Analysts were not expecting the dream run in domestic steel to continue in terms of profitability and spread. HRC at Rs 46,500 a tonne is at a very high level and the spreads were at a decade high, Amit Dixit, AVP, Edelweiss Securities, tells ET Now.
Domestic steel companies profitability is sitting at a decade high, Has it peaked and is there a meaningful reversal in works by the end of FY19?
First of all, in terms of the domestic steel sector, analysts were not expecting this dream run to continue in terms of profitability and spread. HRC at Rs 46,500 a tonne is at a very high level and the spreads were at a decade high.
We are factoring in that spreads will come down. But at the same time, we are not factoring in a reversal to the CY15-16 like situation when spreads contracted. There are a couple of reasons for that. One is that India has imposed anti-dumping duty and that is a major differential compared to CY15 or CY16.
Second, there is China itself. A lot has been talked about China but its inventory is still at a very respectable level. Exports are down. Therefore if you add up everything, consumption in China is more robust than what people expect. China has been giving surprises. Even world steel associations have upped the forecast for China. There is a clear dichotomy in consumption pattern. The construction sector has showed a meaningful increase. If you drill down further downstream, construction and power equipment growth is quite high.
Look at cement equipment growth and cement production growth itself. All these ancillary indicators point to the fact that construction/infrastructure is far more robust than what people expect. On the other hand, there is weakness in flat heavy sectors such as auto and industrial engines, HRC prices were reflecting that. It did not rise as much as rebar prices did.
Talking about the recent meltdown, all of a sudden prices. contracted by 15-20%. That is the range that is typically out on the street. If we look at Chinese profitability in September-October, we saw that was due to reduced prices of HRC.
The non-integrated ones slipped into losses. They were not making profit at all. Now, we have winter months in front of us where typically destocking starts and there are concerns around growth. So, people started dumping inventory and that really resulted in a decline in prices. I would still be happy if prices go down and raw material prices do not because then you do not have marginal players coming in the equation.
The more dangerous point is when raw material prices also come down. When the Dalian Future Index tempered quite meaningfully, that was a cause for concern. But despite concerns, I would not say that the spring like days of domestic steel industry are over as yet.
How do you approach the stocks because we have multi-year profit peaks coupled with valuations which are still looking a little rich in some of the cases?
On the contrary, I would look at the one-year forward EBITDA valuation band of all the steel stocks. Look at Tata Steel, JSW, JSPL and SAIL. If you look at valuation bands, all these guys are trading near their eight-year lows. Valuations are certainly not rich.
JSW is an exception though it is still trading near the eight-year valuation band average. So, definitely there is a case on the valuation front.
I would also say forget about everything. Look at what the current stock price is reflecting. In India, we have this anti-dumping duty measure. If you look at the import parity price, typically even with Chinese export price at $500, the import parity comes to roughly Rs 42,000. In the worst situation, the anti-dumping duty level is at $484 for HRC. So, definitely prices cannot fall below $484. No steel can be imported in the country for less than $484 and then there are other duties also.
I would expect a cap on the prices. Prices cannot go below let us say Rs 41,500-41,600 which is the level suggested by the anti-dumping duty level. The current stock prices unfortunately are very close to that level. So, I would say we are already considering the worst possible situation. I really do not see any reason why steel stocks should go down further because there is protection in terms of anti-dumping duty.
If steel prices go down, typically raw material prices also follow suit. While I really do not expect EBITDA per tonne for companies like Tata Steel to be around 17,000 on an average which they had for H1, but definitely it would not go down to FY16 or FY17 level. We will make healthy EBITDA margin and coupled with a case for valuation upgrade, the companies based on the domestic demand outlook start looking good.