Mining profits with the steel industry
Analysis of the steel industry in India
Most people are betting on steel and power stocks because of the recent rally! But is the industry good enough to sustain investor's confidence? Let's find out.
Steel undoubtedly stands at the forefront of infrastructural development for an economy like India and is the most valuable raw material used in construction. It contributes ~2% to India’s GDP and employs ~5 lakh people directly and 20 lakh people indirectly. In FY21, the production of crude steel and finished steel stood at 102.49 MT and 94.66 MT, respectively with exports at 10.79 MT rising 121.6% since last year. According to CARE Ratings, crude steel production is expected to reach 112-114 MT (million tonnes), in FY22.
The steel produced here has both domestic and foreign demand as the per capita consumption of steel has increased from 57.6 kgs to 74.1 kgs during the last five years and due to China's losing business, metallurgical industries in India have been successful in attracting FDI inflows of US$ 14.74 billion.
Key moves by Tata Iron and Steel Company Ltd in 1907 and Steel Authority of India in 1973 sparked the growth of steel production in India.
Steel exports trend in India:
Let's first understand the product we are talking about. Steel is an alloy, meaning that it is made by combining iron with another element, usually carbon. And proves to be an extremely useful and sturdy building material. It is obviously a main component of industries like construction, railways and automobiles, it is also quite vividly present in the making of consumer durables like irons, utensils, etc.
Here is how steelmaking is actually done:
Most of the steel requires a high rate of energy utilization (due to obsolete technology) and production of steel from iron ore requires solid quantities of coke. Iron ore and coke are both weight losing materials. Thus, most of the steel plants are located near mines. In India, there is a crescent shaped region comprising parts of Chhattisgarh, Northern Odisha, Jharkhand and western West Bengal, which is extremely rich in high grade iron ore, good quality coking coal and other supplementing raw materials.
Since the LPG move of the Indian government, steel prices have been determined by an interplay of domestic and international market forces of trends in raw material prices, demand, supply conditions in the market.
Its growth mainly depends on cyclical industries of construction and automobiles and therefore, premium products and consumer product spaces are able to churn out profits more consistently.
The steel industry, like any other metal industry, is a highly capital intensive one, and a ton of money goes towards buying coke. Indian banks are already grappling with bad loans (NPA) in these pandemic times and this makes it tough to raise money; hence the industry is dominated by a few players like Tata Steel, JSW Steel and the state owned SAIL among others.
Another problem in India that hinders the production is use of obsolete technologies that result in inferior quality products. Slow adoption of new age and efficient methods also weakens our position since other developed countries have adopted better techniques of handling raw material and logistics.
Being a cyclical and competitive industry, a surge in cheap imports from China, Russia, and Japan have dented fortunes. The volatility is also evident with the growth in 2016 being 3.8%, which fell to 0.5% in 2017 and again rose to 6.4% in 2018. Or, Tata Steel's stock price, as depicted in the 15 year time period below!
To add to this, most of the iron ore is exported, since it fetches higher prices abroad and we are left with little to make our own steel.
The government has a fixed objective of increasing rural consumption of steel from the current 19.6 kg/per capita to 38 kg/per capita by 2030-31. Under the Union Budget 2020-21, the government allocated Rs. 39.25 crore (US$ 5.4 million) to the Ministry of Steel. The budget’s focus is on creating infrastructure and manufacturing to propel the economy. In addition, enhanced outlays for key sectors that would provide impetus to steel consumption.
The number one reason why India is one among the leading countries in steel production is because there are loads of iron reserves here. And also, easily available low cost labour, even cheaper than China, aids large scale production.
Steel industry derives its demand from the infrastructure industry as the government has decided to give it the necessary boost in the recent budget. The thriving automobile and railway industries are also seen as such that boost demand for the metal. Its presence is also felt in other important sectors like aviation and consumer durables. Here is a breakdown of the industrial consumption for steel:
Source: PWC research
India’s primary energy consumption of oil and gas is expected to increase a lot by 2040. This increase in demand provides a lucrative opportunity to the steel industry.
It has been pretty successful in attracting lucrative foreign capital and this in turn is expected to bring in data analytics and modern machinery like drones and artificial intelligence into the picture which can contribute to seamless client interaction and higher service levels leading to better financial performance.
Most of the Indian steel makers are striving for continuous modernization of older plants and up-gradation to higher energy efficiency levels.
This industry is heavily reliant on cyclical businesses of the automobile and construction companies.
Through observation, one can see that stock prices of such companies depend on the underlying commodities rather than their financial performance, i.e., they do well when metals are doing well. The best way to go about investing in them is by investing in them during the lows and booking profits during the highs. Buying at each further dip (a rupee cost averaging technique) also works well.
Being it an industry of a select few, here are the best ones to bet on, according to various analysts.
In a nutshell,
Though the iron and steel industry in India is grappling with various on shore and offshore challenges, if given necessary boost by the government and adopted emerging technologies well, can be a huge contributor to the success of the Indian economy at large.