Steel-flat products -- No light at the end of the tunnel

Krishnan Thiagarajan

THE Indian steel industry had the first taste of recovery in the fourth quarter of 1999-2000, when international steel prices, especially of key flat products improved nearly 10-15 per cent over the previous quarter.

Coming as it did after a long spell of depressed steel prices and sluggish domestic demand, most of the Indian steel producers, in the public and private sector, exploited it to the hilt by exporting flat products in large volumes in the last two quarters of 1999-2000. As this price trend improved further in the first quarter of 2000-01, the financial performance of most steel majors began showing signs of a sustainable turnaround.

But this dream run for steel prices turned out to be an ephemeral one. After a relatively flat price trend in the second quarter, the prices nosedived in the third quarter of 2000-01, actually reaching the price range prevailing in the 1998-99 crisis. With the completion of this price reversal, what started off as a `virtuous uptrend' in early 2000 turned into a `vicious cycle' by end-2000. It is difficult to hazard a guess of the factors that contributed to the fickle behaviour of steel prices. But it appears that the combined impact of unused capacity in the international markets and the protective barriers raised by the developed countries have been the key factors dampening price sentiment in steel products, especially hot rolled coils, in the recent past.

Financial performance of steel majors: Among the steel majors, only Tata Iron and Steel Company (Tata Steel) proved to be the most resilient, riding on the price rise in the fourth quarter of 1999-2000 and the first quarter of 2000-01. At the same time, it managed to weather the flat price trends in the second quarter better than the rest of the industry.

The financial performance of Tata Steel in the first two quarters of 2000-01 is a study in contrast. In the second quarter, Tata Steel sales growth was sluggish at 9.5 per cent vis-a-vis a 21 per cent growth in the first quarter of 2000-01. However, the post-tax earnings growth was superior in the second quarter at 186 per cent compared to 161 per cent growth in the first quarter. While in the first quarter, the sales growth was fueled by higher sales volumes and realisations, in the second quarter, the improvement in the operating profit margins of Tata Steel was driven by cost-cutting exercises and improved product-mix.

Although all the other players such as Steel Authority of India, Essar Steel, Jindal Vijaynagar Steel and Ispat Industries also managed to capitalise on the price rise, in relative terms, their performance was several notches below that of Tata Steel in 1999-2000 and in the first six months of 2000-01.

Demand-supply dynamics: With the economy showing no signs of a sustainable recovery, ballooning fiscal deficit, lower spending on infrastructure and public projects and continued sluggishness among end-user segments such as automobiles or engineering, the depressed price trends that set in recently appears set to continue. This price trend may worsen in 2001-02, if the protectionist attitude of developed countries forces Indian steel producers to curtail exports, and at the same time, the domestic sales remain depressed.

Production: In 1999-2000, the production of finished steel increased to 27.17 million tonnes, from 23.82 million tonnes in 1998-99, translating into a 14-per cent growth during the year. While the production performance of integrated steel plants, namely SAIL and Tata Steel improved by 13.7 per cent and SAIL clearing its huge inventory, the secondary steel producers such as Essar, Jindal and Ispat performed even better, improving their production performance by 14.3 per cent. Among the flat products -- hot rolled (HR) coils, cold rolled (CR) coils and galvanised plain/galvanised corrugated (GP/GC) sheet segment, the product that hogged the limelight in production performance in 1999-2000 was HR coils. The HR coil production at 7.834 million tonnes improved nearly 34.6 per cent over the previous year, driven by sharp increases in performance by both the integrated and secondary steel producers.

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Demand: In response to this improved production performance, the domestic consumption of steel picked up after nearly two years of stagnation. According to the Performance Review of Iron and Steel, 1999-2000 by the Joint Plant Committee, constituted under the Ministry of Steel, the demand (or apparent consumption, namely, production + imports - exports) for steel recorded an increase of 7 per cent between 1998-99 and 1999-2000. Even on the demand front, the growth in domestic demand for flats exceeded that of longs by a big margin. Between 1996-97 and 1999-2000, the demand for flats increased by 23 per cent, while longs improved 7.5 per cent. This translates into an annualised demand growth of 7.3 per cent of flats against 2.5 per cent of longs.

