MIP to provide a temporary relief to the domestic steel industry - ICRA
Despite a 2.3% contraction in crude steel production in China during CY2015, its steel exports continued unabated at a growth rate of 20% during the same period on account of a de-growth of 5.7% in apparent steel consumption during the Jan-Oct 2015 period. While the Chinese Government’s stated intent to cut steel capacity by 100-150 mt is a positive, absence of a timeframe to implement the same does not address the immediate overcapacity concerns. In line with China, world steel production contracted by 2.8% during CY2015 and capacity utilization levels dropped to a low of 64.6% in the month of December 2015. Out of the top 10 steel producing countries in the world, only India managed to report a growth in steel production during CY2015, reflecting weakness in other parts of the globe. With World Steel Associat ion forecasting China’s steel demand to contract by 2% in CY2016, capacity utilization rates are unlikely to improve meaningfully in the near term.
Post MIP, extent of cheaper imports in India to reduce significantly next year; domestic steel prices likely to increase by Rs 2700 - 3400/MT in the coming months. Domestic HRC and CRC prices are expected to recover in the coming months because of the imposition of MIP. However, ICRA believes that the extent of increase will not be as sharp as the current price differential between import offers and MIP, which is around USD 130-200/MT. ICRA expects the quantum of increase to be much lower, in the range of USD 40-50/MT (Rs 2700-3400/MT at the prevailing exchange rates). The two key factors that will temper the extent of increase of domestic prices will be: a) Large domestic surplus capacity, with domestic mills currently operating at an utilization rate of ~75%, and ~10-15 mtpa of fresh capacity currently being at advanced stages of commissioning, and b) Domestic demand growth remaining muted, growing by a modest 3.1% in FY15 and 4.4% in 9M FY16. ICRA expects the large integrated players having stronger financial profile to take this as an opportunity to moderately increase prices, and grab a greater ma rket share from their weaker competitors.
Outlook on iron ore price remains weak. During the first nine months of the current financial year, domestic production of iron ore stood at 94.4 mt, as against a mu ch lower 81.8 mt achieved during the same period of FY15, registering a healthy 15% yoy growth. This increase has been on the back of reopening of closed mines in the states of Odisha, Chhattisgarh and Jharkhand post the operationalization of the ‘The Mines And Minerals (Develop ment And Regulation) Amendment Act, 2015’ (MMDR Act, 2015). However, though iron ore supplies have remained buoyant in the current year, demand for iron ore has been weak, especially given that domestic crude steel production has registered a modest growth of only 0.9% yoy during April-December of FY16. Given the headwinds in the seaborne market for iron ore, and the weak demand from domestic steel companies, NMDC Ltd. has continued to cut iron ore prices in Q3 FY16 as well, further revising price of lumps by 12% in October 2015, and again in December 2015, when lump prices were reduced by a sharper 16%. The December 2015 correction marks the 10th rate cut initiated by NMDC since November 2014, with prices of fines declining by 51% and lumps by 52% during the period.
Coking coal prices are yet to bottom out, benefitting blast furnace players. International prices of benchmark low vol. premium hard coking coal contract in Q1 CY2016 have been settled at USD 81.0/MT, showing a 9% qoq decline from USD 89.0/MT in Q4 CY2015. This fall is expected to lead to a decline in cost of steel production by ~Rs 425/MT (~1.7% of HRC price in February 2016). The major Australian miners are undertaking cost cutting initiatives, helped by the weaker Australian dollar. Moreover, though no major fresh coking coal supplies are expected to hit the seaborne market in the near term, a decline in Chinese crude steel production in CY 2015, an increasing share of low cost Mongolian coking coal supplies to China, along with the rise in Chinese coking coal production, would continue to exert pressure on international coking coal prices. Chinese coking coal imports have in fact further declined by 23% yoy in CY 2015, on the back of a 17% yoy decline in CY 2014, which has further intensified the pressure on demand-supply in-equilibrium in the seaborne market, thereby weakening prospects for any recovery in prices in the near t erm. Given that India’s domestic coking coal supplies used in steelmaking has remained stagnant between 15-17 mtpa, dependence on imported coking coal has seen a steady rise and, at present, around 70% of domestic coking coal demand for steel making is being met from imports. Thus, the weak international coking coal price environment would continue to provide a relief to domestic blast furnace players.
MIP to support operating profitability of Indian producers in the near term but coverage indicators to remain weak at an absolute level. Operating margins of the domestic steel industry (collection of 7 large steel players, accounting for over 40% of the current domestic capacity) declined further to 5.5% in Q3FY16 from 9.8% in Q2FY16 and 12.1% in Q1FY16 owing to a steady fall in sales realisations. Imposition of safeguard duty failed to improve the profitability of steel producers due to its limited coverage of products and the fact th at international steel prices corrected further after its imposition. However, with the imposition of MIP in February 2016, operating margins for domestic blast furnace players are expected to improve by around 5% as compared to estimated levels prevailing in the 1st week of February 2016. While there could be an improvement in debt protection metrics for steel players in FY17 from current levels following the imposition of MIP, they would still remain weak in absolute terms. ICRA estimates that even after assuming MIP to be in effect for the entire FY17, the total debt to operating profit ratio for the industry is likely to remain at above 5 time, and the interest coverage is likely to be less than 2.5 time.
Source: Strategic Research Institute