Strong Global Prices
Global flat steel prices have been on an upswing over the past week. The barometer Black Sea price, has risen by over 20% over the past six weeks to its highest level in the past three months. Average spot prices for Quarter 3 FY20 in China and Europe are running ahead of Quarter 2 FY20 spreads, indicating the buoyant outlook.
Chinese net steel exports fell 17% YoY in Nov-19 to the lowest levels since January 2018. With strong Chinese demand, production pull back and Chinese steel inventory at multi-year lows, regional steel prices should hold up at least for the next three months (while the winter suspension in China is ongoing).
Domestic Outlook:
Steel exports were at a four-month low in November. This is quite significant as exports have fallen despite regional steel prices having rallied more than 10%. This may highlight improving domestic demand given steel companies are seemingly under less pressure now to export even as regional steel prices are surging.
Despite the consecutive steel price hikes in November and December, domestic prices are still at ~10% discount to landed Chinese prices (usually domestic prices are at 3-4% premium).
Given that we are entering the peak demand season for steel (until May) and there is a large price differential vs imports, domestic steel prices should firm up in the coming months.
Furthermore, input costs are on the decline. Prices of raw materials iron and coking coal have slipped. Iron ore, for instance, dropped by 15-17% over the past four months, while coking coal prices fell about 32% in the last six months.
This should help alleviate the pressure on operating margins in the near term. The only risk is that there could be disruption in iron ore supply next year, given issues with the Odisha iron ore mine auction. This could put an upward pressure on iron ore prices.
Which Stocks to Buy?
Steel stocks (TATA and JSW) have seen meaningful declines in both FII and local MF ownership in September quarter. With likely consensus earnings upgrade cycle, both stocks could see meaningful upside. If there is any disruption in the price of iron ore (due to Odisha auctions), integrated steel players like Tata Steel would benefit the most.
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