Action
We expect Indian steelmakers to see strong earnings growth in 2QFY11F, primarily
on account of: 1) strong volumes in 2QFY11 after a subdued 1QFY11; and 2) high
operating leverage resulting from higher sales. Despite lower steel prices and
higher raw material costs during the quarter, we believe profitability should be
strong on account of operating leverage. We maintain BUYs on Tata Steel and
SAIL, and NEUTRAL on JSW Steel.
Catalysts
Stable steel prices along with improving demand scenarios in Europe and China
are potential key catalysts to watch for.
Anchor themes
Our positive view on Indian steel is on account of: 1) strong demand; 2) cost
advantages; and 3) a strong pipeline of capacity expansion to maintain earnings
growth.
Quarterly preview
Strong quarter driven by higher volumes
We believe 2QFY11 should be a strong quarter for Indian steelmakers, driven
primarily by: 1) strong volumes and 2) limited impact of higher raw material prices.
We believe players with high operating leverage (ie, high fixed costs) will do better
as almost all companies have sold out of inventory.
Although domestic steel prices during the quarter were down INR2,000-2,500/t on
average and most of the companies faced a full impact of high coking coal prices,
higher volumes more than compensated for the profitability impact. Indeed, for
SAIL, which has the highest operating leverage among our coverage, we believe
its 37.8% q-q volume growth will lift its EBITDA per tonne from INR8,012 in
1QFY11 to INR8,638 in 2QFY11.
Steel prices have come off along with higher raw material costs
All major steel makers in India hiked steel prices by INR4,000-5000/t in April, and
although prices fell subsequently in May and June, average realization in 1QFY11
remained high. With little recovery in prices during the July-September period, we
expect average realization in 2QFY11 to come down by INR2,000/t.
While contract raw material prices had already increased from April, most of the
Indian companies were using raw materials from previous contracts during
1QFY11. We expect them to start seeing a full impact of higher raw material prices
(especially coking coal) from 2QFY11. However, the actual increase for the
companies will vary, depending on the raw material integration.
Operating leverage key for the quarter
As steelmaking is a high fixed-cost business, higher volumes will result in
significant operating leverage. We expect operating leverage to compensate for
higher raw material prices and falling steel prices for SAIL and JSW Steel.
However, we believe the leverage for Tata Steel will be lower because of its lower
volume growth in the quarter.
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