Opinion: Growth momentum in steel to continue into FY2022
Steel

Opinion: Growth momentum in steel to continue into FY2022

Domestic steel demand witnessed a decline of 30 per cent on-year in the first half of FY2021 as end-user industries like building and construction, infrastructure and automotive, constituting around 80 per cent of domestic demand, came to a standstill during the pandemic-induced lockdown in the...

Domestic steel demand witnessed a decline of 30 per cent on-year in the first half of FY2021 as end-user industries like building and construction, infrastructure and automotive, constituting around 80 per cent of domestic demand, came to a standstill during the pandemic-induced lockdown in the first quarter. This came on the heels of a weak fiscal 2020 when demand growth fell to less than 2 per cent from the highs of 8-9 per cent in FY2018 and FY2019.However, domestic steel demand has witnessed a strong recovery in the second half of FY2021, with an estimated on-year growth of nearly 16 per cent between October 2020 and March 2021. This has primarily been supported by pent-up demand from construction and consumption-linked sectors.The recovery in the second half will limit the demand contraction for fiscal 2021 to less than 7 per cent. Further, the growth momentum could continue in fiscal 2022, with increased government push for infrastructure spending along with recovering residential real estate. This will lift domestic steel demand by 13-15 per cent in FY2022, led by long-steel demand growth of around mid-teens.The improved demand has also been accompanied by a steady increase in domestic steel prices.RALLY IN GLOBAL STEEL PRICESDomestic hot-rolled coil (HRC) prices rallied sharply by over 40 per cent from March 2020 levels to a multi-year high of around Rs 56,000 per tonne in early February 2021 on better domestic demand, iron ore supply constraints, and high global prices. Increased domestic steel realisations, pushed by iron ore prices, following global trend   Source: Industry, CRISIL Research; Iron ore prices above are NMDC 64% Fe FinesOn the raw material front, domestic iron ore supply could not catch up with demand from steel mills as mining operations could commence on only around 8 of the 19 auctioned mines in Odisha. Tight supply increased domestic iron ore prices, which more than doubled from May-June levels.Further, global steel prices also have a bearing on domestic price hikes since August 2020. Global steel prices, too, rose sharply driven by the robust recovery of nearly 8 per cent in China’s steel production, coupled with cost-led push due to soaring global iron ore prices.However, with improved domestic availability since January 2021, iron ore prices slipped more than 10 per cent in February. Further, the budget for fiscal 2022 has reduced basic customs duty uniformly to 7.5 per cent from 12.5 per cent on semis/flat steel products, and to 10 per cent on long-steel products.With softening of iron ore prices and reduction in customs duty, domestic steel prices had witnessed moderation during February 2021. However, with continued demand support and a strong increase in global prices, domestic steel prices resumed their upward rally during March 2021.Domestic prices are expected to remain strong during the first quarter of fiscal 2022 with a likely QoQ increase of nearly 10 per cent in average prices. However, the prices are expected to moderate from the second quarter onwards as tailwinds to the realisation from higher input cost and global prices could abate going forward.  That said, realisation in fiscal 2022 could still be nearly 13-15 per cent higher over fiscal 2021 and more than 25 per cent higher than the past five-year average.MODERATION IN DOMESTIC IRON ORE PRICES LIKELYDomestic iron ore prices are also expected to moderate going forward with improved supply, though average prices in FY2022 would still be nearly 20 per cent higher over fiscal 2021. Seaborne coking coal, which accounts for over half of raw material costs, prices are expected to increase nearly 15 per cent on-year in FY2022, with China’s continuing halt of Australian exports, though remain fairly benign. This, in combination with rising volumes and higher realisations would mean primary steel producers sustaining robust operating margins (EBITDA) of nearly 24 per cent in fiscal 2022, despite some moderation over fiscal 2021’s level of nearly 25%.Operating margins to moderate, though remain healthySource: Company filings, CRISIL RatingsAs can be seen in the chart here, this is a significant improvement over the decadal low of nearly 9% operating margin seen by domestic steel producers in the previous down-cycle of fiscal 2016. Apart from higher steel prices, increased raw material linkages and improved operating efficiencies of stressed assets after consolidation with stronger peers have helped.  Operating profits of domestic steel producers are expected to exceed their levels of FY2020 by over 40 per cent in FY2021 and should increase nearly 25 per cent in FY2022. This would, in turn, improve cash accruals to nearly Rs 400 billion in fiscal 2021, followed by another 20 per cent growth next fiscal.This spurt in cash accruals is largely going to support the balance sheets of steelmakers, which had reduced Capex in FY2021 to conserve cash and pare down debt to fortify financials.STEELMAKERS EXPECTED TO PARE DEBTSteel producers are expected to have cut debt by over Rs 250 billion in fiscal 2021.  And, even with a likely 15 per cent rise in Capex next fiscal, they look to be in good stead to cut debt by at least another Rs 100 billion in fiscal 2022. This would drive a sharp improvement in credit metrics, with financial leverage (ratio of debt to EBITDA) diving below 2.5 times for FY2022 compared with above 4.0 times in FY2020.Improved profitability to support de-leveraging Source: Company filings, CRISIL Ratings; Interest cover = EBITDA / interest; Leverage = gross debt to EBITDAThe strengthening of balance sheets should position the industry well for the next phase of growth. With current capacity utilisation at over 90 per cent for the primary steel producers, Capex is expected to be stepped up towards increasing both steel capacities as well as efficiency improvements.While the domestic steel industry has seemingly come out of the pandemic blues, any sharp fall in steel prices due to weaker global demand and higher supplies, especially from China and the second wave of Covid-19 afflictions impacting domestic demand will bear watching.Manish Gupta is Senior Director, CRISIL RatingsNaveen Vaidyanathan is Associate Director, CRISIL Ratings

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