fines that recently sold at about $43 per tonne in the domestic market are now expected to cost over $70 per tonne. While NMDC’s provides iron ore at lower prices to domestic companies (as compared to its prices for global customers), prices are revised according to the trend in international prices. The rationale behind this seems to be the higher international iron ore prices. The Australian long-term contract prices are now being negotiated at about $110-120 per tonne, which is almost a 100 per cent jump from $60 per tonne a few months back. The Chinese spot iron ore prices have also moved up from $90 per tonne in October 2009 to currently about $152 per tonne.

The situation is equally grim in the case of coking coal prices, which have seen a steady rise for last six months. Coking coal benchmark price for the quarter April 2010 to June 2010 has been set at $200, which is significantly higher compared to last year’s benchmark price of $128 per tonne. Analysts believe that the coking coal prices could further rise and cross the $200 a tonne in 2010-11.

…and its impact
The rise in coal and iron ore prices would mean that the cost of production for the every tonne of steel will go up by almost $120-130 or by Rs 5,400-5,800 per tonne. No wonder that domestic flat steel prices have been moving up; they are up by 18 per cent in last three months and currently hover around Rs 37,810 per tonne.

More importantly, analysts believe as the raw material prices have increased and are expected to increase further, the recent increase in steel prices still does not offset the impact of higher input costs. For instance, Indian steel producers have increased steel prices by Rs 2,500-3,000 per tonne whereas the cost escalation has been in the range of Rs 5,400-5,800 per tonne. This is also a reason that analysts believe that the companies might further increase prices, in a manner that steel demand is not disturbed.

Demand-supply situation
Given the current market scenario, companies have so far been able to pass on a part of the input cost increases to the consumers on the back of the reviving global economic growth. According to the data provided by the World Steel Organisation, India’s steel production was up by 20 per cent in February 2009 followed by 25 per cent growth recorded by China. Even the world steel production was up by 27 per cent in February as a result of recovery in the steel demand.

The demand for steel is expected to continue to be good considering the industrial revival and higher spending on the infrastructure and construction activity in the country.

This in turn should give steel producers some pricing power.

Outlook
Steel producing companies that do not have captive sources of raw material supply can now feel some relief given that higher steel prices will allow them to pass on the increase in raw material prices. However, the major benefit of this will accrue to companies which are fully integrated.

For instance, SAIL has the advantage of 100 per cent captive iron ore, while it procures 30 per cent of its coal requirements from the domestic market and 70 per cent from imports. On the other hand, JSW Steel depends on imported coal for its entire requirement and only 20 per cent of iron ore is from captive sources. This is also a reason that SAIL and JSW Steel earned EBIDTA per tonne of about Rs 8,000-9,000 per tonne as compared to over Rs 13,700 per tonne earned by the Tata Steel, which is a fully integrated player (excluding its global operations).

In the present scenario, analysts thus are expecting companies like Tata Steel and Jindal Steel & Power to be in better position given their access to captive raw material supplies. Any further increase in the steel prices (as expected by analysts) will mean higher gains for these integrated players.

Source BS

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