Steel on a structural mend

After a prolonged hiatus, the steel sector’s fortunes have started to look up as domestic demand revives and resolution of stressed assets referred to the National Company Law Tribunal (NCLT) under the Insolvency and Bankruptcy Code gathers pace.

The sector had a sedate run in the five fiscals through 2018, when domestic demand logged a compound annual growth rate (CAGR) of just 4.3 per cent, lagging growth in gross domestic product. The lone aberration was fiscal 2018, when demand spurted 7.8 per cent, led by the flat steel and alloy steel segments, but on a low base given demonetisation in the previous fiscal.

In the next five fiscals, demand is expected to clock a CAGR of 6-6.5 per cent .

Growth will ride on a pick-up in infrastructure projects, some revival in housing, and robust growth in the automotive and consumer goods sectors. Government-led initiatives in affordable housing, railways, metros, water supply and sanitation, and road development under Bharatmala would be the key drivers.

Resolutions under NCLT would be an added spur. Around 22 million tonnes (mt), or a fifth of India’s crude steel capacity, is expected to swing to larger domestic and/or international players as part of the first round of stressed assets resolution under NCLT, altering the very landscape.

This is expected to boost working capital and liquidity management, leading to improvement in utilisation levels.

The five companies referred under NCLT I have been operating at abysmally low utilisation levels, of less than 60 per cent. Compare this with large players, which typically operate at over 90 per cent utilisation.

The capex cycle

What’s more, in the last few years demand growth has been typically preceded by supply additions — a trend that could potentially reverse in the near to medium term, yielding a positive run-up for utilisations.

The capex cycle in the last five years was defined by a mix of brownfield and greenfield capacity additions, involving high capital costs and extended timelines.

Acquisition of the 22 mt of underutilised capacities, which also have a brownfield capacity expansion potential of another 20 mt, will redefine the upcoming capex cycle in two ways: One, the aggregate capacity additions will nearly halve to 18-20 mt in the next five years, compared with 36 mt in the past five years.

Two, these capacities would largely be brownfield in nature and, thereby, be characterised by lower capital costs — typically, brownfield capex expansion costs half that of a greenfield set-up — and lower turnaround time.

Another interesting event can potentially unfold in the flat steel segment with NCLT I resolution, in terms of the sector getting more consolidated and being controlled by fewer players.

India’s flat steel market is dominated by six players that account for 85 per cent of the capacity, with the rest distributed between smaller players and re-rollers. Of these six, three are currently part of the NCLT I resolution process. In other words, these are being eyed by large domestic and international steel makers for expansion or entry strategies.

Based on various acquisition scenarios, the flat steel market in India is expected to consolidate further (85 per cent controlled by six players, currently) to anywhere between three and four players.

Further, with a few flat re-rollers being referred to NCLT, even these assets can be acquired by the large players, thereby strengthening their position. As the dynamics of a more consolidated industry play out in the flat steel space, the spreads between landed and domestic prices are expected to narrow. Higher utilisation and volumes, coupled with better pricing, augur well for the profitability of large players.

The flip-side

On the flip-side, if the consequent rise in prices hurts consumers, there is a risk of the government intervening. Global prices would also have a bearing, as will domestic demand and supply.

Resolution of steel companies in first and second round of NCLT will provide relief to bankers, given that these are among their larger stressed assets and constitute more than half of the steel sector’s outstanding credit (₹3.26-lakh crore as of March 2018).

The key hurdle would be in resolving the balance part, which is distributed over several smaller steel units that typically operate in sponge iron, long steel, and non-value-added alloy steel segments.

The writer is Director, CRISIL Research.

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