China winter cuts—steel markets to tighten further. The winter curtailments in China’s main steel producing regions will tighten supply—industry utilization is already >80% post supply-side reforms. The capacity utilization for unaffected capacities can increase to 95% due to supply tightness. As a consequence, (1) China’s steel prices will rise and margins improve, and (2) steel exports will fall aiding global steel prices. We expect domestic steel prices to increase and buoy earnings of Indian steel companies over the next two to three quarters. Maintain ADD on TATA, JSTL and BUY on JSP.
China’s steel supply chain to be stretched due to winter cuts & post supply side reforms
The winter cuts imposed on Chinese steel producers will significantly tighten the global steel markets over the next three to four months (and this tightness may possibly stretch to May – June 2018). Post the structural supply side reform, steel capacity utilization in China has improved to >80% (Exhibit 1). The further tightening of supply will stretch the Chinese steel supply chain and aid steel prices. Capacity utilization at Tangshan, one of the main steel producing regions in China has already fallen by close to 20% in recent weeks due to winter capacity cuts. As per CISA, crude steel production in China declined by 1.7% during November 11-20, 2017.
The main targets of China’s steel capacity cuts are steel making facilities located in provinces of Hebei, Henan, Shanxi, Shandong and Tianjin—these regions together account for close to 50% of China’s steel output. The steel producers in these regions are required to cut output by up to 50% during the winter heating period (until March 15, 2018)—instructions are individually issued to each steelmaker. Depending on the levels of production cuts over the next four months, China’s steel output can fall close to 32 mn tons (45% output cut in these regions).
Dual impact—China heads into a seasonal restocking period while supply tightens
The impact of lower production in the main steelmaking regions due to winter cuts will be that the balance steel capacities will be stretched to meet demand—it is possible that capacity utilizations in the rest of China may increase to close to 95% (of blast furnace capacity). This will essentially also affect steel exports from China (which have so far declined by 30% in 2017) as more steel is diverted to domestic markets. This will have two consequences—(1) China’s domestic steel prices will rise given tightness and (2) lower volumes & higher priced exports from China will aid volumes & prices of steel producers in other regions.
We highlight that China’s steel market is heading into a restocking period while supplies will be under pressure. Over the last few weeks steel inventories in markets (distribution chain) declined by 6% and steel mills saw a drawdown in inventories (per CRU estimates).
Implications for Indian steel producers—expect prices hikes, better volumes
India steel prices are subdued in the context or rise in global prices due to higher production growth (+6% for April –October 2017) and subdued demand (+4.5%). Weak demand has led to a 58% rise in exports over April – October 2017 to 5.6 mn tons (Exhibit 7). We expect strong tailwinds to aid Indian steel prices including (1) lower Chinese exports and hardening in China’s steel prices, (2) improvement in domestic demand as we head to a seasonally strong quarter, and (3) fading impact of disruptions caused due to GST earlier.
We maintain our positive stance on Indian steel stocks
We maintain ADD rating on Tata Steel (TP: `780), JSW Steel (TP: `270) and BUY rating on Jindal Steel & Power (TP: `185). We expect strong earnings improvement (led by margin expansion) over the next two to three quarters for Indian steel names—possibly exceeding our full year estimates on operating margin front.
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