The steel sector, which has been facing headwinds in the past year, continued to report disappointing results in Q2FY25. The sector reported a 6/46 per cent year-on-year decline in revenue and PAT for this period and key stocks (JSW, Jindal Steel, Tata Steel and SAIL) in this space have corrected 6-15 per cent in the last one month.

The weakness stems from steel pricing despite strong demand and cost structure turning favourable. However, the sector valuations have held on to optimism on expectation of a recovery in steel prices (see ‘Valuation and Outlook’). To provide a direction to investors in steel stocks, we analyse the primary headwinds and the outlook for the sector.

Demand side pull and China factor

Thanks to the post-Covid recovery, the finished steel consumption in the country grew at 13 per cent CAGR in the last three years to 136 mtpa (million tonnes per annum). Consumption has sustained at a similar 11 per cent year-on-year growth in H1FY25. Thus, the demand side pull has been strong and is expected to sustain post the monsoon season. Recovery in government spending, which slowed on account of elections earlier this year, is also expected to help.

For the long term, steel consumption is expected to sustain 9-10 per cent yearly growth (deriving from GDP growth and steel consumption multiplier ranging from 1.1-1.2 times). Indian per capita steel consumption at 97 kg significantly trails even global average at 220 kg per capita and can be expected to undergo long stretches of high growth.

Indian steel supply has kept pace with the demand and with an eye on the long term, steelmakers have announced large expansion plans as well, which will be commissioned in the next three years.

Despite strong demand and steadily expanding domestic supply, steel prices have constantly declined in the last two years. Post Covid, steel prices rallied to 85,000 per tonne levels by mid-2022 and steadily declined to 60,000-levels by March 2024. The correction continues into FY25 with prices dipping below 50,000-levels currently. While earlier correction was influenced by a global fall in prices, the recent slip has been on account of excessive Chinese exports.

Steel exports from China to the World topped 11 million tonnes (mt) in October 2024, which is closer to its earlier peak reached in 2015. This destroyed steel prices globally and India imposed Anti-dumping duty (ADD) starting from mid-2016 to protect its domestic industry. Without any such protection now, the domestic prices have continued to decline in the current period.

The glut in exports and that too at a significant discount to domestic prices is a double blow to steel realisations. The most-recent steel exports were at around $500 per tonne. Considering that the cost of coal ($250 per tonne of coal), logistics and other expenses (around $250 per tonne of steel), iron ore ($100 per tonne of iron ore), asset financing and depreciation costs, the export prices can barely cover cost of production and is essentially aimed at covering at least the fixed costs. The slump in real estate activity in China and a steel production capacity of 1,000 mtpa has been the main driver of exports. Going by the weak response to the recently-announced fiscal stimulus in China, the focus on exports may not change.

The Indian government is currently investigating a need for ADD, having received representations from the steel industry. With exports from China rising, other countries will also be evaluating on similar lines. This implies that global steel trade will move towards low-tariff regimes. In the meantime, Trump’s second term also implies a high degree of import tariffs on Chinese products. This would further increase the coming of steel into India unless an equilibrium though tariff regime is put in place. Overall, the next two-three months will likely increase the volatility in steel trade and the current declining trend in prices should be expected to continue in the short term.

Lower cost of production

Coal followed by iron ore and other expenses such as power and logistics are the leading costs for steel production and lower costs are currently offsetting the lower realisations to an extent.

The cost of coal has declined to $230-250 per tonne from the earlier range of $300 per tonne. With the global demand slowdown and deflation in China softening the commodity rally, the cost of raw material (RM) can be favourable to the steel industry. But iron ore prices have risen. As per NMDC, the price of iron ore has increased 22 per cent in the last one year. Other expenses, which include power, logistics and other commodities, have also increased over the past year. Overall, the EBITDA margins have shrunk by an average of 60 bps in Q2FY25, primarily offset by improved RM costs.

