While the outlook for India's steel sector remains positive, rising iron ore and coking coal prices may pose a potent challenge for the industry. That's the word coming in from two global brokerage houses.
The prices of both key raw materials for steel making, iron ore and coking coal, have spiked in the last three months. Some of this should be temporary (weather-related supply disruptions), but the sharp moves point to a lack of slack in the steel value chain according to a Credit Suisse report.
The broking firm has maintained a ‘conservative' outlook on the steel sector's earnings before interest, tax, depreciation and amortisation (EBITDA) margins.
Meanwhile, Morgan Stanley expects metals companies with recent expansions to benefit with higher volume growth, given that India is a net exporter. Steel demand is likely to remain firm in the second half of financial year 2017-18, and the overall demand outlook bears an upside risk of 6 percent, said the brokerage house said in its research note.
Credit Suisse
- The brokerage prefers Tata Steel Ltd. over JSW Steel Ltd., given its iron ore integration.
- Credit Suisse maintained its 'Outperform' rating on JSW Steel with price target of Rs 265 and expects strong earnings before interest, tax, depreciation and amortisation (EBITDA) growth in financial year 2018-19.
- The brokerage's 'Neutral' rating on Jindal Steel and Power Ltd. is based upon its target price of Rs 140, reflecting their view that the stock is fairly valued at current prices with most of the upside already built-into expectations.
- For Tata Steel, Credit Suisse expects stable domestic EBITDA growth and improvement in European Union's profitability as the business gets restructured. It has an 'Outperform' rating on the stock with price target of Rs 651.
Probable Risks To Target:
- Steep increase or fall in steel prices
- Withdrawal of domestic barriers on trade
- Rise in iron ore and coking coal costs in excess of estimates
- Sharp increment in power plant load factors
- No progress in EU restructuring, for JSPL
Morgan Stanley
- The brokerage believes that Tata Steel and SAIL Ltd. are relatively better place, given their backward integration on iron ore.
- JSW Steel and JSPL are estimated to benefit from higher steel prices, it will be partly offset by higher input costs, particularly in JSW Steel's case due to its 100 percent dependence on iron ore purchases.
- Tata Steel is the brokerage's top pick with price target of Rs 741 due to improving fundamentals, like better demand, ramp up of Kalinganagar project and better cost structure.
- Turnaround in European operations with stable spreads and operating efficiencies in U.K. operations add to Tata Steel's preference too.
- The brokerage maintained ‘Overweight' on JSW Steel with price target of Rs 267, with expected benefits from strength in domestic steel prices and operating efficiencies with capacity utilization.
Probable Risks To Target:
- Weaker-than-expected steel prices
- Continued disappointment in global earnings
- Lower operating cash flows leading to balance sheet challenges
- Faster project ramp-up leading to cost efficiencies and higher margins
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