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India's Steel sector profits may fall in Q2 FY20: report

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MUMBAI (Scrap Register): Over the last four quarters, operating profit margins of India's domestic steel industry have been on a slippery ground, declining steadily from 22.6%1 in Q1 FY2019 to 18.2% in Q1 FY2020.

Downward trend in India's steel sector profitability is expected to continue in Q2 FY2020, as steel margins get further squeezed between weakening domestic steel consumption, and a weak outlook for global growth amidst escalating trade war related tensions, rating agency ICRA said in its latest report.

Elaborating further, Jayanta Roy, Senior Vice-President & Group Head, Corporate Sector Ratings, ICRA, says “Steel prices have been retreating southwards across most steel consuming hubs globally, be it the USA, the European Union or Asia. We have seen Chinese hot rolled coil spot export offers declining by around 13% since the start of FY2020. Spot HRC prices by end-August 2019 hovered at around US$ 462/MT, levels last seen during June 2017, when much of the industry was in distress. Not surprisingly, the steel spreads have witnessed a significant contraction in FY2020 thus far compared to FY2019. This leads us to believe that in the current fiscal, unless steelmakers are able to supplement weaker margins with higher sale volumes, a decline in industry earnings over the FY2019 highs remains likely.”

Surprising most market participants, the Indian economy grew at only 5.0% in Q1 FY2020, the lowest levels in the last six years. With steel demand growth being dependant on GDP growth, domestic steel consumption growth slowed down to 5.7% in April – July of FY2020, against much higher growth rates of 7.5% and 7.9%, achieved in FY2019 and FY2018 respectively. Further, given the slower pace of infrastructure and construction activity during the ongoing monsoon season, and with auto sales continuing to contract in July and August of 2019, early lead indicators for a steel demand uptick in Q2 FY2020 remain weak.

Official statistics indicate that domestic steel consumption growth weakened from 6.4% in June 2019 to 3.5% in July 2019, and this weakness is expected to continue for the remainder of Q2, the agency said.

In this regard, Roy adds, “The positive impact of recent policy actions of the Central Government would be gradually visible over the course of the second half of the current fiscal. However, unless infrastructure spending picks up in a major way, achieving a 7.0% steel consumption growth in the current fiscal looks challenging. In our view, a 5.0-6.0% consumption growth would be a more realistic target that the industry can look at in FY2020.”

On the positive side, the significant fall in prices of coking coal, which accounts for around 40% of the cost of steelmaking, remains a silver lining for the domestic blast furnace operators, ICRA said.

Seaborne coking coal spot prices plummeted by a steep 25% between May and August of 2019. Given a lead time of around two months for coking coal procurement, the benefit of this price drop is expected to fully flow in the margins of domestic steelmakers from the ensuing third quarter.

ICRA’s analysis suggests that the steel spreads for a domestic blast furnace based flat steel producer in Q2 FY2020 are expected to be sequentially weaker by around US$ 25-30/MT over Q1 FY2020, largely dragged by softer steel prices. However, the benefit derived from lower coking coal consumption cost is expected to sequentially increase spreads by US$ 35-40/MT in the third quarter, more than compensating for the drop witnessed in the second quarter. Consequently, after deteriorating in Q2 FY2020, the industry’s profitability and debt coverage metrics are expected to improve somewhat from Q3 FY2020. Nevertheless, the industry’s operating and net margins would be weaker in FY2020 than the FY2019 levels in ICRA’s opinion, the report said.

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