ICRA, in its latest research note on the steel sector, expects the imposition of sanctions on Russia to impact domestic steel companies in terms of elevated input costs for some time till raw material trade flows readjust.
Being the fifth largest global coal producer, Russia accounted for 10 percent and 17 percent of the international trade in metallurgical and thermal coals respectively in CY2020.
Since the start of FY2022, international coal prices have already rallied quite sharply, with spot prices of premium hard coking coal (Free on Board Australia basis) and high-grade thermal coal (FoB South Africa basis) increasing by 300 percent and 125 percent respectively.
Elevated coal costs have started to nibble at the margins of listed steelmakers from Q3 FY2022, as earnings trended downwards from the high watermark of Q2 FY2022.
In addition, Russia is the third-largest global producer of nickel, a key raw material used in stainless steel production and, along with Ukraine, Russia is also a leading global exporter of iron ore pellets.
Supply disruptions of these key steelmaking raw materials, where Russia is a key global supplier, would lead to heightened input cost pressures for Indian steel companies.
Elaborating on this, Jayanta Roy, Senior Vice-President & Group Head, Corporate Sector Ratings, ICRA, said, “After reporting a steep 65-70 percent sequential increase in cost of coking coal in Q3 FY2022, a further increase of 15 percent QoQ is expected in the fourth quarter. Though price of iron ore has moderated somewhat from the highs of Q3, and domestic mills have announced some steel price hikes from late January 2022, these will not be able to entirely compensate for the steep rise in coking coal costs.
"The ongoing conflict in Eastern Europe could further exert input cost pressures on domestic steel mills, which makes us believe that the gross spreads for a primary steel producer, who is dependent on market purchase of raw material, would be sequentially lower by around 15 percent in the current quarter, and the industry’s fourth quarter earnings would be lower than Q3 FY2022 level. Nevertheless, in absolute terms, the industry’s earnings are expected to remain at healthy levels in the next 12 months, leading us to maintain a Positive outlook for the sector.”
Apart from supplying several steelmaking raw materials, Russia and Ukraine are the 5th and 12th largest steelmakers in the world respectively, cumulatively accounting for around 10 percent of the global steel trade.
Around 45 percent of the steel production from Russia and around 75 percent from Ukraine are exported to other nations. This could lead to regional steel supply shortages as Russian mills brace for sanctions and Ukrainian steel production gets severely disrupted by the conflict. Therefore, in the export markets, leading Indian steel companies can expect to see some market-share gains if they can further increase their capacity utilisation levels.
“Reduced market access for Russian steel mills could help Indian steel producers increase footprint in geographies like Europe and the Middle-East, where the C.I.S countries cumulatively exports around 22-23 million tonnes of steel annually. Indian mills could also vie to have a greater footprint in the USA, where Russia is a key supplier, and where the presence of Indian steel companies is fairly limited so far. However, extent of export would be limited by the already high capacity utilisation levels of leading steel companies in India,” Roy added.
Following the outbreak of the second wave at the start of the current fiscal, and the Omicron outbreak subsequently in November 2021, domestic steel demand recovered from these setbacks and started to register a healthy sequential pick-up from December 2021 as construction activity gathered momentum. Monthly domestic steel consumption crossed 10 million tonne in January 2022, the highest level recorded in the last eleven months.
With the Government making a strong push for infrastructure led growth in the country centered around the Gati Shakti Master Plan in core sectors like railways, roadways, multimodal logistics parks, and energy, domestic steel demand is expected to grow at a healthy rate of 7-8 percent in FY2023 on the back of an estimated growth of 11-12 percent in FY2022 and a contraction of 6.0 percent in FY2021.
The metals meltdown of FY2016 led to a prolonged industry downturn which persisted for several years, making both lenders and steel mills cautious on new investment projects. However, after a gap of eight years, with the industry’s capacity utilisation poised to touch 80 percent in FY2023 again, new investment activity has seen a rebound as lenders redraw their negative list for sectors following the earnings surge of steel companies.
In the next five years (FY2022 – FY2026), India’s steel capacity is likely to increase by 40 million tonne per annum (mtpa), which is almost double the quantum of capacity added during the previous five-year period spanning from FY2017 – FY2021. However, notwithstanding these sizeable expansion plans, given the deleveraging that has happened and the healthy cash flows likely to be enjoyed, the steel industry today is more resilient to withstand project related risks, which had significantly weakened the sectors’ credit profile during the previous capex cycle of FY2012-FY2016.
Moreover, with the capital deployment for these upcoming projects remaining relatively modest during the initial years of implementation, the industry’s (Sample of 21 listed steel companies comprising 55 percent of industry capacity) key leverage ratio of total debt/ OPBITDA (Operating profit before interest, tax, depreciation, and amortization) is expected to remain at a comfortable one-time in FY2023.