Metals - Expectations of an extended cyclical recovery on hyperbole as steel prices resume strength - ICICI Securities

Cyclicality will eventually manifest it, higher prices will lead to demand destruction sooner than expected and regional demand disappointment will lead to the next round of steel price correction. Till then, as steel prices globally show strength from their already record high levels, we reiterate our REDUCE rating on Tata Steel and JSPL, and SELL rating on JSW Steel. We reinitiate coverage on SAIL with HOLD rating and a target price of Rs81/share. We do see the current environment as being controlled and devoid of adequate risk perceptions. Strong Chinese demand along with capacity cuts helped another round of FY22 earnings upgrades.

- A controlled global policy and regional demand-supply environment is creating a perceived sense of stability and helping metals (steel) outperform. The continued strength of steel prices have been driven by i) capacity cut in Tangshan (China), taking out the possibility of increased Chinese exports in H2CY21 even when demand contracts, ii) heightened iron ore and coking coal prices (within China) impeding spreads, iii) supply chain disruptions ex China and iv) continued expectations of capacity reduction as carbon neutrality is targeted in China. To top that, there is clarity (I-Sec strategy team inputs) that global monetary policy will remain accommodative both in terms of rates and asset purchases for the foreseeable future. Capacity cuts + accommodative monetary and expansionary fiscal stimuli akin to a controlled environment is fuelling expectations of lengthening steel cycle duration. Higher prices is also having a positive impact on sector deleveraging.

- Some normalising trends which we expect to see as prices sustain at these levels. CISA has suggested that downstream steel demand has started to see the impact of higher steel prices. One can very well guesstimate that if China's demand starts getting impacted on account of steel prices, what will happen to regional demand (including that of India). We have already turned to meaningful discount to regional prices and we see consolidation of the trend. The regional seaborne supply will progressively increase at a much faster rate than estimated at this point in time. Chinese steel capacity cuts will pressurise iron ore prices and improve spreads further.

- The realisation glide path and the assumed cycle duration. Steel equities are already factoring in ~3+ year extended cycle - keeping in mind that Q1FY21 was the bottom of the cycle. We have now factored in a 10 quarter (trough to trough) cycle length. We don't see adequate risk reward in the sector to turn constructive. We will wait for cycle correction for better entry opportunity. We continue to value steel equities on FY23E book at their through cycle RoEs.

Source : Equity Bulls

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