Shares of steelmakers have been under pressure of late and the pressure seems to have exacerbated in the wake of the Indian government's imposition of export duties on steel, steelmaking raw materials and intermediaries to preserve higher domestic supplies and control rising prices.
So now, most of the exports of steel and stainless steel will attract a 15 percent export duty now which was zero earlier. While the government's move is aimed at reining the soaring inflation, it is seen as bad for steelmakers.
"While we were expecting an EBITDA increase cycle to play out over the next three-four quarters in steel, the same has been interrupted. Downstream converter plays will be relatively less impacted by the move, in our view," said ICICI Securities.
Metal stocks have been melting in May so far. The BSE Metal index has fallen more than 18 percent in May so far against a 5 percent fall in the market benchmark Sensex.
The government action was unexpected and could result in a ₹5,000-7,000/te impact on EBITDA, the brokerage firm underscored.
"While the contours of the tax structures and the detailed earnings impact of the steel equities are yet to be known, it can be broadly assessed that ₹5,000-7,000/te of impact on EBITDA is very much possible on integrated steel players, while for unintegrated steel equities like JSW Steel the impact can be nearly ₹5,000/te. While there is an inclination to club this decline with the expected decline in EBITDA/te caused by cyclical factors, the same should be clearly demarcated," ICICI Securities said.
The fact is that the imposition of export duties does not address any issue related to the steel sector and instead adds to its worries.
"The measures did not address two things: (a) elevated international coking coal prices, and (b) how will the customers of steel (autos, real estate, infra, etc.) pass on the benefit to the end consumers? Will this lead to lower prices of housing, automobiles, and construction? We do not think so," said brokerage firm Motilal Oswal.
While the government's move may be a temporary one, Motilal Oswal believes this can adversely impact the valuation and the ability to invest in capacity growth in the long term.
"While steel companies can continue to export by paying 15 percent export duty and take a hit on their P&L (profit and loss) to the extent of exports, this can protect the domestic market from a significant price correction. However, steel producers have to ensure that no dumping happens in the domestic market. If this discipline is not maintained and the material is dumped in the domestic market, steel prices could correct sharply," said the brokerage firm.
Motilal Oswal underscored steel producers can resort to lower production if these measures are not withdrawn soon. The oversupply of steel in the domestic market can be arrested to that extent.
"Steel stocks under our coverage are currently trading in the range of 4-5 times FY23E EV/EBITDA. The industry is coming off from its best times in terms of profitability and is heading into a turbulent monsoon period where domestic demand is down, Chinese demand is adversely impacted by Covid-19 and coal prices are relentlessly high," said Motilal Oswal.
Deepak Jasani, Head of Retail Research, HDFC Securities also agreed that an export duty imposed on steel products is negative for the sector as it would weigh on domestic prices in an oversupplied market.
"Export duty hike on iron ore and a slight cut to coking coal import duty should provide some cost relief. Also, the possibility of a global recession could mean demand for metals could remain subdued and prices could remain depressed. In such a circumstance, steel stocks could suffer more due to valuation shrinkage than earnings shrinkage," said Jasani.
Rating agency ICRA believes the steel industry was hit by a moving train as the government imposed an export duty to reign in elevated prices.
ICRA pointed out that almost 95 percent of India’s finished steel export basket has been hit with 15 percent export duties; domestic steel prices could potentially correct by nearly 10-15 percent in the coming months as demand enters the seasonally weak monsoon quarter.
"Industry could now be on the way to an accelerated mean reversion as the operating environment becomes far less attractive in the coming weeks and months; expansion plans of many steelmakers could be impacted if the duties are maintained in the medium term," said ICRA.
What should investors do?
Soaring inflation, weak demand and now the imposition of export duty are not going to augur well for steelmakers. Analysts are advising to avoid steel companies. Some brokerages have started to downgrade the sector.
ICICI Securities sees the government's move as an extremely negative development for the steel sector and expects broad-based multiple de-rating.
"We downgrade steel and stainless equities under our coverage to either Hold, or reduce, or sell," said brokerage firm ICICI Securities.
ICICI Securities has downgraded Tata Steel, JSPL, JSW Steel and SAIL to 'reduce' and maintained 'buy' on APL Apollo.
"The impact of export tariffs on domestic steel supplies could be unfavorable for steel producers' margins. Because metal stocks are cyclical, we advise our clients to avoid them for at least the next year. Then we'll assess the economic situation and make our decision," said Akhilesh Jat, an analyst at CapitalVia Global Research.
Jat highlighted that the metal sector is currently facing numerous challenges, including a deteriorating global economic situation, a downturn in metal sectors, rising inflation, and rising interest rates.
"These factors are affecting metal demand, and on May 21, the Indian government announced an increase in export duties on many steel products from 30-50 percent. This increase in duties will further hamper margins, so we recommend waiting until green shoots appear in sectors," said Jat.
Disclaimer: The views and recommendations made above are those of individual analysts or broking firms and not of MintGenie.
