Demand slowdown, overcapacity loom large on Indian steel player profitability

As end-user demand for steel in India continues to fall, CRISIL Research estimates domestic steel demand to grow at a subdued rate of 2-4 per cent in 2013-14.

Due to execution delays owing to environment clearances, many construction and infrastructure projects have not taken off as expected.

Slowing economic growth has also put the brakes on consumption-driven sectors such as automobiles and consumer durables.

While near-term demand is expected to remain muted, long-term prospects are forecast to be steady.

CRISIL Research expects steel demand in India to pick up from 2014-15 with an expected pick-up in demand in key end-user sectors such as construction, infrastructure and automobiles.

However, growth in demand will be lower compared with the robust growth rate of the last decade.

CRISIL Research estimates domestic steel demand growth at 6-7 per cent CAGR between 2013-14 and 2017-18 compared with around 9 per cent CAGR over the last decade.

This rate of increase will see steel demand in India touching 93-94 million tonnes by 2017-18.

Since incremental demand for finished steel is expected to be considerably lower the demand-supply gap will widen, when majority of the planned capacities are scheduled to be commissioned (16 million tonnes in 2013-14 and 8 million tonnes in 2015-16).

The widening gap will encourage, even compel, steel manufacturers to increase exports to arrest the expected fall in operating rates.

However, the demand-supply equation globally too is not favouring domestic steel manufacturers.

A shift in China’s focus from investment to consumption, accentuated by weak economic conditions in mature developed countries will force a deep structural slowdown in global steel demand over the next 5 years.

We, therefore, expect global steel demand to grow by 2-3 per cent compared with 5.5 per cent growth over the last decade.

As global demand growth slows at a time when there is acute global overcapacity, competition is expected to intensify in the export market.

While the cost competitiveness of India’s steel players, excess domestic capacity and a weak rupee is expected to increase steel exports from India, an extremely competitive global export market, weak global and domestic demand, and the commissioning of huge domestic capacities will rein in domestic capacity utilisation rates in the medium term.

Globally too, utilisation rates are expected to remain below 80 per cent over the next five years.

Global steel prices

Consequently, global steel prices will continue to trend downward. This will, in turn, exert tremendous pressure on global contract prices of iron ore and coking coal. On the domestic front too, steel prices, both long and flat, are expected to come under pressure and decline by around 3-4 per cent y-o-y each.

On the raw materials front, although coking coal prices are expected to decline the depreciation in the rupee is expected to continue to partly negate the benefit of the steep fall in coking coal prices in 2013-14. Additionally, while the domestic iron ore supply constraints are set to ease marginally, non-availability and high prices of thermal coal remains a worry for the marginal long steel producers in India.

Profitability under pressure

We believe that the profitability of the Indian steel industry will come under pressure because of deterioration in the demand-supply equation on the back of macroeconomic challenges being faced by the country (which has led to a steady inventory build-up for Indian steel players) on one hand, and a rapidly increasing supply base on the other. This is likely to keep steel prices under check.

The prices of the key raw materials (especially non-coking coal)are, however, expected to remain high in the near term, given the concentrated industry structure and the supply-side bottlenecks.

Raw material costs

Since raw material costs account for the bulk of the total steel production cost, firm raw material prices are likely to keep production costs high even as weak demand conditions may make it difficult for steelmakers to pass on the cost-increases to consumers. This is likely to adversely impact the margins and cash flows of Indian steel companies across the value chain:

•The profitability of integrated steelmakers, with access to captive mines, will continue to be under pressure at 17-19 per cent in 2013-14.

•Margins of integrated players without access to captive mines are expected to fall marginally in 2013-14 due to continued disruption in the supply of iron ore. For these players, higher input costs, amid lower demand, will cause margins to drop marginally y-o-y to 15-17 per cent during 2013-14.

•Small and mid-sized manufacturers of long steel are facing issues over availability and prices of iron ore and non-coking coal. Additionally, sluggish demand for long steel is expected to limit the ability of these players to fully pass on the rise in input costs, which will keep their margins also under pressure in the near term.

The author is Director, CRISIL Research