A Chinese demand contraction may test the mettle of steel stocks

Sep 12,2020

The recent increase in global steel prices has added a bit of clarity to the steel companies' profitability. But it does not add much too cheering investors as the market for Chinese steel will continue to taper off analysts claim. Stocks can still represent the benefits of the steel turnaround, which has so far risen from 9-44 per cent over the past two months.

With China's economic development in high gear, steel demand is driven by its infrastructure and property sector. After May this year, steel export prices to China have risen by almost 30 per cent. Domestic prices have risen 8 per cent riding on the back of improving international prices.

Siddharth Gadekar, analyst, Equirus Securities said, “In the steel market, China is a sizeable player. Demand in the Chinese market is leading to global steel prices moving up. The price rise has nothing to do with domestic demand."

Domestic demand is still lower than pre-covid levels. Yet companies have been operating at full capacity. Analysts point out that even if domestic demand isn't reviving, production companies will be able to cater for export markets.

In addition, lower prices of iron ore and coking coal of domestic raw materials are likely to increase profitability. In the coming quarters, analysts claim, a rise in steel prices and higher sales volumes coupled with lower input costs could cause an improvement in operating margins.

While all that is good, further growth will hinge on a continued uptick in Chinese demand. “While we expect the robust steel demand in China to continue due to the lag effect of the implemented stimulus measures, and further accommodative fiscal and monetary policy, we believe the hot-rolled coil (HRC) prices rally could be in its last leg," said analysts at HSBC Securities and Capital Markets in a note. They also said that due to the high base and end of the 13th five-year plan, steel demand could likely taper in China.

That may not be good for Indian steel stocks. “With the market caps of India steel producers strongly correlated to Chinese Hot Rolled Coil prices, we see downside risks to flat steel producers," noted the HSBC report.

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