Coal costs to be canaries in the mine for steel firms

QOQ profit growth in Q2 estimated to be weak; base metals may see limited impact

Rising prices of coking and thermal coal used in making ferrous and non-ferrous metals, respectively - are expected to have an impact on the margins of metal companies in the July-september quarter (second quarter, or Q2) of 2021-22 (FY22). Steel companies may see margins getting swallowed up, while base firms could stand to benefit, say brokerages.

Since metal is a cyclical sector, a year-on-year (YOY) comparison for earnings would offer a better picture. However, due to the ongoing Covid19 pandemic and last year’s low base, sequential comparison has been taken into consideration to delve into the pricing and volume trend.

Coking coal prices, a key raw material used in steel-making, have risen $25-30 per tonne sequentially, along with prices of other consumables.

A varied impact on margins is expected for steel companies, depending upon their coal consumption pattern (both domestic and international) and share of captive resources, add brokerages.

For Tata Steel, the country's oldest steel producer, domestic operations may be impacted partially by higher coking coal cost. Even so, domestic realisation is expected to increase ~2,000 per tonne, states an Edelweiss report. The company has a captive source of coking coal up to 25-30 per cent, which could lend support to realisations.

On a consolidated basis, however, a sharp improvement in earnings before interest, tax, depreciation, and amortisation (Ebitda) is likely for Tata Steel, led by turnaround performance of its European operations, it adds.

For Naveen Jindal-led Jindal Steel & Power (JSPL), despite a sharp uptick in sales volume, its Ebitda for Q2 is expected to be impacted by higher coking coal and iron ore prices. On the realisation front, steel longs have declined ~2,000 per tonne sequentially, accentuating Ebitda further, underscores the report.

JSPL’S steel sales volume surged 32 per cent sequentially in Q2 and 10 per cent YOY to hit a record 2.13 million tonnes (mt) during the quarter. In Q2FY22, JSPL steel sales for the first time breached 2 mt for the quarter, said the company in its recent release.

For Sajjan Jindal-led JSW Steel, Ebitda growth, led by higher realisation, stable sequential volumes, and reliance on exports, would be key for the quarter gone by.

In JSW Steel’s India operations, crude steel produced for the quarter under preview stood at 4.92 mt, up 26 per cent YOY, and flat from the preceding quarter. In the company’s US operations, production was up 12 per cent sequentially.

Domestic steel prices have been muted, compared to April-june, and there has been a divergence between flat and long product prices, says Systematix Institutional Equities.

Exports continue to boost sales, with the share of exports rising to greater than 40 per cent in Q2FY22 (from 34 per cent in the first quarter of FY22 and 38 per cent in Q2 of 202021), says JSPL in its release.

On the other hand, on a YOY basis, net sales and profit growth for the steel pack are expected to be strong due to a low base and sharp increase in steel prices.

Analysts at IDBI Capital say the deleveraging will continue. “Higher profits will lead to strong improvement in balance sheets of steel companies, which should likely improve further during the second half (H2) of FY22 in our view,” they observe.

Additionally, non-ferrous metal companies are set to report strong performance on increased London Metal Exchange prices and higher competitiveness due to fixed coal prices.

International thermal coal prices have surged more than 100 per cent since May to $240 per tonne. The Indonesian low gross calorific value coals witnessed similar trends.

This has increased the competitiveness of domestic aluminium producers who procure more than 80 per cent of the coal at fixed prices from Coal India.

Anil Agarwal-led Vedanta’s Ebitda in the quarter under preview is seen rising 58 per cent YOY and 4 per cent sequentially. Vedanta is also expected to gain from higher crude oil prices.

Hindalco Industries’ Ebitda is also seen rising 36 per cent YOY and 5 per cent sequentially.

Crystal-gazing

Between October and March FY22, domestic steel profitability should diverge materially across companies, given the different coking coal consumption patterns and product mix.

Assuming spot coking coal prices remain unchanged, how much of this impacts Ebitda per tonne in the fourth quarter of FY22 will depend upon steel price hikes in H2FY22, automotive industry exposure, contract price hikes, volume growth, and fixed cost absorption, along with captive coking coal and sourcing patterns, says JP Morgan's Asia Pacific Equity Research report.

Coking coal (excluding Australian) prices rose sharply over April-june, from $130 per tonne to $180 per tonne and are now above $350 per tonne.