FY19 seen as yet another strong year for steel firms
Analysts are bullish on improving volumes, realisations
Steel companies are in the news for strong production numbers. In FY18, JSW Steel posted a 5 per cent increase in production and Tata Steel India (domestic operations) reported its highest ever output at 12.48 million tonnes (mt), an increase of 7 per cent. Analysts expect to see healthy growth in volumes and profitability in FY19, too.
Shares of Tata Steel and JSW Steel are up 7-9 per cent, while Steel Authority of India (SAIL) and Jindal Steel and Power (JSPL) have gained 1217 per cent from their Marchend lows.
The confidence not only stems from good volumes but improving realisations also. In the quarter gone by (Q4 FY18), realisation of long products surged 20 per cent sequentially, helped by increase in construction activities, said analysts. Higher realisations also mitigate concerns on higher raw material costs for non-integrated players.
Analysts at Kotak Institutional Equities expect domestic firms to report strong improvement in earnings, led by sharp rally in prices. Their earnings before interest, tax, depreciation and amortisation (Ebitda) are expected to improve 15-32 per cent sequentially in Q4FY18. The ~4,000-5,000 per tonne sequential rise in steel prices during Q4, despite being partially offset by rise in coking coal and iron ore prices, would still help Tata Steel, JSW Steel and JSPL see a 11-26 per cent sequential improvement in their per tonne operating profit. Analysts expect JSPL to report a net profit in Q4 after 13 quarters of losses, aided by higher realisations and capacity ramp-up at Angul (Odisha).
SAIL’s operating profit rose 51 per cent sequentially. FY17 FY18E FY19E The turnaround for JSPL and SAIL will improve their balance sheet, and is a key reason for the sharp rally in their stock prices.
The domestic environment has been helped by higher steel exports (up 35 per cent year-on-year to 8.9 mt in FY18). The analysts expect firms to report higher mix of export sales, especially JSW Steel and Tata Steel.
Analysts at Morgan Stanley say domestic fundamentals remain strong. They expect a 6 per cent demand growth in FY19 compared to 4 per cent in FY18. This, coupled with India’s modest exports, will lead to an improvement in capacity utilisation, from a decade low of 81 per cent in FY16 to 85 per cent in FY19. The 12 per cent rise in China’s steel prices in 2018 should support domestic realisations, though the analysts remain watchful of US imports.
Among steel stocks, JSW Steel remains the top pick. Rising domestic volumes, lower iron ore prices and superior balance sheet are benefitting the firm. Sharekhan estimates JSW’s consolidated Ebitda to compound at 13 per cent annually during FY17-20. Though Tata Steel India should perform well, analysts are monitoring Tata Steel Europe’s exports to the US. The market always works on sentiment, particularly of global investors. If the sentiment is bearish globally no matter how much earnings growth you have here, there will still be no effect on the market. Having said that, I would say political uncertainty is the biggest factor right now. Investors are worried that the BJPled National Democratic Alliance (NDA) may not get a complete majority. The market has not yet priced in a BJP defeat.
Do you see a UPA-1 like correction in case the BJP loses?
We could see an even more severe correction. The market will be fine if the BJP forms a minority government. But if the BJP or the NDA partners don’t get a majority at all, it will be a setback for the country. Election uncertainty will keep the market sideways. It wouldn’t have been so much of an issue, if we would have had a strong Opposition in place. Today we know that the Congress may not get a majority or near-majority. So they might have to form a coalition government. It will all depend on how it shapes up. If the 2019 elections result in the formation of a third-front government, the market may fall even more than what it had witnessed when the UPA-1 came to power in 2004.
But the market and the economy have not done that badly under coalition governments.
It depends on what kind of coalition we get. We haven’t seen a third-party coalition, which has survived for a long term. This time it can be different. It can’t be compared with anything else in the past. Parties not aligned to each other are coming together to form a government. Again if the Congress gets 200 seats, it won’t be a problem for the market. The governance narrative has changed. Even the Congress will have a different approach to governance.
What are other key concerns for the market?
Globally, things are very volatile. Interest rates are going up in the US. The flattening of the yield curve is signalling a recession two years from now. The trigger for the recession could be anything. There is this China-US trade war or the possibility of a war between the US and Russia. There is so much geopolitical uncertainty.
Are high oil prices also a worry?
Oil has been going up as new capacities were not created in the past few years amid softness in prices. But with oil climbing back to $70 a barrel, we will once again see new investments. I don’t see oil prices going through the roof as capacities are coming up and also the use of alternative fuels is increasing. So I think the ceiling will be $80 a barrel.
Given headwind, how does one play the market at this juncture?
I would say come in for the long term. When everyone is selling, it is a good time to buy. State-owned banks can be good bets, they have corrected a lot. A lot of investors say PSU banks are dead. But I think they can emerge stronger. The entire PSU space has a lot of potential. Due to the government interference and poor governance, they are being undervalued. Some of these will get privatised at some stage.
We have seen a lot of investors lowering their India weight. Is overseas investors’ sentiment towards India waning?
I think the political uncertainty is weighing on the sentiment. On the whole, foreign investors are very positive on India, the Narendra Modi government and its policies. If the NDA government gets a second term, we will see a lot of investments as there will be another bout of reforms.
What reforms are you looking at?
There is a lot that needs to be done. Ease of doing business still needs to improve. The next big reform can be privatisation and changes to the income tax framework. Some of the reforms have been initiated, for instance privatisation of Air India. Whichever party gets elected next should continue with the reforms process.