Steel makers' profit margins to remain under pressure this year

Last Updated: Thu, Jan 10, 2013 02:31 hrs

The profit margin of steel producers is likely to remain under pressure in 2013, even after effecting a Rs 500-1,000 a tonne rise in output price in December.

According to a report by credit ratings and research agency India Ratings, the marginal price increase is not going to help revive profitability due to the persistent high cost of production and limited ability to pass on the higher costs to customers following subdued demand from end-user industries. The margin pressure will be higher on producers with no captive raw material linkages.

The cost of funding working capital requirements remains high, despite a marginal reduction in the repo rate by the Reserve Bank of India in early 2012. India Ratings expects a gradual reduction in interest rates in 2013, which should provide some relief in interest costs. While higher-rated issuers invariably have access to bank funding and capital markets in certain cases, most issuers in the IND A’ and below categories rely largely on bank financing and are severely affected by high interest costs.

Steel show during Jan-Nov (in mn tonnes)
Particulars 2011 2012 Change (%)
Production 65.9 68.2 3.5
Consumption 63.4 66.7 5.2
Imports 5.6 7.0 25.0
Exports 3.7 4.3 16.2
Source : Joint Plant Committee

Considering the modest demand scenario, a further rupee depreciation could pressurise the margins of companies producing flat steel through the blast furnace route, as bulk of coking coal is imported. This is despite import price parity for flat steel products. Moreover, a weaker rupee raises the financial leverage of steel producers with significant un-hedged foreign currency liabilities, resulting in a decrease in financial flexibility. However, the agency expects the financial leverage of rated entities to remain within the guidelines stipulated for the respective rating category.

The iron ore mining industry is undergoing a difficult phase, given regulatory intervention in various states. Though this intervention bodes well for the domestic industry in the long term, in the short to medium term, steel producers will continue to face inadequate availability of domestic ore and might have to import. India’s steel-making capacity is slated to cross 100 million tonnes (mt) in 2013, which will require 160-170 mt of iron ore. There could be a shortage of about 30 mt, given the ongoing challenges in the mining sector.

A negative outlook could arise from the continued weak macro conomic environment, which could adversely affect the financial and liquidity profiles of issuers beyond that expected by the agency. Positive rating changes are unlikely in 2013, with India Ratings being more likely to take rating actions on a company-basis rather than on the sector as a whole.

Hence, India Ratings expects credit profiles of its rated steel producers to remain stable in 2013, driven by continued albeit slow growth in domestic steel demand. The majority (92 per cent) of ratings is on Stable Outlooks and most are below IND BBB-’, which reflects the inherent risks in the steel sector.

The World Steel Association has forecast steel consumption in India to grow at five per cent in 2013. Steel producers may see a spurt in demand in the medium-term if the Indian government implements its $1-trillion infrastructure investment plan in a timely manner. The demand for flat steel from automobiles, white goods and capital goods sectors is likely to remain modest in 2013, given the continued slow economic growth.

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