CLSA maintains a cautious stance on the Indian steel sector despite the recent rally in metals. They point out several reasons for their concern, including a shift in profit distribution towards miners, expectations of reduced spreads compared to previous periods, and high stock valuations not aligned with anticipated spread compression, which isn’t reflected in consensus estimates.
Tata Steel has been downgraded by CLSA from ‘outperform’ to ‘sell’, with the target price cut to Rs 135 from Rs 145. Similarly, JSW Steel’s rating has been lowered from ‘underperform’ to ‘sell’, with the target price revised to Rs 730 from Rs 810. Despite expectations of robust volume growth due to capacity expansion over the next two years, CLSA predicts lower margins for both companies due to weaker spreads.
However, JSPL retains an ‘underperform’ rating from CLSA, acknowledging its relatively better position due to margin expansion projects, even amidst weaker industry spreads. The brokerage has raised JSPL’s target price to Rs 840 from Rs 820 per share.
CLSA also warns about the potential impact of India’s rapid blast furnace-based steel capacity expansion, foreseeing lower spreads and a shift towards raw materials. They anticipate the spread for FY25/26CL to be at $360 a tonne, below the 10-year average, attributing it to surplus supply, increased exports, and domestic steel prices likely below import parity.
Furthermore, higher steel production might strain iron ore and coking coal supply despite efforts to increase captive iron ore mines. India’s role in the coking coal balance and rising demand could offset China’s avoidance of Australian coal. CLSA highlights a shift in the dynamics of the steel sector, noting rising valuations driven by optimistic demand outlook and expectations of Chinese stimulus over the past 18 months. However, they caution that consensus estimates for profitability in FY25-26 might be overly optimistic. The potential impact of China’s stimulus remains a key risk factor, affecting Indian mills based on sustained or weak demand.
Lastly, CLSA points out potential positive surprises in China’s policy continuity, as current spreads in China are at unsustainable lows. If spread improvement occurs due to lower costs, favoring Mongolia, Indian mills could face challenges, concludes the report.
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