Ride the steel cycle

The demand-supply gap for steel is widening and analysts are positive about this sector. R Sree Ram tracks some promising stocks.

R Sree Ram        Print Edition: April 17, 2008

Why are prices rising:

• Demand-supply mismatch

• Supply disruptions, rising prices of raw materials

• Lower US inventory levels

And why will they rise:

• Robust demand from developing economies and Asian countries

• Slowdown in Chinese steel production and exports

• Delay/slippages in capacity additions

Wake up at the crack of dawn to the ringing of your alarm clock. In the cab to the airport, you glug from a can of cold coffee. On the early morning flight to Mumbai, wolf down an indifferent breakfast kept warm in aluminium foil. From food cases to automobiles to aeroplanes, steel literally makes the world go round. Demand for this metal is rising almost by the minute but supply is unable to keep up. The result? High prices.

India, which consumes 52-55 million tonnes of steel a year, is expected to fall short of 5-6 million tonnes due to growing demand from the infrastructure, automobile and housing sectors. “Over the past two years, steel demand has picked up by around 10-11% in India, absorbing the excess capacity. There is a tight demand-supply situation as new capacity additions are taking time to get into the market,” says Prasad Baji, metals analyst at Edelweiss Capital. In India and many regions across the world, supply has been unable to keep pace with strong demand.

Industry trends Average steel prices in Europe have gone up by 16-30% since the beginning of this year. In India, steelmakers have hiked prices by around 16% in the January-March quarter, largely due to the tight supply situation coupled with rising prices of key raw materials: iron ore and coking coal.

Historically, rising prices have led to increased production. For the first time in 15 years (see graph below), the steel industry is bucking the trend. This is largely due to raw material disruptions and slippages in capacity additions.

Steel price trend
“Under normal circumstances, $150-plus price increase per tonne since July 2007 would have led to a strong supply response globally. However, in the past six to seven months, production growth has slipped as prices have risen,” says a Credit Suisse report, which estimates that the global economy is going to fall short of around 35 million tonnes of steel. Analysts expect the current uptrend in the steel cycle to last at least for the next 3-4 years.

“While demand in India is growing at the rate of 12-15%, supply is increasing by just 6%. We will see steel prices hitting new highs in 2008 and maybe in 2009 too,” says Ashish Poddar, research analyst at Almondz Global Securities.

Stock trends India, which is a net importer of steel, is likely to live with steel shortages until 2012, when new capacities are expected to kick in. In light of the impending crunch, and the consequently higher prices, analysts are getting vocal about suggesting that investors ride the steel cycle. “This is the right time to invest, as stocks have fallen even as steel prices are looking up,” says Rakesh Arora, associate director (research), Macquarie Capital Securities.

If you’re just entering this sector, analysts suggest that you stick to vertically integrated companies, as they have captive mines and reliable sources of raw material supplies. We recommend that you look mainly at large-cap stocks, which are well-poised to benefit from the impending steel crunch. For instance, Tata Steel is recommended because of its strong volume growth and impending synergies after its acquisition of Corus. JSW Steel is strongly recommended by BNP Paribas, which says: “The company is expected to add 6 million tonnes of capacity over the next two years. This will account for 40% of the country’s total capacity addition in the next two years. As a result, we expect JSW’s revenue to grow at 53% CAGR over the next two years.” BNP has set a target price of Rs 1,650, implying a potential upside of a good 48%.

Some analysts also recommend selected mid caps such as Bhushan Steel, Adhunik Metaliks, Jai Balaji Industries and Welspun Gujarat. Adhunik Metaliks, hovering around Rs 130, has successfully commissioned a steel rolling mill, and is in the process of doubling its steel capacity. Edelweiss has recently come out with a buy recommendation, and has arrived at a sum-ofthe-parts value of Rs 260 per share.

If you’re looking to hedge your bets, analysts suggest a combination of steel manufacturing companies and raw materials providers such as iron ore or coking coal firms. “Investors can acquire a combination of stocks that could provide some natural hedging. They can buy SAIL and Gujarat NRE Coke as SAIL has 100% iron ore, GNC would provide relief if coking coal prices go up. Another combination can be JSW Steel and Sesa Goa, where Sesa Goa would provide relief in case iron ore prices move up,” says Giriraj Daga, research analyst at Khandwala Securities.

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