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Supply-squeeze driven price ‘fever’ continues

Regional HRC prices are consolidating at US$1000/te. The current fever in global prices is allowing ~Rs7,000-10,000/te increase in domestic prices for Q1FY22, thereby, taking the cycle amplitude to unseen levels. April, ’21TD has witnessed ~Rs7,000/te increase in prices. While we are factoring in a steady cyclical correction post Q1FY21, the extent of price increase is leading to improved estimates of deleveraging, future RoE profile and therefore, higher attributable P/B. We are, therefore, changing the stance on the sector to neutral from negative. We upgrade Tata and JSPL to HOLD from REDUCE and JSW Steel to REDUCE from SELL. We maintain HOLD on SAIL. We continue to work with the through cycle P/B valuation for Tata Steel, while we increase the same to ~0.9x for JSPL. The cycle will correct, but even a 12-quarter cycle length, given the current amplitude would make Indian steel sector leverage a thing of the past (Chart 2)

* We now factor in ~Rs7000-10,000/te of price increases in Q1 and subsequent moderation. The new base case glide path creates a higher EBITDA trajectory for FY22/23E and a better deleveraging and RoE profile for all sector participants. Along with that the increase in book value given the elevated earnings in FY22E leads to increase in our through cycle fair value for the names. To underline, we are still extremely cautious of the current spreads, but prices sustaining at US$1000 for a couple of quarters are having a disproportionate impact on leverage and RoE profile.

* Capex cycle not picking up with this kind of quick-fire upcycle. Spreads have recovered to all-time recorded highs in a span of 4 quarters and have helped deleveraging and expected deleveraging. While companies are actively looking out for acquisitions and organic capex, the rate of capex increase will not be as quick as the increase in spreads leading to deleveraging. This may create an enhanced window for balance sheets to remain comfortably leveraged for longer. This alone should enhance the through cycle RoEs and the through cycle P/B – we see such a case with JSPL.

* Chinese policy interventions to control production, continuation of Chinese demand stimuli and world ex-China restocking driving the pricing strength. Our interaction with the industry veterans across regions highlights the unsustainability of current prices. There is consensus on demand decline in China in H2CY21, and world ex-China restocking demand is creating a bull-whip effect on prices. Current iron ore prices are unsustainable and likely to correct. Yet, the high amplitude wave is creating value for most Indian steel players, improving their RoEs. Prudent balance sheet management hereon can remove the concerns that were visible for majority of players in the last cycle; can lead to further rerating.

* Based on our glide path net debt to EBITDA of the entire universe is ranging from 0.26-1.23x for FY23E. 0.26x is for JSPL and 1.23x is for Tata Steel. For Tata Steel this will be the lowest sustainable net debt to EBITDA seen from FY07 (since the acquisition of Corus). Any solution involving Europe can increase sustainable RoE and increase the attributable P/B. JSPL and SAIL are on course to become debt free by FY23E, if they stay on course. The key concern is whether incumbents will allow this accelerated deleveraging.

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