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3Q margins to expand; steel import parity suggests strong pricing support

Metal stocks have rallied 10-12% recently, driven by news-flows on China un-lockdown. China HRC steel futures have recovered sharply by ~15% from recent lows, given recent easing on real estate lending norms and anticipated un-lockdown. Indian secondary steel prices across products averaged INR1.5k-3k/t lower QoQ. Further, a decline in India export prices (7%) suggests an overall blended realisation decline of ~INR2k/t sequentially. However, a recent sharp surge in China export price (US$580/t) indicates that mills could have been done with the last of price cut announcements for now. Industry data points to an average consumption growth of ~8% over 2Q, though a repeat of 2Q volumes may be difficult given high base driven by inventory liquidation. Exports averaged 26% lower QoQ, while imports averaged 29% higher QoQ – this is likely to reverse going forward given removal of export duty and near zero price gap with import parity. Expected coking coal benefits could range between ~US$70-80/t in 3QFY23. This could result in a margin uplift of atleast ~INR4k/t QoQ. Given the drop in prices, de-leveraging numbers could be higher QoQ.

Improving spreads in 3Q and seasonally strong demand period in 4Q could further boost prospects. The sharp correction in steel price has rendered spreads negative for Chinese players. Recent removal of export duty, impending recovery in Chinese demand and a seasonally strong period for steel in 4Q could set the tone for a further rally in metal names. Tata Steel (sector leading spreads domestically) and Hindalco (structural earnings uptick in Novelis; smelter production curtailments in winter) remain our preferred picks in the metal space. JSP / SMEL, running into a seasonally strong construction period in 4Q, with a significantly de-leveraged balance sheet is likely to be further re-rated.

* Chinese demand to likely benefit from easing Covid policy: Chinese steel demand is expected to benefit from recent stimuls announced to aid the real estate sector and expectations of easing covid policy. Consequently, China HRC steel futures have recovered sharply by ~15% from recent lows. Near term demand is expected to remain adversely impacted with real estate starts down 38%YoY YTD (accounts for majority of steel demand). Demand is expected to improve in the medium term with likely easing of covid policy and improvement in real estate sector backed by recent stimulus announced.

* Spreads for Indian steel majors to expand: India HRC secondary steel prices averaged INR56.5k/t lower QoQ, while rebar averaged INR49.3k/t QoQ during 3QTD. India export prices of steel declined further by 7% during the quarter. JPC steel industry data points to a average consumption growth of 10% over 2QFY23. Exports averaged 26% lower QoQ, while imports averaged 29% higher QoQ. Consequently, blended realisation for India steel companies is set to average INR4-6k/t lower sequentially. Expected coking coal benefits to range ~US$100/t in 3QFY23, this will likely aid margins for steel companies which are set to recover sharply by ~INR6k/t QoQ as per our estimate. Given the drop in both finished product and raw material prices, we expect companies in our metal universe to report higher de-leveraging numbers QoQ.

* WSA Oct’22 outlook indicates relatively stronger demand for Indian steel: World Steel Association’s Oct’22 short range outlook indicates a 2.3% YoY decline in steel demand during 2022 to 1.79 bn tons (vs earlier estimates of 1.84 bn tons) with Chinese demand expected to decline 4% YoY to 914 mn tons (vs earlier estimates of 952 mn tons) while Indian demand is expected to increase 6.1% YoY to 113 mn tons (vs earlier estimates of 114 mn tons). World demand for steel is expected to marginally increase by 1% YoY in 2023 to 1.82 bn tons (vs earlier estimates of 1.88 bn tons) with Chinese demand expected to remain flat at 914 mn tons (vs earlier estimates of 962 mn tons) while Indian demand is expected to increase by 6.7% YoY to 120 mn tons (vs earlier estimates of 121 mn tons).

* TATA / JSP preferred name in ferrous space; HNDL top-pick: Metal stocks have rallied 10-12% recently, driven by news-flows on China un-lockdown. Recent removal of export duty, impending recovery in Chinese demand and a seasonally strong period for steel in 4Q could set the tone for a further rally in metal names. Tata Steel (sector leading spreads domestically) and Hindalco (structural earnings uptick in Novelis; smelter production curtailments in winter) remain our preferred picks in the metal space. JSP, running in to a seasonally strong construction period in 4Q, with a significantly de-leveraged balance sheet is likely to be further re-rated.

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