Tata Steel, JSW Steel, JSPL: Should you buy or sell steel stocks? CLSA answers

Foreign brokerage CLSA in its latest sectoral note on steel downgraded two steel stocks namely Tata Steel and JSW Steel to 'Sell' while maintaining its cautious stance on the domestic steel sector, as it felt that the profit pool in India should incrementally move towards miners from converters as steel capacity addition picks up pace.

Historically, CLSA said, the sector has given positive returns if bought at trough spreads, which are generally accompanied by low valuations. That said, unlike the past, valuation (PB) multiples for Indian steel companies have risen in the past 18 months while steel prices have corrected. This, the foreign broking firm said, is likely driven by a better demand outlook, the expectation of a stimulus in China and overall elevated valuations in Indian markets.

"Consensus estimates are implying FY25/26 profitability in line with or above Q3FY24 levels, which we find unjustified. While spreads have compressed further in the past two months, Q3 numbers had been insulated due to the lag effect of cost inflation China stimulus a key risk," CLSA said.

CLSA said its has revised FY24-26 Ebitda estimates for steel players under its coverage by minus 6 per cent to 5 per cent on lower spread assumptions. It has reduced price targets by 7-10 per cent for Tata Steel (from Rs 145 to Rs 135) and JSW Steel (from Rs 810 to Rs730)

"On the back of lower estimates, we now have SELL ratings on both JSW Steel (was UPF) and Tata Steel (was O-PF). We raise our target price for JSPL from Rs 820 to Rs 840 and maintain U-PF, as we believe it is relatively better off because weaker industry spreads will be more than offset by the margin expansion projects," it said.

CLSA said unlike the past, valuations for steel stocks have risen in the past eighteen months to 1 standard deviation above their median, and hence while spreads are at a trough, multiples are not.

It felt that the consensus estimates for steelmakers are not factoring in spread compression.

"We maintain U-PF on JSPL and believe it is relatively better off, as weaker industry spreads will be more than offset by the margin expansion projects. A broad based demand driven stimulus in China is a key risk to our thesis. Domestic profit pool to shift from steel mills to miners," CLSA said.

The sharp increase/ramp-up of blast furnace-based steel capacity in India over the next three years is likely to weigh on spreads and shift incremental margins from steel conversion to raw materials, CLSA said.

"As supply outstrips demand growth, and reliance on exports rise, domestic steel prices are unlikely to trade above import parity. We forecast the FY25/26CL spread at $360/tonne versus the 10-year average of $410/tonne (spot: US$305/t), though in rupee terms spread expectations are higher than the past average. Higher steel production is likely to drive higher demand for iron ore and coking coal. The ramp-up of captive iron ore mines may not be adequate to cater to this demand, particularly in a rising export environment. Hence, we expect the discount to import parity to narrow," CLSA said.

CLSA said India is a key player in the coking coal balance. A rise in blast furnace-based production in India would partly offset the impact of China avoiding Australian coal.  A sustained higher demand in China, driving up spreads, is the best outcome for Indian mills given the self-sufficiency of iron ore in the country, CLSA said.

“However, if China production remains elevated, with weak demand, spreads could remain lower for longer,” it warned.