JSW Steel: Falling flat

The stock of JSW Steel has fallen 27 per cent since our buy call last September. This mirrors the deterioration in the steel major’s financial performance. Posting a fourth consecutive quarter of declining revenue and operating profit, JSW Steel reported revenue of ₹10,907 crore and operating profit of ₹1,729 crore in the September 2015 quarter.

These were down 22 per cent and 39 per cent, respectively, compared with the year-ago period. Net profit was down 84 per cent to ₹117 crore. The surge in cheap steel imports from countries, such as China, Japan and Korea has hurt the realisations of domestic steel manufacturers, such as JSW Steel.

After the price fall, the stock trades relatively cheap. At ₹916, it quotes at one time its consolidated book value as on March 2015, lower than its five-year average valuation of 1.3 times. But investors can consider selling the stock given that global steel prices are likely to remain weak, putting pressure on domestic prices. Also, while domestic steel consumption has improved, the sustainability of this increase remains to be seen. After growing at 3.9 per cent year-on-year during 2014-15, domestic steel demand grew at 7 per cent in the June 2015 quarter. This was then followed by two months of sub-1 per cent growth, picking up to 5 per cent in September.

After rising 71 per cent to over nine million tonnes in 2014-15, steel imports into India rose a further 53 per cent in the June 2015 quarter. So, even as domestic steel consumption grew, a large part of this increase in demand was met from imports. For instance, during the June quarter, as against an incremental consumption of 1.3 million tonnes, incremental steel imports totalled 0.9 million tonnes.

And, while imposition of the 20 per cent safeguard duty on imports of certain flat steel products since mid-September offers some protection, the impact may be limited.

One, as of now, the duty has been imposed for only 200 days until the Directorate General of Safeguards completes its enquiry. Two, the duty applies only to certain categories of flat products, leaving others outside its coverage. Some of these duty-exempt products can serve as substitutes for those on which duty has been imposed.

Moreover, international steel prices continue to remain under pressure. Steel exports (hot-rolled products) from China, which produces half the world’s steel, are cheaper by 38 per cent since the start of this year and 5 per cent since September. The country produces half the world’s steel. With steel demand in China, which is also the world’s largest consumer, expected to contract 3.5 per cent in 2015 and 2 per cent in 2016, the gap between global demand and supply and the weakness in steel prices are likely to continue.

This, in turn, would keep steel realisations under pressure, impacting the company’s profitability, as has been the case so far. In fact, despite the fall in raw material cost, JSW Steel’s operating profit has been on the slide since the September 2014 quarter.

In the latest September quarter too, helped by the greater use of cheaper domestic iron ore as the company liquidated the old stock of costlier imported iron ore, raw material costs eased. But the company’s operating profit (EBITDA) per tonne of steel, a key performance metric, shrank to ₹4,909 during the quarter, down 38 per cent from the same period a year ago.

JSW Steel has, in fact, been reporting a year-on-year decline in its EBITDA per tonne since the December 2014 quarter. This has been despite the company’s efforts to increase its share of high-margin value-added steel products, such as specialised automotive and electrical steels to bump up its realisations.

Value-added products accounted for 35 per cent of JSW Steel’s total sales volume in the June quarter (latest available data), up from 29 per cent a year ago.

Not just that, to beat the slowdown in global steel demand, JSW Steel has been increasingly shifting focus towards the relatively better domestic market.

Here, higher demand from some key user industries such as automobiles, has been a positive. But a sustainable increase in overall steel consumption helped by higher public spending has not yet set in.

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