The steel sector is in a state of doldrums. The culprit-in-chief is slackening demand, compounded by lack of credit due to the NBFC crisis and government project delays, according to JSW Steel.
The end result? Steel prices are struggling. What is rubbing it in is a flood of imports and pricey inputs, including higher iron ore prices. Currently, nearly 66 percent of steel imports are from FTA (free trade agreement) countries with zero percent duty. Iron ore prices are already up by 40-50 percent this year while coking coal has remained largely flat.
Low demand, falling prices
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As an established player, JSW Steel is feeling the pinch. Its June quarter (Q1 FY20) results bear all the tell-tale signs of the demand hit as domestic volumes fell 2 percent to 3.75 million tonne, hurt by a subdued growth in automobile and white goods industries. Sales in the auto sector were down by as much as 20 percent year-on-year (YoY).
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Low demand invariably leads to low prices, which showed up on JSW Steel’s books. The June quarter realisation came off by 5.1 percent YoY to Rs 45,733 per tonne. The company also took an inventory loss of $21 million from its overseas operations. While its US subsidiary Acero reported an EBITDA loss of $36 million, the loss for Italy-based Aferpi read $4 million.
Operational downturn
A confluence of factors such as loss from overseas subsidiaries and cost pressure kept overall profitability under strain. Raw material cost as a percent of sales jumped to 52.2 percent during April-June as against 49.7 percent in the same quarter last year. As a result, earnings before interest, tax, depreciation and amortisation (EBITDA) dropped a significant 27.2 percent YoY to Rs 3,716 crore.
What made the going tougher for JSW Steel is the addition of fixed cost. Both depreciation and interest cost have seen a spike as the steelmaker capitalised its balance sheet. By the end of June quarter, its net debt stood at Rs 47,800 crore, resulting in further deterioration in profitability. During the quarter under review, net profit took a big blow, plunging a sharp 55.7 percent on a YoY basis.
Stretched valuations
At the current market price, JSW Steel is trading at 7 times its enterprise value to estimated EBITDA of FY20. Valuations are a little stretched in light of the concerns over steel prices and demand in the medium term.
Even as demand is on the way down, the company is pushing ahead with steel production. During the three months to June, production grew 3.2 percent from a year ago while sales volume fell 2.1 percent. Lower sales are only adding to the worry line with a spike in inventory, which calls for a sense of caution.
Any uncertainty surrounding acquisition of Bhushan Power and Steel and the funding are a price overhang. Investors would do well to walk with care.
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