Shares of steel companies have risen significantly in the recent past in anticipation of recovery in demand and prices.
Reversing the soft trend in prices seen in the recent past, two of India’s top steel producers raised prices last week. Tata Steel raised prices by Rs 2,000 a tonne whereas SAIL withdrew the discounts it offered to customers. Very soon, most likely in early January 2010, others such as JSW Steel, Bhushan Steel and Essar Steel are expected to increase prices by about Rs 1,500 per tonne.
The price hikes are in line with the rise in international steel prices, which is due to higher costs of coking coal and iron ore. Also, global demand has been looking up due to improving economic outlook and restocking of inventory. According to data from 66 countries, production was up 24.2 per cent in November 2009; Chinese steel production was up 37.4 per cent whereas India’s was up 4.7 per cent.
In terms of inputs, in April 2009, Indian steel companies entered into annual contracts for coking coal at about $130 per tonne, which was significantly lower than the $300-350 per tonne in early 2008. However, spot coking coal prices are hovering around $170-180 per tonne and are expected to rise to about $200 per tonne in 2010. If the trend prevails, companies that depend on imported coal will have little choice but to renew contracts (due in April 2010) at higher prices, leading to pressure on costs. Similarly, global spot iron ore prices, which had dropped to almost $65 in early 2009, have risen to over $120 per tonne. These, too, are expected to remain firm.
Positively, there is some relief for Indian steel manufacturers given the recent hike in export duty on iron ore by 5 percentage points. However, the move will have some negative implications for companies like Sesa Goa, which exports about 90 per cent of its iron ore production, of which a large part is sold in the spot market. According to analysts’ estimates, the hike in export duty could impact the company’s earnings per share (EPS) by less than 5 per cent. They now peg the EPS for 2010-11 at Rs 34 based on the average spot price of $85 and the contract price of $70 for a tonne of iron ore. At the current price of Rs 404, they believe the stock is fairly valued and could move up only if iron ore prices gain more ground.
Meanwhile, most of the rise in steel prices is on account of the cost push. Hence, gains will not be significant for companies that do not have sufficient captive inputs. Thus, only integrated players like Tata Steel and SAIL stand to gain; for the former, the overhang of its Corus operations could limit the gains. Analysts say while the short-term (five-six months) outlook for the sector looks good, steel prices are not expected to move up drastically in the long run given that the global demand is still low and any meaningful recovery is expected only in 2011. However, shares of steel companies have risen significantly in the recent past in anticipation of the recovery in demand and prices. This is also reflected in their valuations, given that most of these stocks are trading at 9-10 times their estimated earnings for 2009-10.