Coking coal price spurt to pare profitability of steel makers

Mumbai, Nov 2 (SocialNews.XYZ) The operating margin of primary steelmakers will reduce by a third to 24-26 per cent in the second half of this fiscal, versus the first half as input cost soars owing to over two time rise in coking coal prices since July.

However, for the full fiscal, the operating margin will average a robust 31-32 per cent, a good 400 basis points (bps) higher than in last fiscal, due to a strong first half that saw healthy steel prices and moderate input costs.

The consequent robust accruals will support increased capital expenditure, continued deleveraging and strengthening of balance sheets, a Crisil study of the top five steelmakers, which account for 58 per cent of domestic production, shows.

Global coking coal prices have rallied strongly since July, rising from $175 per tonne in June to $400 per tonne in October, mainly due to disruptions in the Australian and Chinese mines, and logistical issues such as freight and container unavailability, amid healthy demand from global steel producers, especially ex-China.

The prices are expected to ease only gradually as supply takes time to ramp up. Given that domestic primary steelproducers rely mainly on imported coking coal, their production costs will rise sharply.

In contrast, iron ore, the other key raw material that accounts for 15-20 per cent of the cost of production, is entirely met from domestic sources (captive plus merchant supplies). Although global iron ore prices have fallen 60 per cent between July and October, domestic prices have fallen only 30 per cent as supply continues to be tight.

Crisil Ratings Director Naveen Vaidyanathan said: "The surge in coking coal prices, which account for about a third of the total cost of production, will materially elevate cost pressures for domestic primary steel makers. At the same time, the fall in domestic iron ore prices has been significantly lower than the increase in coking coal prices, thereby providing limited cushion. These factors will lead to an overall increase in cost of production by 30 per cent for domestic steelmakers in the second half of the fiscal."

Global steel prices - after rallying in the first half of this fiscal by 1.8x the average price last fiscal - are expected to remain healthy in the second half. While prices were supported by strong demand and costlier iron ore in the first half, the second half will see more supply cuts in China as part of green initiatives there, and higher coal costs. Prices are expected to average $850-900 per tonne this fiscal, more than 60 per cent higher on-year.

Domestic steel prices, which are significantly driven by the landed cost of imports, have also continued to be strong despite some moderation in the second quarter of this fiscal due to weak domestic demand amid the second wave.

Further, healthy global realisations, strong domestic demand growth (14-16 epr cent on-year this fiscal), high export potential and increased cost of production are expected to prop domestic prices during second half of the fiscal.

Crisil Ratings Team Leader Ankush Tyagi said: "Although domestic steel prices are expected to remain strong, further upside from current levels could be limited because the discount of domestic steel prices to the landed cost of imports has already reduced to 15 per cent in October from 25 per cent at the beginning of the fiscal.

"Also, players could witness challenges in taking steep price hikes in the domestic market due to the nascent economic recovery. This, along with increased cost of production, could reduce operating margins to 24-26 per cent in the second half against an estimated 35-37 per cent in the first half. That said, the average operating margin for the fiscal could still be 350-400 bps higher than 27.5 per cent last fiscal."

Healthy annual accruals should support planned capex towards capacity expansion and also strengthen the balance sheet of the players. Net debt-to-Ebitda is expected to be less than 1 time this fiscal against 1.9 times last fiscal, whereas interest cover will increase to more than 8.5 times, almost double from last fiscal.

A sharper-than-expected correction in global steel prices, weaker global demand, significantly higher-than-expected input costs would be the key monitorables from here.

Source: IANS