India – Steel Will Sink-With Or Without Safeguard Duties

The Indian steel sector’s overall debt is at Rs2.8tr, of which a significant Rs1.95tr is with tier-II steel mills. (As per our banking analyst, Rs1tr debt has already been recognized as stressed assets). Steel prices in India are down 16% YTD, and this has impaired the interest paying capacity of tier-II unorganized steel mills. We estimate their profit before interest, depreciation and taxes are down to 32% of FY15 levels, and the firms could fall short of interest payments by about 40%. 

With the Indian banking industry already reeling under power sector’s non-performing assets (NPA; see SEBs near-term risk; Govt. banks more exposed 4 Aug ‘15), steel sector issues can exacerbate NPA problems. …higher import duty has not stemmed cheap imports In the last couple of months, China hot rolled coil (HRC) export prices have fallen 20% and CNY depreciation has nullified India’s import duty hike of 5%. In addition to imports from China, are imports from Free Trade Agreement (FTA) countries, which are up 70% YTD in FY16.

Hence, the government’s efforts to boost steel prices have not been effective. Tier-I mills – have maintained premium pricing, and… Despite high imports, tier-I mills (Tata Steel, Sail, JSW Steel and JSPL) have been able to maintain premium pricing. These mills sell premium products, have direct distribution reach to end consumers via dealer networks and have brand value.  …lower raw material cost/market share gains have boosted profit In flat steel too, tier-I mills prices have declined by ~200bp less than the prices of tier-II mills. Tier-1 mills are mostly blast furnace-based producers, and hence, have gained from the decline in coking coal and iron ore prices.

Market share gains at the expense of smaller mills have also helped them to gain operational leverage and boost profitability. But no respite for tier-II mills In contrast, falling prices, higher electricity costs and interest burden have hit tier-II mills. Almost half of these capacities (around 10% of overall capacity of 110mn tonnes) are already closed in major production centers like Raipur and Mandi Gobindgarh. 

If prices do not improve, we believe the rest (around 30% of overall capacity) may shut down too.  ‘Safeguard duty’ could be atleast 20%… To prevent the small steel mills from going out of business and their debt (Rs 1.95 tr) from becoming NPAs, we believe domestic steel prices need to be up by by 7-8%. Hence, we believe the government might impose a ‘safeguard’ duty of at least 20%; if this is implemented it could boost prices across product categories. As per media reports,  Indian steel companies have made a proposal to initially impose the duty on HRC and some long products.