What Beaten-Down Valuations Of Steelmakers Reveal
India’s steelmakers are trading at valuations lower than the previous two downcycles as U.S. President Donald Trump’s protectionist tariffs and China’s retaliation, waning demand in a slowing global economy and a stronger dollar pulled down metal prices.
The Nifty Metal Index has tumbled nearly 30 percent so far in 2019, the most in four years. Fourteen of the 15 constituents of the gauge have fallen.
Shares of domestic steelmakers tracked the decline. Apart from global headwinds, JSW Steel Ltd., India’s largest steelmaker, and Tata Steel Ltd. also blamed it on softer public investment ahead of general election in India, falling sales of cars to appliances and a weak sentiment.
All that contributed to pulling down the valuations of local steelmakers below 2008-09 and 2015-16.
How Do Fundamentals Compare?
The benchmark China hot rolled steel prices have remained stable above $450 a tonne, according to Bloomberg data. That compares with a decline to an all-time low of $258 a tonne in December 2015, and a collapse from $1,120 to $475 a tonne during the 2008-09 global crisis.
Iron ore turned costlier this time following disruption of supplies at Brazil’s Vale SA, the world’s largest producer of steelmaking raw material. Chinese steel price benchmark has fallen 8.50 percent this year while iron ore has jumped as much as 32 percent.
“Inverse direction of raw material and finished good prices, supply-side adjustments and trade restriction differentiate this bearish cycle than the ones witnessed in 2008-09 and 2015-16,” Seshagiri Rao, joint managing director and group chief financial officer at JSW Steel, told BloombergQuint.
But margins and return on equity—a measure of profitability— are better than 2016, aided by higher volumes and cost cuts. The two indicators, however, pale in comparison with 2009 when the domestic market was relatively resilient.
Is A Recovery In Sight?
A key trigger for a recovery in stock prices and valuations would be the underlying demand for steel. There’s no unanimous view on that.
While Moody’s Investor Service downgraded outlook for Asian steel producers to negative on weakening profitability, the rating agency expects India's steel demand to remain the strongest in the region. Moody’s expects the falling steel prices to bottom out in India because of limited new capacity addition and growing demand.
Phillip Capital expects steel demand to improve in the second half of financial year on the government’s focus on infrastructure, construction, and housing, which represents more than half of India’s steel use.
But Rao of JSW Steel doesn’t expect a reversal anytime soon till India gets some fiscal and monetary stimulus which could aid growth of the industry, largely disrupted by the surplus production in China. “Not intent but only action towards stimulus measures by the government could lead to cycle reversal.”
What Does History Suggest?
According to Rakesh Arora, managing director at Go India Advisors and a long-time industry watcher, historically, during periods of extreme slowdown, valuation multiple of most metal companies, especially highly leveraged steelmakers, bottoms out near 0.5 times the book value.
“With the market factoring in higher recession globally, the current valuations are also indicative of this trend,” he said. “With any sign of economic stability in sight, expect the valuations of these companies to bounce back to 1.”
And going by the previous two downcycles, valuations recover quickly and stocks also return handsome gains once a recovery sets in. Arora remains optimistic about a recovery.