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Steel demand to improve in H2, but weak H1 expected: Crisil

Sep 27,2019

Crisil rating agency in its latest research report on steel sector has said, Domestic steel demand and global market sentiment are likely to improve in the second half, but a weak first half is expected to lead to a 5-6 percent contraction in realizations for steelmakers this fiscal.


Falling spreads on Ebitda (earnings before interest taxes depreciation and amortization) will weigh on steel sector capex, the report said, adding that the industry is yet to see a recovery in prices despite a run-up in raw material costs.


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


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


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


To add to it, "subdued domestic demand and weak export markets cloud the industry’s prospects in the rest of this fiscal as well," the Crisil report said. After a robust 7.5-8 percent growth in the previous two fiscals, the domestic steel industry is expected to witness a mid-cycle slowdown at 4-5 percent this fiscal, given muted construction investments and weak automotive market, the report predicted.


Prasad Koparkar, senior director, CRISIL Research said: “Steel prices have not been able to recover despite a cost-push. We, therefore, believe weak realizations will shear 350-370 basis points off the sector’s Ebitda margins for the first half and 200-250 basis points for the fiscal as a whole, reversing a three-year climb. Large non-integrated players will see their margins shrink more, by 300-350 basis points this fiscal, given weak flat steel market and a 3-5 percent rise in iron ore prices amidst weak flat steel market and a 3-5 percent rise in iron ore prices amidst weak realizations.” All this will be a drag on the sector’s aggregate operating profit, which is expected to fall 12-13 percent in fiscal 2020.


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.


Hetal Gandhi, Director, CRISIL Research said, “The industry plans to add 28-30 million tonnes steel capacity in the next 5 years, entailing a capital expenditure of Rs 1.4-1.5 lakh crore. Of this, nearly three-fourth of capacity will be added by large players, apart from assets being acquired under NCLT 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 anti-dumping duty across steel products (for a period of five years) will help avoid the freefall of prices and profit as seen back in fiscal 2016.