India Ratings market wire on steel sector

Volatile Coking Coal Prices May Put Pressure on Steel Sector Spreads

The volatility in input cost, mainly coking coal prices is likely to keep the steel sector spreads (difference between price and raw material cost) under pressure in FY18, says India Ratings and Research (Ind-Ra). The price of coking coal, a key raw material restarted its up move in April 2017, after softening from the elevated levels of November 2016. Ind-Ra believes the recent surge in prices is temporary and it may soften in the near term, however its unlikely to correct significantly in FY18.

Ind-Ra had highlighted in the report ‘FY18 Steel Outlook: Increased Government Spending will be the Key’ that the softening of input cost would be a key determinant for the steel sector’s profitability. However, price of coking coal has surged by 100% to around USD310/t in April 2017 mom.

Ind-Ra believes this may not be fully passed on and could impact profitability in 2QFY18, as for domestic steel producers it takes around two to three months from order to consumption. The sudden surge in coking coal prices in April 2017, is on account of the disruption in exports from Australia a major exporter of coal, due to a cyclone which damaged railway lines connecting mines.

Ind-Ra believes that the current situation in Australia is temporary and once the supply situation eases, regular coking coal prices will correct from the current peak, however it may not decline to the lows of USD75/t witnessed in January 2016. However, if coking coal prices remain high without the commensurate opportunity for the players to pass on the increased cost during FY18, the profitability could be severely impacted.

Input prices were volatile even in FY17, with coking coal prices surging 310% between January 2016-November 2016 to USD308/t and thereafter correcting to around USD150/t in March 2017. Despite a correction of around 50%, it remained significantly higher than the low of around USD75/t in January 2016.

The exponential surge in input cost can led to a decline in spreads between realisation and raw material prices by around USD40/t-USD50/t in 4QFY17, since the increase in cost could not be fully passed on to the end consumer due to the oversupply situation. The likely impact of the exponential surge in coking coal price in 3QFY17 would have been felt in 4QFY17.

The surge in raw material prices have pushed both international and domestic finished steel prices close to the limits imposed by anti-dumping duty which has now been recommended by Directorate General of Anti-dumping and Allied Duties for five years at marginally higher rates, pending the final notification.

The sustained high prices in finished steel in response to the increase in input cost can make the protection infructuous, as the domestic steel sector will open up for international competition and will have a fallout on the profitability of domestic players.

Ind-Ra believes that companies producing a higher proportion of steel through the blast furnace route with a dependence on imported coking coal will be hurt more than players with access to domestic sources of coking coal or those producing steel through the direct-reduced iron route.

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