Rising steel prices could add heft to Tata Steel’s profits, but they must sustain
Things are falling in place for Tata Steel. As both production normalises and demand continues to upswing, the steel sector is now on a better footing than before. The street expects Tata Steel Ltd to post better operating profitability in Q3. The scrip is trading close to its 52-week high with 38% gains till date in November.
An improvement in its troubled European operations is also on the cards. Steel spreads could improve to record levels in Europe, thanks to lower inventory levels and rising steel prices. Tata Steel’s European sales volumes are expected to clock gains as overall European production rebounded strong 9% month on month in October.
European capacity utilisations of 65% are at the highest levels and realisations are at 2-year highs since February, points out Credit Suisse in a report.
Note Europe operations had posted losses at the operating level of ₹462 crore in September, which was lower than the ₹626 crore loss in Q1. This shows that better realisations and demand can improve forward prospects of European operations.
Indeed, Morgan Stanley in its note recently said that “Europe is witnessing price hikes in carbon steel leading to material improvement in spreads, which if it sustains for longer will lead to earnings upgrades for companies including Tata Steel.”
An asset sale of its Ijmuiden, Netherlands, facility is expected to fetch about $2-2.5billion as per analysts estimates. This could ease net debt levels in the coming quarters.
In addition, global steel prices remain buoyant. China’s domestic hot-rolled coil prices increased by $40 per ton in the past month to $630 in end-October. Besides, domestic prices increased by about ₹3700 per ton in the past month.
On the other hand, prices of raw material coking coal has been soft. Rising iron ore prices are not likely to dent Tata Steel’s profitability due to captive iron ore mines. “Sharp increase in realisation, muted coking coal costs and self-sufficiency in iron ore is likely to boost gross margins further for all steel majors in 3Q,” said JM Financial Institutional Equities in a client note.
Still, investors must watch for sustainability in steel prices. While the cyclical uptick in demand has been good, production disruption during lockdown has meant that channel inventories have slipped. This is one reason why steel prices are rising. A rise in inventories could see global steel prices take a breather.
Further, the global economy remains week, hence any slowdown poses a risk to steel prices. Note Tata Steel’s one-year forward price-earnings multiple for FY22 is at about 9 times earnings as per Bloomberg consensus estimates.