Imports of prime grade and seconds/defectives : The saga of the minimum floor price regime, first introduced by the Ministry of Commerce in India in December 1998, showed signs of coming to an end in late 1999. In late 1999, the Directorate-General of Foreign Trade announced that the minimum floor prices for prime grade steel and seconds/defectives on a range of steel products were to be first lowered and finally withdrawn with effect from January 1, 2000. Practically all the steel majors protested against the move, claiming that it would sound the industry's death knell.

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Although this withdrawal came into effect on January 1, 2000, within two months, the domestic producers filed a petition in the Calcutta High Court against the Government on the issue of withdrawal of floor prices. In February, the High Court ruled that the withdrawal of the minimum import prices was ``not in the interest of the domestic industry'' and the floor prices were reinstated. In response to this judgment, the Government filed another case in the Supreme Court against the Calcutta High Court verdict and there stands the issue so far.

The import statistics furnished by the Joint Plant Committee and SAIL shows that the imports of seconds/defectives of HR coils, CR coils and GP/GC rose in 1999-2000 vis-a-vis the previous year. But that in itself is hardly justifies keeping the floor price mechanism in place for both prime grade and seconds/defectives. On the one hand, the Indian industry deeply resents the imposition of protection barriers by the US and the European Union on the imports of flat products from India, especially HR coils. On the other, these domestic producers in India favour the imposition of floor prices on different flat products to ensure that their domestic demand is not affected.

In the past couple of years, the Cold Rolled Manufacturers Association (Corsma), representing the interests of standalone CR manufacturers, has repeatedly made representations to the Government to have the floor prices withdrawn. Their contention is that through this floor price, the domestic steel majors are curtailing access to cheaper imports of HR coils, the key raw material for CR coils manufacture. However big the threat maybe for cheap imports, by keeping the floor price mechanism in place, India is sending the wrong signals to the world about the openness of its markets and its obligations under the WTO.

Investment outlook

The steel industry is still in the doldrums. After a fleeting price recovery that fueled exports in the first two quarters of 2000, the industry once again slipped into the sluggish mode.

Steel players continue to reel under the impact of operational and financial factors. On the operational front, the domestic steel manufacturers are still operating in an oversupply situation in key flat products, lacklustre growth in end-user domestic consumption, cost side pressures on the administered cost of inputs and poor labour productivity norms. Similarly, on the financial front, the bloated capital structure of most private sector steel producers left them with a huge interest burden and a high depreciation charge.

Integrated players: Despite a huge restructuring package approved by the Government for SAIL in February, SAIL continues to trade below par and is still unattractive from an investment standpoint. In the steel sector, the only stock attractive from the investment perspective is Tata Steel. The stock is a good investment candidate for investors with a medium-term perspective. Existing shareholders can stay invested, while fresh exposures can be contemplated at declines by investors aiming to diversify their investment portfolio.

Secondary players: The three key private sector steel producers -- Jindal Vijaynagar Steel (JVSL), Essar Steel and Ispat Industries -- are suffering on the interest and depreciation front. Even if one assumes these players are competitive on operating costs, they will be internationally competitive only if the financial institutions approve a financial restructuring plan. Among the first to approach the FIs with a novel and complex financial restructuring plan recently was Jindal Vijaynagar Steel. The three-tier restructuring plan involves capitalisation of debt into equity, conversion of existing equity into preference shares and linking interest costs to steel prices.

Even as JVSL's restructuring plan is under consideration by the FIs, there is growing clamour from Essar Steel and Ispat Industries for similar restructuring benefits. Given the complexity of the restructuring proposals and the price volatility in the steel markets, none of the three private sector steel producers (trading below par) is worthy of investment at this time.