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Steel market conditions bullish but investors not buying it

Steel shares have been volatile in recent weeks, although the general trend has been downward. This may seem a bit surprising considering that market conditions support a bullish case for steel producers.

Iron ore prices are striking a strong bullish stance. As of 4 December, the price of imported ore at Qingdao, China, was up by 8% over a week ago, and was up by a fifth from a month ago. Chinese steel prices are increasing with rebar prices hitting a three-month high this week.

The main driver of rising prices has been China’s planned winter steel output cuts since mid-November. The cuts are old news, but that they are actually being implemented as planned is affecting the market.

Earlier, iron ore prices were helped by mills producing more steel in preparation for the cuts. Now, Bloomberg reports that the unaffected steel mills are buying higher quality ore, as it lowers pollution levels. That is, in turn, pushing up prices of high quality iron ore. Higher ore prices, lower steel inventories and a tight supply situation in China are supporting rising steel prices.

China’s steel cuts are till March, implying tight supply conditions will continue. Its exports would moderate to the extent that domestic demand remains robust. If global steel output ex-China rises sharply, in response to higher prices, that can be a risk.

Back in India, finished steel output in April-October rose by 5.1% over a year ago. With domestic steel consumption growing by only 4.7%, companies have had to export, explaining the 57.7% increase in exports. Imports are making a comeback after declining in FY17, as rising steel prices are giving them room to regain share that was earlier lost due to protectionist measures.

Could the fear that this can accelerate be the reason why domestic steel stocks are under the weather? Higher global prices mean exports should fetch more, but the domestic market is the main market. A relatively subdued domestic market and rising imports may keep domestic price increases under check.

Add to that mix rising input costs and it can pose a threat to margins. Iron ore prices are increasing. NMDC Ltd increased the prices of iron ore lumps by 13% and of fines by 9.7% for December, over the previous level. Along with rising iron ore costs, inputs such as coking coal and energy costs are likely to be higher as well. They had put some pressure on margins in the September quarter.

A 6 December report by Kotak Institutional Equities on steel strikes a positive note, stating that it expects China’s actions to buoy earnings of steel companies over the next two to three quarters. It also expects domestic demand to improve, on the back of higher domestic demand heading into a seasonally strong quarter and fading impact of GST-linked disruptions.

A Fitch Ratings report on India and China’s steel sector in 2018 says India’s domestic steel demand could grow by around 5% but prices could decline in line with its global forecast. But profitability may remain intact due to lower input costs. Also, below a certain price level, India’s anti-dumping duties will kick in and protect domestic steel-makers. A Moody’s report on Asian steel in 2018 says operating conditions will be most supportive in India with robust domestic demand and protectionist measures, despite higher raw material prices and new capacity.

Thus, the overall outlook for Indian steel producers appears positive. What may be worrying the Street is the risk of margins coming under pressure if prices do not increase enough to absorb higher costs. There is another imponderable. Large steel producers intend to bid for steel companies that have defaulted on loans and overpaying for them is a balance-sheet risk that bears watching.
Source: Live Mint

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