Pullouts could benefit the Indian steel sector

Fri, 2 Aug Pre-Open

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Global steel behemoths ArcelorMittal and Posco pulled out of their plans to set up capacities in India recently. The reasons for the same are ones that add to the grim picture of India's dented image as an attractive foreign direct investment destination. Long delays on the back of issues like protests, land acquisitions and tying up requirements (coke and iron ore availability as well as power linkages) for the steel manufacturing process are believed to be the key reasons for their decision.

With these global steel players pulling out, it may however provide some relief to the Indian steel manufacturers. Especially since they have been and will be expanding aggressively.

India's steel capacity stood at about 91 m tonnes per annum (mtpa) as of December 2012. At the end of FY12 it stood at 89 mtpa. With utilisation levels of 83%, the country managed to produce only 73.8 mtpa in FY12. The major Indian players namely SAIL, Tata Steel and JSW Steel have combined capacities of about 35 MTPA at present; thereby controlling a significant share of the market. Once their ongoing expansion plans get commissioned, it would take the country's installed capacity beyond the 100 mtpa mark.

ArcelorMittal and Posco had initial plans to add about 18 mtpa of capacity combined. This would have upped India's capacity built up substantially; possibly leading to a situation of overcapacity (India currently is a net importer) and would have eventually put pressure on prices. As such, this development can be viewed as a positive development for the Indian steel manufacturers.

So what should investors do?

The BSE-Metal Index is down by 38% since the start of the year. With this sharp decline, steel stocks are trading at very attractive valuations; with many of the players trading way below their respective book values! Sticking with the largest companies is not an approach that would be preferred. This we say due to select companies not having efficient operations, while select stocks are no more pure India centric plays.

Steel sector is a cyclical one. With the sector being going through a down cycle phase, one ideally needs to wait for signs of the cycle turning around. With reducing steel prices, poor growth prospects and possibility of India becoming a net exporter in sometime, the outlook does seem grim. Best approach may be for investors to take a wait and watch approach, we believe.