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Indian Steel
Sharp Earnings Volatility Ahead; Mapping the lag
impact of the 3 key variables into the P&L
• When would the current spot coking coal price flow through the P&L: Spot
prices are near $300/MT and expected to spike up even further. JPM forecast is
$300/MT for June, and then trending down to $215/MT for Dec. Current spot
coking coal would crystallize into contract prices in the June quarter and
depending on the inventory (in plant + in transit) which ranges from 2-4 months
across companies, would flow through the P&L mainly in Sept/Dec qrtr.
However, Indian mills would likely have to enter the spot market for the June
quarter if supply ramp up from Australia is delayed. SAIL, JSW and TATA’s
European operations are most exposed to coking coal. We estimate a coking
coal increase of at least $50/MT of steel between Sept-11 and Dec-10 qrtr with
bulk of it flowing through in Sept. SAIL should have relatively lower coal
inflation given high base (large carryover volumes at $300/MT) over last 2 qrtrs.
• When would the current spot iron price flow through the P&L: Dec-Jan spot
prices are so far +14% ($177/MT) and the Dec-Feb average would become the
June quarter contract. For JSW, which sources from NMDC and domestic spot
market, there is likely going to be an increase from the April of nearly the same
quantum as NMDC’s export prices and similary for Corus. The current spot
price strength in iron ore would flow through the P&L between June and Sept
quarters (with a higher lag for Corus compared to JSW). TATA and SAIL have
captive iron ore.
• When would the current steel price flow through the P&L: Of the 3 key
variables, steel prices have the quickest flow through. Domestic prices are up
between $30-50/MT from Dec and some more price increases are likely in the
domestic market. In flat steel, we estimate a large part of SAIL and JSW’s steel
sales in our view are on spot basis, where prices are re-set on a monthly basis,
while TATA has a relatively higher share of quarterly/6-monthly contracts. In,
long steel, in our view there is a far higher component of spot sales across
companies. For Corus, even spot sales are essentially 3-month contracts with
prices set during the last 30 days of the current quarter. Hence for Indian steel
mills we are likely to see sharp ASP increase (6-8%) in the March qrtr and a
more modest increase 2-3% in June before likely declines over next 2 qrtr.
Corus on the other hand would likely see large increases in the June qrtr and
some modest increase in Sept qrtr, while March should also be up q/q.
• All this translates into very volatile earnings picture over March-Dec: Net
Net we expect Indian mills to have peak earnings for CY11E in March and the
weakest likely in Sept. We estimate SAIL to have a sharp margin rebound in
March and decline through Dec. TATA India's margins are likely to reach
record highs in the March/June period. We would be buyers of TATA in any
stock price weakness over the next few months.
1-2 quarter lag of spot raw material into P&L
While the quarterly system of raw material contracts has potentially reduced annual
earnings volatility given that all 3 key variables – coking coal, iron ore and steel
prices have broadly moved in a band of 15-20% over the last 4 qrtrs, the quarterly
earnings volatility has increased given the lagged impact. For SAIL the quarterly
volatility has been exacerbated by the carryover volumes of ~2.6MT at $300/MT
when contract prices ranged between $200-225/MT and thus margins have been on
the lower side in the last 2 quarters on the high cost inventory flowing through the
P&L.
Spot coking coal has reached $300/MT even as we believe Indian steel mills have not
yet entered the spot market aggressively. The current March quarter would see
coking coal costs reduce q/q as the Dec qrtr ($208/MT) flows through. SAIL in our
view is likely to see a sharp q/q drop in coking coal cost as we estimate its blended
coking coal cost in Q2-Q3 was ~$250/MT. Given ample inventories, the mills have
yet no issues in terms of availability for March production even as supplies from
Australia have been severely impacted. JPM estimates June quarter contracts at
$300/MT, BHP is expected to deliver first the 'force majeure' impacted volumes
which would be at the $225/MT coking coal.
We believe Indian mills face a peculiar situation given that as of now there is not
enough visibility on when and how much would supplies from Australia ramp up
(most of Indian mills get their supplies from Australia), but if they enter the spot
market spot prices which are at $300/MT would likely spike up further. Also June
quarter tends to be one of the weakest in terms of steel sales/production and mills
tend to take maintenance shut downs. Additionally system inventories in India of
steel are still on the higher side with weak demand.
