A worker grinds a length of steel rod. (Photographer: Vincent Mundy/Bloomberg)

What Led To A Selloff In Steel Stocks

Steel stocks slumped more than 15 percent in the last three months as prices declined and input costs rose.

Shares of Steel Authority of India Ltd., Jindal Steel & Power Ltd., JSW Steel Ltd. and Tata Steel Ltd. tumbled between 15 percent and 32 percent during the period, according to Bloomberg data, with the sharpest drop coming in the last one month. That compares with a 15 percent slide in the benchmark NSE Nifty Metal Index.

“A supply glut, tight financial conditions and an increase in trade tension led to a correction in steel prices globally,” Seshagiri Rao, joint managing director and group chief financial officer of JSW Steel, said. “Indian steel prices mirroring the global trend are expected to fall in the near future.”

The input costs, however, remained elevated. That led to lower product spreads—the difference between the cost of raw material and selling price—impacting the margin of steelmakers.

Falling Steel Prices

Global steel prices also fell as pollution-related production cuts in China—supplier of more than half the world’s steel—were lower compared to last year, implying higher output and exports. Hot-rolled coil prices, the key global benchmark, declined 18 percent from their June highs to trade at $760 per tonne, according to Bloomberg.

What Led To A Selloff In Steel Stocks

“China’s steel demand remains seasonally weak until February, and unless pollution-related cuts are enforced, prices may continue to remain soft until February 2019,” Priyankar Biswas, analyst at Nomura, said. Realisation of steelmakers, he said, may remain under pressure in the second half of the ongoing financial year as domestic prices are expected to be lower unless the rupee depreciates significantly.

What Led To A Selloff In Steel Stocks

While Chinese steel prices have fallen significantly, the extent of decline in the domestic prices has been lower due to a weaker rupee—local prices are pegged to global rates.

That implies a downside risk in the near term as Indian steel prices are at a premium to import parity prices, according to Ashish Jain, analyst at Morgan Stanley. In contrast, domestic prices traded lower or on a par with import prices two years back.

Channel checks by Morgan Stanley shows that hot-rolled coil prices in India are down by Rs 1,500 a tonne and long-product prices by Rs 1,500-2,000 a tonne.

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Rising Input Costs

Globally, the iron ore prices recovered sharply in November. NMDC Ltd., India’s largest iron ore miner, hiked prices of lumps and fines by more than 25 percent since July. The price of coking coal, a key raw material used in steel, too, remained elevated.

What Led To A Selloff In Steel Stocks
What Led To A Selloff In Steel Stocks

“Indian input costs have risen faster in rupee terms due to a hike in iron ore and imported coking coal prices, while steel prices witnessed a smaller decline,” Biswas said. This, he said, is expected to hit profitability of Indian steelmakers, particularly non-integrated players such as JSW Steel, in the third quarter.

Rao of JSW Steel, too, had expressed a similar view during an interview with BloombergQuint. The fall in global steel prices will hurt operating margin due to relatively high inventory costs, he had said, adding that steelmakers may take at least a quarter to recover from the effect of decline in prices.

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Valuations

Following the recent sell-off, all steel stocks are trading below their five-year average. Yet, brokerages Nomura and Citi cut their target prices. Nomura cut its target price for JSW Steel by 18 percent on lower global prices. Citi downgraded Tata Steel, JSW Steel and SAIL on concerns about lower spread.

What’s Next

While Goldman Sachs expects regional prices to continue to fall, it all depends on China.

Nomura said Chinese steel demand may pick up from the financial year ending March 2020 due to a possible infrastructure investment push. Though benchmark steel spread may face pressure in the third quarter, the brokerage said, it’s expected to moderate from late fourth quarter as steel prices rise but input costs remain more resilient.

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