Operational leverage, RM linkages and the presence of a value-added portfolio are the other qualitative factors shielding margin compression despite a sharp correction in realisations. Capacity expansion is in progress and the companies have started realising a gradual improvement in capacities. Utilisation is currently at a healthy 80 per cent for the industry. This has improved operational leverage. Companies are also investing in raw material linkages. JSW Steel has commissioned iron ore and coal mines in Karnataka, Odisha and Goa, which has aided lower costs. Jindal Steel similarly acquired four coal mines and has ramped up production, leading to lower coal procurement in the open markets. Companies’ investments in renewable energy is also adding to lower cost of production.

Tata Steel commissioning a new cold rolling mill, Jindal with increasing deliveries to automobiles and construction sectors, and JSW Steel’s 60 per cent sales from value-added portfolio is another lever utilised by the domestic industry to improve margins. This also lowers reliance on imported steel, which, apart from regular steel, also serves high-end applications with alloys, TMTs and steel for electrical infrastructure. JSW Steel has recently acquired technology for manufacturing steel for transformers, aimed at increasing value-added mix in sales.

Balance sheet and leverage

The Indian steel industry is on an expansionary mode. Tata Steel aims to achieve 40-mtpa capacity from the current 30-mtpa capacity, having commissioned 5-mtpa blast furnace at Kalinganagar in the current quarter. In the next phase, further expansion at Kalinganagar, Neelanchal and Angul will be targeted, and preliminary studies are underway.

Jindal Steel expects to move from its current capacity of 9.6 mtpa to 15.9 mtpa by FY26, which is a 60 per cent growth mostly at its Angul facility. This encompasses projects adding to finished product capacity and projects for margin improvement. The company has commissioned coal mines recently and iron ore pellet manufacturing capacity is also under construction. This will be complemented by blast furnace, iron slab caster, hot strip mill and other downstream capacity to complement the expanded capacity.

JSW Steel is expected to commission a 5-mtpa expansion at Vijayanagar and another 5-mtpa expansion at Dolvi is being planned, which is a part of a sustained expansion aimed at 10 per cent volume CAGR for the next five-seven years and doubling its capacity to 42 mtpa by FY28.

Most companies have realised their first phase of expansion and are about to commit to the second phase. The primary indicator of industry health — steel prices not finding a bottom despite sustained decline may add to uncertainty for the industry.

While the EBITDA margins may have been somewhat flat, absolute EBITDA is on a downward trend owing to lower realisations. This will impact the industry’s debt servicing ability. The undercurrent for rerating of steel industry post-Covid can be attributed to deleveraging of balance sheets. But with the recent round of capacity expansion, the leverage ratio net debt to EBITDA has started trending downwards. The lower EBITDA and elevated cost of financing are starting to impact the balance-sheet health.

Valuation and outlook

In the last one year, we have recommended investors accumulate the stocks of JSW Steel and Jindal Steel and Power. Prior to that, we also recommended investors buy SAIL and hold Tata Steel . We now move SAIL to ‘hold’ and reiterate the accumulate/hold calls in other recommendations. SAIL has returned 30 per cent to date and while the company has expansion plans, timely execution is crucial to reap benefits.  

The other three stocks are trading at an average 17 per cent premium to one-year forward EV/EBITDA of the past decade. The steel realisations are depressed, but the drivers such as margin expansion, value-added portfolio and, most importantly, capacity addition and long-term steel demand in the country continue to remain positive. Even at current realisations, the companies have a strong operating margin owing to these factors. With additional capacity and operating leverage from the higher capacity accumulating in the next two-three years, the growth runway is modestly visible. But arresting the steel price decline at the current level is of crucial importance. Jindal Steel and JSW Steel have announced a ₹1,000-2,000 per tonne price hike at the end of October, which should be reflected in Q3FY25.

A tariff spill-over can have varying implications. For example, any US tariffs on China steel can be a boost for exports from India. This can be a positive for Indian steel stocks. At the same time, this can also have the effect of more Chinese steel getting rerouted to India, impacting the domestic business for steel companies. Hence, any start of tariff wars will require close monitoring. Nevertheless, the net impact of this for Indian steel players could be positive.

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