On the whole while June quarter coking coal costs should move up q/q, we
believe the full impact of the higher spot prices and likely $300/MT contract
prices would be felt in the Sept quarter and with even a greater lag at Corus, in
the Dec quarter. TATA's India operations given the 50% captive coking coal,
faces the least pressures. SAIL given the high base from its carryover’ volumes
at $300/MT, in our view faces lower q/q pressure. TATA’s European operations
(Corus) and JSW face the most severe pressure.
Unlike iron ore, India's blast furnace steel capacity is almost entirely dependent
on imported coking coal (mainly Australia) and hence any continued a) supply
issues and b) price spike up could potentially force some Indian mills to have
extended shut downs in June quarter, specially if the current steel price rally
does not hold up.
Iron ore is a less wider problem given that both SAIL and TATA India have captive
iron ore. JSW and Corus are likely to face iron ore cost increases in the June quarter.
However for JSW, we believe the cost hike while likely not as material as coking
coal, it would be more immediate given that it sources bulk of its iron ore ore from
NMDC and we estimate does not maintain large inventories given that it is near the
iron ore mines at Bellary. For Corus, we believe similar to coking coal, bulk of the
cost pressure would likely be felt in the Sept/Dec quarter
P&L impact- March likely the best, Sept potentially the
weakest
We expect March quarter to benefit from the steel price hikes but also lower
low material costs. While TATA’s India operations are among the lowest cost in
the world and hence would likely see near record margins, we believe SAIL %
EBITDA margins improvement is likely going to be the highest given the
lessening impact of the carryover coking coal (this benefit is likely going to
continue in the June quarter as well, though likely to be tempered given
potential spot purchases).
Given the possibility that spot steel prices for the near term could hit an air pocket
and with sluggish domestic demand (over capacity does not help), we expect margins
to drop sequentially in the June/Sept quarter, with Corus likely to face further
headwinds into Dec.
We would be buyer of TATA into any stock price volatility over the next few
months given that a) India expansion is less than 3 quarters away and b) India
operations would likely have near record profitability.
India Equity Research Reports, IPO and Stock News Visit http://indiaer.blogspot.com/ for complete details �� ��
Indian Steel
Sharp Earnings Volatility Ahead; Mapping the lag
impact of the 3 key variables into the P&L
• When would the current spot coking coal price flow through the P&L: Spot
prices are near $300/MT and expected to spike up even further. JPM forecast is
$300/MT for June, and then trending down to $215/MT for Dec. Current spot
coking coal would crystallize into contract prices in the June quarter and
depending on the inventory (in plant + in transit) which ranges from 2-4 months
across companies, would flow through the P&L mainly in Sept/Dec qrtr.
However, Indian mills would likely have to enter the spot market for the June
quarter if supply ramp up from Australia is delayed. SAIL, JSW and TATA’s
European operations are most exposed to coking coal. We estimate a coking
coal increase of at least $50/MT of steel between Sept-11 and Dec-10 qrtr with
bulk of it flowing through in Sept. SAIL should have relatively lower coal
inflation given high base (large carryover volumes at $300/MT) over last 2 qrtrs.
• When would the current spot iron price flow through the P&L: Dec-Jan spot
prices are so far +14% ($177/MT) and the Dec-Feb average would become the
June quarter contract. For JSW, which sources from NMDC and domestic spot
market, there is likely going to be an increase from the April of nearly the same
quantum as NMDC’s export prices and similary for Corus. The current spot
price strength in iron ore would flow through the P&L between June and Sept
quarters (with a higher lag for Corus compared to JSW). TATA and SAIL have
captive iron ore.
• When would the current steel price flow through the P&L: Of the 3 key
variables, steel prices have the quickest flow through. Domestic prices are up
between $30-50/MT from Dec and some more price increases are likely in the
domestic market. In flat steel, we estimate a large part of SAIL and JSW’s steel
sales in our view are on spot basis, where prices are re-set on a monthly basis,
while TATA has a relatively higher share of quarterly/6-monthly contracts. In,
long steel, in our view there is a far higher component of spot sales across
companies. For Corus, even spot sales are essentially 3-month contracts with
prices set during the last 30 days of the current quarter. Hence for Indian steel
mills we are likely to see sharp ASP increase (6-8%) in the March qrtr and a
more modest increase 2-3% in June before likely declines over next 2 qrtr.
