Metals and Mining - Steel: Margins to expand in spite of cost headwinds: Edelweiss

Please Share:: India Equity Research Reports, IPO and Stock News
Visit http://indiaer.blogspot.com/ for complete details �� ��

n  Macro indicators suggest revival in growth

Global PMI, after bottoming for 2010 in September at 52.5, has shown a sharp up move to 55 currently. We expect global industrial production (IP) to accelerate in H1CY11.

n  Signs in sector indicating pick-up in demand

Order backlogs for US/CIS steel mills have increased from 1-2 weeks to 4-6 weeks. Eurofer expects European construction steel to pick up modestly by 2.1% in 2011E after three years of contraction; Eurozone IP is expected to rise 3.4% in 2011E.

n  Expect margins to expand in spite of current cost headwinds

H2CY10 saw softening in demand as reflected in moderation in PMIs. In line with that, global steel production declined 7% from its peak in May 2010. As a result, the raw material cost push could not be passed on. Considering our view of pick-up in demand for 2011, we expect margins to expand from Q3FY11 levels in spite of the continuing iron ore and coking coal cost push.

n  However, coking situation to moderate extent of margin expansion

With 50-year record floods in Queensland (Australia) we expect contract hard coking coal prices to rise to USD 280/t for Q1FY12E (USD 225/t in Q4FY11). We moderate our earlier estimates of margin expansion led by this, i.e., our earlier expectation of margin expansion of USD 50-55/t in FY12 over Q3FY11 levels is reduced to USD 30-35/t.

n  Steel prices to rally in H1CY11 followed by moderation in H2CY11 

Spot HRC prices have already rallied between USD 75/t and 200/t across various regions led by restocking, cost push, and some signs of pick up in real demand. Further increases are on cards. This is against a cost push of USD 80-100/t. However, we expect both raw material and steel prices to moderate in H2CY11.  

n  Outlook: Positive; Tata Steel continues to be top pick

We are revising up our FY12 HRC price assumptions for Europe and India from USD 660/t and INR 31,818/t (net) earlier to USD 775/t and INR 34,545/t, respectively. Contract hard coking coal and iron ore (FOB Australia) price assumptions are now USD 251/t (earlier USD 200/t) and USD 138/t (USD 100/t), respectively. Led by this, we expect FY12E EBITDA margins for JSW Steel and Tata Steel Europe to be USD 177/t (earlier USD 200/t) and USD 61/t (USD 80/t), respectively. Tata Steel India’s margins increase from earlier estimate of USD 356/t to USD 375/t in FY12 considering raw material integration. We change our FY12 USD:INR assumption from 43 to 46, which buffers the cut in USD margins. We reiterate our positive view on steel with marginal cuts in FY12E EBITDA. We retain our recommendations on Bhushan Steel, JSPL, JSW Steel, SAIL and Tata Steel of‘BUY/SO’, ‘HOLD/SP’, ‘BUY/SO’, ‘HOLD/SU’, and ‘BUY/SO’. Our top pick is Tata Steel with a fair valuation of INR 778/share.