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3Q to be a soft quarter for steel; non-ferrous relatively better positioned

Chinese domestic HRC steel price has undergone a significant 11% correction from 2Q average to US$794/t in 3Q and US$770 spot driven by a) complete melt down in cost curve – iron ore price corrected 35% QoQ to average US$103 China CFR; alongside a sharp correction in Chinese coking coal price led by regulator intervention b) weak demand across end user segments in China. The only saving grace in the Chinese steel landscape has been the dramatic cut down in production from a monthly high of 100mn tons in May’21 to 69mn tons in Nov’21, driven by carbon emission norms / pollution curbs. This rigorous supply side discipline has ensured that the surplus production over consumption remained a small quantum, resulting in muted exports out of China (sharply below the 5 mn ton benchmark – 3.4 mn tons of flats+longs for Nov’21) despite Chinese steel prices being at a discount to global steel prices.

Contrary to Chinese steel prices, Indian steel HRC dealer price moved up from an average of INR66k to INR68k spot driven by 1) a restocking cycle post monsoon season 2) significantly higher coking coal price. Exports during 3QFY22 QTD stood 38% down implying higher reliance on domestic sales. We expect blended realisations to increase only by INR500- 700/ton given weaker mill realisations, lower export prices and lower price spread in the value added product chain (CRC-HRC). An expected US$100/t increase in coking coal cost, partially offset by lower domestic iron ore prices is likely to keep the EBITDA/ton fall contained to INR3k/ton for most companies, in our view. We remain cautious on the steel sector given the extra-ordinary volatility in global prices / raw mat. and constant re-alignment of spreads at this juncture. We recommend exposure to select names – HNDL/TATA/JSP and await further stability in prices before recommending any bottom-fishing in steel names.

* China’s production curbs the only barrier to export threat: Chinese domestic HRC steel price has undergone a significant 11% correction from a 2Q average of US$891/t to US$794/t in 3Q and US$770 in spot as a function of a) complete melt down in cost curve – iron ore price corrected from US$159/t to US$103 in 2Q and US$81/t spot; alongside a sharp correction in Chinese coking coal price as the regulator intervened with a price cap on thermal coal to resolve the electricity crisis b) weak demand – China’s real estate starts stood 9% down YoY YTD, excavator sales down 37% YoY YTD, vehicle sales down 9% YoY YTD and appliance sales down 6% YoY YTD as at end Nov’21. The only saving grace in the Chinese steel landscape has been the dramatic cut down in production from a monthly high of 100mn tons in May’21 to 69mn tons in Nov’21, driven by carbon emission norms / pollution curbs. This rigorous supply side discipline has ensured that the surplus production over consumption remained a small quantum, resulting in muted exports out of China (below the 5 mn ton benchmark – 3.4 mn tons of flats+longs in Nov’21) despite Chinese steel prices being at a discount to global steel prices by a significant margin. Chinese steel inventory stood at 10.2mn tons as at end Nov’21 (down MoM/YoY) vs recent highs of 16mn tons in Jul’21.

* 3Q to be a soft quarter for steel; non-ferrous relatively better positioned: Contrary to Chinese steel prices, Indian steel HRC dealer price moved up from an average of INR66k to INR68k spot driven by 1) a restocking cycle post monsoon season 2) significantly higher coking coal price. Exports during 3QFY22 QTD stood 38% down implying higher reliance on domestic sales. We expect blended realisations to increase only by INR500-700/ton given weaker mill realisations, lower export prices and lower price spread in the value added product chain (CRC-HRC). An expected US$100/t increase in coking coal cost, partially offset by lower domestic iron ore prices is likely to keep the EBITDA/ton fall contained to INR3k/ton for most companies, in our view. We expect 3Q to be a soft quarter volume wise. De-leveraging is likely to be impacted by higher working capital requirement during the quarter (higher coking coal price). Non-ferrous names are expected to deliver a relatively stronger set of numbers with higher commodity prices, higher volumes offsetting the increase in energy costs / inflation QoQ.

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