Corus on the other hand would likely see large increases in the June qrtr and
some modest increase in Sept qrtr, while March should also be up q/q.
• All this translates into very volatile earnings picture over March-Dec: Net
Net we expect Indian mills to have peak earnings for CY11E in March and the
weakest likely in Sept. We estimate SAIL to have a sharp margin rebound in
March and decline through Dec. TATA India's margins are likely to reach
record highs in the March/June period. We would be buyers of TATA in any
stock price weakness over the next few months.
1-2 quarter lag of spot raw material into P&L
While the quarterly system of raw material contracts has potentially reduced annual
earnings volatility given that all 3 key variables – coking coal, iron ore and steel
prices have broadly moved in a band of 15-20% over the last 4 qrtrs, the quarterly
earnings volatility has increased given the lagged impact. For SAIL the quarterly
volatility has been exacerbated by the carryover volumes of ~2.6MT at $300/MT
when contract prices ranged between $200-225/MT and thus margins have been on
the lower side in the last 2 quarters on the high cost inventory flowing through the
P&L.
Spot coking coal has reached $300/MT even as we believe Indian steel mills have not
yet entered the spot market aggressively. The current March quarter would see
coking coal costs reduce q/q as the Dec qrtr ($208/MT) flows through. SAIL in our
view is likely to see a sharp q/q drop in coking coal cost as we estimate its blended
coking coal cost in Q2-Q3 was ~$250/MT. Given ample inventories, the mills have
yet no issues in terms of availability for March production even as supplies from
Australia have been severely impacted. JPM estimates June quarter contracts at
$300/MT, BHP is expected to deliver first the 'force majeure' impacted volumes
which would be at the $225/MT coking coal.
We believe Indian mills face a peculiar situation given that as of now there is not
enough visibility on when and how much would supplies from Australia ramp up
(most of Indian mills get their supplies from Australia), but if they enter the spot
market spot prices which are at $300/MT would likely spike up further. Also June
quarter tends to be one of the weakest in terms of steel sales/production and mills
tend to take maintenance shut downs. Additionally system inventories in India of
steel are still on the higher side with weak demand.
On the whole while June quarter coking coal costs should move up q/q, we
believe the full impact of the higher spot prices and likely $300/MT contract
prices would be felt in the Sept quarter and with even a greater lag at Corus, in
the Dec quarter. TATA's India operations given the 50% captive coking coal,
faces the least pressures. SAIL given the high base from its carryover’ volumes
at $300/MT, in our view faces lower q/q pressure. TATA’s European operations
(Corus) and JSW face the most severe pressure.
Unlike iron ore, India's blast furnace steel capacity is almost entirely dependent
on imported coking coal (mainly Australia) and hence any continued a) supply
issues and b) price spike up could potentially force some Indian mills to have
extended shut downs in June quarter, specially if the current steel price rally
does not hold up.
Iron ore is a less wider problem given that both SAIL and TATA India have captive
iron ore. JSW and Corus are likely to face iron ore cost increases in the June quarter.
However for JSW, we believe the cost hike while likely not as material as coking
coal, it would be more immediate given that it sources bulk of its iron ore ore from
NMDC and we estimate does not maintain large inventories given that it is near the
iron ore mines at Bellary. For Corus, we believe similar to coking coal, bulk of the
cost pressure would likely be felt in the Sept/Dec quarter
P&L impact- March likely the best, Sept potentially the
weakest
We expect March quarter to benefit from the steel price hikes but also lower
low material costs. While TATA’s India operations are among the lowest cost in
the world and hence would likely see near record margins, we believe SAIL %
EBITDA margins improvement is likely going to be the highest given the
lessening impact of the carryover coking coal (this benefit is likely going to
continue in the June quarter as well, though likely to be tempered given
potential spot purchases).
Given the possibility that spot steel prices for the near term could hit an air pocket
and with sluggish domestic demand (over capacity does not help), we expect margins
to drop sequentially in the June/Sept quarter, with Corus likely to face further
headwinds into Dec.
We would be buyer of TATA into any stock price volatility over the next few
months given that a) India expansion is less than 3 quarters away and b) India
operations would likely have near record profitability.
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