Cost pressures amidst weak demand signal challenging times ahead for domestic steel players: ICRA

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ICRA expects the recent sharp rally in international coking coal prices to hurt the profitability of domestic blast furnace players in Q4 FY2017. International contract prices of benchmark low volatile premium hard coking coal (HCC) for Q3 FY2017 have been settled at US$200/MT, showing a 116% quarter-on-quarter (QoQ) increase. Moreover, given that premium hard coking coal prices have steadily increased since October 2016 from US$213/MT to US$309/MT at present in the spot market, contract prices in Q4 FY2017 are poised to be settled at an even higher level than US$200/MT.

Mr. Jayanta Roy, Senior Vice-President, and Head – Corporate Ratings, ICRA said: “Due to this doubling of contract coking coal prices, cost of steel production for domestic blast furnace players will increase by around Rs 5,750/MT in Q4 over Q3 of FY2017. As a result, the benefits from trade protection measures, which helped hot rolled coil (HRC) prices recover after February 2016, are likely to largely disappear after the end of Q3 FY2017.”

As per ICRA’s estimates, gross contribution levels of domestic blast furnace players in Q4 FY2017 are likely to dip by around Rs 4,000/MT from the Q3 FY2017 levels, unless the increased coking coal costs are accompanied by commensurate price hikes by steel makers.

Domestic steel demand remained largely stagnant in Q1 FY2017, with consumption growing by just 0.4% year-on-year (YoY) during this period. However, with demand for steel starting to improve from July 2016 onwards, steel consumption growth in Q2 FY2017 was much higher at 6.8%. However, going forward, an anticipated slowdown in the real-estate sector on account of the Government’s demonetisation drive will impact demand of long steel players in the immediate term.

“Given that a majority of the small to medium-sized secondary steel players in India are positioned in the long product segment, the impact of this slowdown in real estate demand is expected to affect their capacity utilisation levels,” Mr. Royadded.

In the flat product category on the other hand, the impact of the slowdown would be limited, though rural demand for some of the flat products like corrugated sheets, galvanised sheets etc. is likely to reduce in the near term, transactions being largely cash-based. For the auto sector, the impact of the demonetisation is expected to be marginally negative in the near term, especially for the two-three wheeler segments, where the share of the cash purchases has remained higher.

Domestic hot-rolled coil (HRC) prices witnessed an uptrend since the imposition of anti-dumping duties in August 2016, and increased by 15% to Rs. 33,750/MT in November 2016 from around Rs. 29,250/MT level in July 2016. In the backdrop of an unabated rise in coking coal price, as well as a resilient Chinese steel demand, international HRC prices have rallied from US$328/MT in June 2016 to US$475/MT in November 2016. As a result, with domestic HRC prices now being cheaper than imported offers by around US$40/MT, pricing pressures from imports remain low at present. This leaves some headroom to domestic blast furnace players to pass-on the cost-increase coming from higher coking coal costs. Nonetheless, given the muted demand outlook in the near term post the currency demonetisation, ICRA believes that steelmakers will only be able to partially pass on such cost increases, in turn putting pressure on their operating profit margins in Q4 FY2017. Additionally, due to the leveraged balance sheets of many large steel companies, the debt protection metrics of the industry are expected to remain depressed in the near term.