Insurance against low steel margins for SAIL, Tata Steel

Last Updated: Mon, Nov 26, 2012 19:40 hrs

Don’t expect much from the metals sector, particularly steel, as the country’s index of industrial production (IIP) in September shrank 0.4 per cent after expanding 2.4 per cent in August on the back of earlier two contracting months. What should be particularly disturbing for our steelmakers was capital goods sector registering a negative growth of as much as 12.2 per cent. The sectoral contraction happening in a row of seven months is to be seen as a statement of the disappointing investment scene in a high-interest regime. Consumer durables calling for use of flat steel too, had a disappointing September with negative growth of 1.7 per cent.

The country’s industrial sector also had to take a knock in the face of “continuous contraction in world trade,” which saw our exports falling 1.63 per cent in October. Steel and raw materials like iron ore and coal that go into the making of the metal are among the world’s most highly-traded commodities. Therefore, the 27 member Euro zone sliding into the feared second recession since 2008-09 with gross domestic product shrinking for two consecutive quarters and fears of a further fall in the final quarter do not bode well for steel finding wide application in infrastructure projects, house building and manufacturing sector. In fact, it is because of the external demand risk the Euro zone presents, that China in spite of its exports accelerating in October says trade outlook remains grim. It is quite possible EU steel use in 2012 will fall more than 5.6 per cent predicted by the World Steel Association in October. In this year’s first nine months to September, the region recorded steel production fall of 4.7 per cent to about 144 million tonnes (mt).

Whatever difficulties the industry may be facing, particularly in Europe, Steel Authority of India Limited (SAIL) Chairman C S Verma and Tata Steel Managing Director H M Nerurkar will find some cushion here in our local market where demand rise for the metal will finally be supported by the slew of recent policy initiatives by the government and the prime minister’s resolution to ensure infrastructure spending of $1 trillion in the current 12th plan period. Whatever it is, September IIP has left both the government and industry highly disappointed. At the same time, Planning Commission Deputy Chairman Montek Singh Ahluwalia is right in pointing out that September figures were too early to have been impacted by new reform measures.

Verma and Nerurkar are building new capacity for their respective groups. Selling steel, particularly high-value products, in India will not be an issue. What is important to figure out is at what prices the metal is sold and what margins that would leave for steelmakers. These, at all times, will be decided by the behaviour of aggregate economy here and abroad, specially as steel imports invite customs of 7.5 per cent and a preferential impost of three per cent if products originate in countries with which we have free trade agreements like Japan and South Korea. In the first half of 2012-13, our steel imports surged 33.7 per cent to 3.85 mt. Exports in the corresponding period rose by five per cent to 2.367 mt.

Last quarter proved particularly difficult for steel companies across the continents. Mercifully, some leading Indian steelmakers, including Tata Steel and SAIL, could negotiate challenges thrown by weak local demand and large imports and earn reasonable profits in the given circumstances. But look at the world’s largest steel group ArcelorMittal. It reported the lowest quarterly profit in nearly three years. The group’s response to the crisis is by way of trying to sell non-core assets, capacity closure and moving production to relatively low-cost centres. What, however, came as a rude shock for the industry is when Moody’s cut its rating for ArcelorMittal debt to junk. Many came to believe that the rating involving the world’s largest steelmaker gives an idea of the “acute industry crisis”. Moody’s sees “challenging conditions continuing for ArcelorMittal over several quarters with its operating environment likely to get worse before it gets better.” Earlier, Standard & Poor’s (S&P) rated the company with net debt of $23.2 billion one notch below investment grade.

ArcelorMittal, however, is not the only steelmaker in a rarefied group to have its debt papers downgraded by rating agencies. The world’s fourth largest steelmaker Posco, which has invented the ground-breaking Finex technology, allowing iron making from iron ore fines and non-coking coal in an environment-friendly way, too, has found its credit rating lowered by S&P. The agency has cited tough conditions for the steel industry over next 18 months as Posco reported profits fall over three quarters in a row leading the company to downgrade its guidance for the year. It will be an uphill task for Tata Steel Europe to make itself an “all-weather business” as it claims it will become in the long run. Fortunately, unlike in Europe, SAIL and Tata Steel will have the advantage of a steel market that is set to grow at a healthy rate. The bothering issue will, however, be margins for steelmakers. Both Verma and Nerurkar are seeking insurance against low margins by moving products in the value chain and also through market differentiation.

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