Steel soft

Insight

For any commodity, the key price determinants are demand and supply. Indeed, steel prices have been firm on account of robust demand, and this is reflected in their quarterly performances. The industry has been abuzz with activity post the Corus acquisition, and has done well at the bourses.

Barring some individual developments, the firm pricing was the key reason for the year-on-year rise in revenues and profits of steel companies.

For Q1 FY08, Tata Steel’s standalone net sales were up by 8% at Rs 4,197.58 crore, even as volumes declined due to temporary shutdown at two of its plants. The improvement in net realisation due to firm steel prices and lower proportion of semi-finished steel helped operating profit margin improve to 40.5% from 38.2%.

While total expenditure grew in line with sales, a net forex gain of Rs 553 crore, along with an 87% rise in other income to Rs 146 crore, boosted net profit (up 28%) to Rs 1,222 crore. Adjusted for these, the net profit would have de-grown by 19%, exaggerated by the interest burden on account of the Corus deal, which has increased by 173% on a net level to Rs 80 crore.

For JSW Steel, higher production and better realisations led to a relatively sharper rise in performance-these would have been better, but for the shutdown of its Corex blast furnace for 32 days during the quarter. Net sales rose 37% y-o-y to Rs 2,190.70 crore. The increase in export incentives by 3% (from April 2007) also contributed to growth. Thus, operating profit increased by 52% to Rs 694.90 crore and margins expanded to 31.7% from 28.7%.

Effective tax rate for JSW at 30.2%, down from 36.1% in Q1 FY07 on account of expansions, led to doubling of net profit. But, if forex gains of nearly Rs 79 crore are added, the bottomline grew by 151% to Rs 428 crore.

Government-owned SAIL’s adjusted revenues grew 17% during Q1 FY08 to Rs 8,039.50 crore, backed by a 3% volume growth. This emanated from higher production—hot metal by 6.4% and crude steel by 2.4%.

SAIL’s net profit grew even faster to Rs 1,525 crore, on account of higher operating profits and other income (interest). Interest costs also dropped 15% to Rs 79.60 crore, due to a reduction in borrowings.

Companies integrated in terms of raw materials with captive mines, should benefit in the long term. Chinese exports may cast their ominous shadow on prices, which remains a concern for steel companies.

The key upside for SAIL would be in the form of better operational efficiencies. Tata Steel, though, is highly leveraged on a comparative basis and benefits from Corus will be only in the future. This (high leverage) is also visible from the company’s decision to increase its contribution by $700 million to $7.4 billion towards funding of the acquisition by way of increased fund raising from issue of 2% preference shares. For JSW Steel, lack of captive supplies of raw materials for expansion remains a concern. The benefits of inorganic initiatives and expansion plans for these two companies will accrue only in the long term.

Meanwhile, global steel prices have slipped lately from their highs in May 2007, forcing SAIL to cut flat steel prices. While any further slippage is likely to impact profitability, the consolidation in the global steel industry should provide some cushion. Investors willing to bet on the commodity may consider a wait and watch approach.

Realisation woes
Aluminium producers Hindalco and National Aluminium Company (Nalco) had none of the luck of the steel producers as alumina prices dropped sharply (average decline of over 30%) and the rupee got stronger during the quarter ended June 2007 (Q1).

No wonder, their performance was impacted. Nalco’s revenues declined by 21.5% y-o-y to Rs 1,165 crore, while higher volumes helped Hindalco register a 9.5% rise in revenues to Rs 4,678 crore.

Hindalco saw relatively higher realisations for each tonne of aluminium it sold on account of its value added products, compared with Nalco. Also, increased capacities during Q1 helped Hindalco produce more metal and products.

Hindalco’s copper business also helped, as it benefited from higher production and better treatment and refining charges. However, while it accounted for a big chunk of revenues (62%), the copper business contributed only 15% to profits. Hence, that didn’t help much to arrest the fall in Hindalco’s overall operating profit. Analysts see a drop in the copper refining margins ahead, which means sustaining the profitability could be challenging.

On the other hand, Nalco saw a marginal slump (2%) in aluminium production, while alumina production rose by 8% in Q1. But, the lower realisations clearly showed. Operating profit fell faster by 34% and net profit was down 28.2% despite a higher other income (up 57% to Rs 131 crore) and decline in interest, depreciation and tax expenses.

For Hindalco, net profit remained almost flat, helped by a sharp rise in other income and lower interest and tax outgo.

Going forward, Hindalco’s acquisition of Novelis Inc, which has not been consolidated in the Q1 numbers, is seen as a drag on consolidated numbers by analysts.

As far as Nalco is concerned, new capacities (about 115,000 tonnes per annum) will come only around December 2008, which means, in the near term, earnings will be under pressure if realisations continue to remain soft. A majority of analysts are not positive on Hindalco and Nalco, which trade between 9-10 times their respective estimated earnings for 2007-08.

Contributed by Devangi Bhuta & Pallavi Pengonda