Ferrous Sector - Results Preview - Higher Input Costs to Affect Margins

Historically Strong Quarter but...

4Q is the strongest period in terms of demand, sales volumes, prices, and profitability, historically. However, this time, we saw a divergence of this trend in 4QFY22. Prices remained sluggish in the first half of 4QFY22, as international prices continued to slide. A fresh wave of Covid-19 cases in China and a slowdown there impacted steel prices, which continued to correct in Jan'22, before recovering in Feb'22. However, supply disruptions ensured firm Chinese domestic prices. Chinese domestic HRC steel prices remained flat in 4Q to average US$792/t, while the cost curve has increased with iron ore prices increasing 23% QoQ to an average US$126/t in 4QFY22. China steel export HRC prices have corrected 6% in 4QFY22 to average US$815/t but trade at elevated levels of US$920/t (spot), driven by gaps in the European market. The exceptionally strong price push in Mar'22 was driven by a massive jump in coking coal prices and a resurgence in domestic demand.

Coking Coal Prices

Prices in the international market continued to rally in 4QFY22. Prices of premium hard coking coal (HCC) stood at US$379/tonne at the start of 4QFY22. However, due to delays in Australian floods to recede and weather-related disruptions in the US, coupled with the Russia-Ukraine conflict, spot prices touched a peak of ~US$700/tonne in mid-Mar'22. However, since then, coking coal prices have seen a sharp decline and corrected to ~US$385/tonne. The fall can be attributed to factors like buyers' reluctance to accept high prices, Covid induced lockdowns in China, improvement in the supply situation in Australia and easing of panic over the Russia-Ukraine conflict. As per the Australian Government's Office of Chief Economist, premium hard coking coal (HCC) prices are forecast to ease from an average US$227/t in CY21 to a still high of US$183/t by CY23. However, we believe that a correction in prices could take longer than expected due to the geopolitical tension. This fall in coking coal prices comes at a time when higher steel prices were on the verge of hurting demand. We believe steel prices will cool off from the current highs if this situation persists. Spreads, however, are likely to witness an expansion, while demand would no longer be under a risk if steel prices correct. We expect this to be a positive for the ferrous space overall.

Result Expectations

We expect JSW Steel and SAIL to report a YoY and QoQ contraction in EBITDA/tonne due to higher raw material inflation. The significant steel price surge witnessed came towards the second half of the quarter, primarily in Mar'22. Consequently, JSW Steel is likely to see a soft realization sequentially. However, higher sales volume in a seasonally strong 4Q is likely to lead to higher absolute EBITDA for the company. Prices rallied strongly across the board in Mar'22 on expectations of a shortage in several commodities after the breakout of the Russia-Ukraine conflict. The latter resulted in a ban on several Russian banks from accessing the international payments messaging system - SWIFT. Overnight, it became difficult to settle trades in steel, coking coal and thermal coal, resulting in a shortage of these commodities globally, and pushed certain commodity prices to record highs. Like other commodities, pellet prices too witnessed a jump, and we expect pellet realization for GPIL to be higher by ~Rs1,450/tonne on a QoQ basis. Pellet is a high value-added iron ore, used in both blast furnaces and DRI plants, and its demand is on the rise in China as sintering facilities are shutting down under tougher pollution control regulations.

Our View

We remain positive on the Indian ferrous sector, as we believe that domestic steel companies are well-positioned to benefit from the multi-year high spreads due to structural advantages. In our view, China is serious on its path to control production, lower exports and decarbonize, whereby there will be higher capex/opex. Hence, structurally we see better spreads compared to the past cycles. Further, the Indian steel industry's demand is poised to grow with considerable investments expected in the construction, infrastructure, and manufacturing sectors in view of the expected economic revival over the next few years. We rate JSW Steel (BUY, Target Price Rs808), GPIL (BUY, Target Price Rs551) as our top picks in the sector, while remaining positive on SAIL (BUY, Target Price Rs131) and MOIL (BUY, Target Price Rs233).

Source : Equity Bulls

Keywords

FerrousSector Q4FY22 ResultsPreview RelianceSecurities