ICRA: Rally in Steel Prices May Halt Due to Coronavirus

Moderate domestic demand notwithstanding, India’s domestic steel prices have witnessed an uptrend since November 2019, in line with international trends and are expected to come under pressure in the near term as an aftermath of the COVID-19 outbreak. Domestic hot-rolled coil (HRC) had touched a low of Rs. 32,250/MT in the first week of November 2019 and prices have been on the rise and are currently ruling at around Rs. 37,000/MT, implying an increase of 15% in the last three months. Price hikes by domestic steelmakers were largely a function of the supportive international price trends as the domestic steel demand growth remained unencouraging at 3.8% in 10M FY2020 (7.5% reported in FY2019). However, China’s export HRC prices, after increasing to $496/MT in January 2020 from $428/MT in end-October 2019, have witnessed a 6% fall since mid-January due to a slowdown in China’s steel consumption, following the coronavirus outbreak, leading to weaker economic activities. 

 

Elaborating further, Mr. Jayanta Roy, Senior Vice-President & Group Head, Corporate Sector Ratings, ICRA, said that domestic steel prices are currently trading at a discount of 7% to landed cost from China and at a discount of 3% to landed cost from Japan. This may be providing headroom to domestic steelmakers to increase steel prices, but the rising number of confirmed cases of coronavirus in India still remains a concern. And the same coupled with the continuing macroeconomic headwinds, could affect domestic steel consumption and pressurize steel prices in the coming months. Consequently, they estimate the domestic steel consumption growth to remain between 4% to 5% in FY2021, as against our November 2019 forecast of 6.5%, he said.

 

With respect to import/export trends, India remained a net steel exporter during 10M FY2020 with steel exports witnessing a 40% YoY growth and imports registering a YoY decline of 8.5% during the same period. The combined share of China, Korea, and Japan in India’s steel imports stood at about 73% in 10M FY2020. However, given the risk of delayed deliveries due to bottlenecks in production, logistics, and port handling capacities, as well as the risk of transmission from import consignments, resulting in stringent scrutiny from port customs authorities, India’s steel imports are likely to remain low in the coming months. On the other hand, barring Italy, which accounted for around 10% of India’s total steel exports during 10M FY2020, none of the other steel export destinations for Indian mills have seen a serious impact of COVID-19 so far, which presents opportunities for Indian mills to increase market share from the space left open by steelmakers in China, Korea, and Japan. On these trends, Roy said that a slowdown in steel production in key steel-producing nations may provide market substitution opportunities to Indian steelmakers in the near term. But a prolonged outbreak could have an adverse impact on global steel demand and international steel prices and its long-term effect would far outweigh such short-term opportunities.

 

Looking at the emerging raw material scenario, regulatory certainty provided by the Government following the extension of mining clearances for two years to the winning bidders in Odisha has resulted in aggressive bids, with captive users bagging a large share of iron ore reserves. In ICRA’s view, better integration of the ore supply chain with steel plant operations by streamlining the ore logistics network can partly mitigate the impact of the aggressive bids, and hence investments in conveyor belts/slurry pipelines could come up in future. Domestic iron ore prices have gone up by 29% since November 2019 due to uncertainties surrounding iron ore availability in H1 FY2021. While there could be some supply disruptions during the transition process leading to a short-term spike in domestic iron ore prices, high prices in the medium term may not sustain as some large buyers will have captive ore now and would, therefore, buy less from the market. In case of coking coal, prices remained soft during November-December 2019 but started heading north from January 2020 onwards to reach $162/MT in end-Feb 2020 from $141/MT in end-December 2019. High shutdown costs for blast furnaces are preventing Chinese mills to cut output to match supply with the weak domestic demand following the COVID-19 outbreak. This, coupled with supply restrictions from Mongolia, has increased China’s dependence on imports and in turn, led to a rise in coking coal prices.

 

On industry financials, ICRA’s analysis suggests that following continued correction in steel prices and relatively firm raw material costs, the operating margins of the steel industry dropped to 14.6% in Q3 FY2020 from 15.4% in Q2 FY2020 and 21.1% in Q3 FY2019. Despite a sequential dip in operating profitability, the industry’s interest coverage ratio improved slightly to 2.3 times in Q3 FY2020 from 2.2 times in Q2 FY2020 due to reduced interest expenses. However, the interest coverage in Q3 FY2020 remained much lower than 3.3 times, reported in Q3 FY2019. Aided by a sequential decline in coking coal costs and a series of price hikes, domestic blast furnace operators’ gross contribution levels are expected to improve by 17% QoQ in Q4 FY2020. Despite this, as per ICRA’s estimates, the industry’s operating margin is expected to remain at around 16.6% in FY2020, 440 basis points lower than the same in FY2019, and the industry’s interest coverage is expected to remain at close to 2.6 times in FY2020 as against 3.1 times in FY2019, indicating a sequential weakness in the industry’s credit profile in the current fiscal.