Will steel embrace efficiency or protectionism?
Vivek Jain, November 29, 2015
The Indian steel industry has been reeling under elevated levels of stress as reflected by the increasing gross outstanding bank debt of Rs 2.8 trillion in FY15, from Rs 1.3 trillion in FY10, a CAGR of 17.3 per cent along with a decline in operating profitability. Over FY11-FY15, net debt/EBITDA of the largest (by revenue) eight steel players has increased from 2.4x in FY11 to 6.0x in FY15.
The stress in the sector was precipitated by the confluence of a multitude of factors with the key ones being muted domestic demand, imports, capacity expansion, decline in prices, negative operating leverage and high exit barriers. If the price and demand recovery do not happen by FY17, the sector would slip into further stress.
In such a situation, the ability of the sector to raise funds could be jeopardised, thus constraining refinancing. The domestic finished steel consumption over the period FY10-FY15 grew at a slower pace of 5.3 per cent compared with the finished steel production CAGR of 8.6 per cent, thus leading to oversupply. The problem was further exacerbated by the increase in quantum of imports, which reached 9.32 million tonnes (MT) in FY15, from 7.38 MT in FY10. Therefore, despite having sufficient domestic capacity, the imports into India have increased.
The China factor
The increase in imports has been a result of slowdown in China, thus forcing the Chinese to look outside their home market. China is the largest producer of steel with a capacity of 1,250 MT, production at 823 MT, and a domestic demand of 711 MT in 2014. The quantum of exports from China stood at 62.1 MT during January to July 2015, slightly higher than the 61.4 MT steel produced by the second largest country, Japan over the same period. Additionally, the depreciation of the Russian Ruble has also led to an increase in Russian imports into India. As per the ministry of steel, the private sector has brownfield capacity and greenfield expansion plans of 9.46 MT and 21.9 MT respectively by FY17. Though some of the capacity expansion plans by the private sector may be shelved, the public sector capacity expansion plans of 14.9 MT are likely to be completed by FY17. The trinity of higher imports, low domestic demand, and capacity expansion led to a drop in capacity utilisation levels from 88 per cent in FY10 to 81 per cent in FY15.
Steel being a capital intensive industry has a high per million tonne capital cost at Rs 50 billion. The interest and principal repayments annually alone would amount to nearly Rs 5 billion with 50 per cent debt funding. Therefore, the plant needs to run at high capacity utilisation (90 per cent) and generate sufficient EBITDA/T of nearly Rs 5,500/T to break-even. A more aggressive funding could push up the break-even EBITDA/T. However, given that utilisations in India have declined and so have EBITDA/T, the possibility of the plants making returns on their investments looks difficult.
Companies, in order to ensure healthy EBITDA/tonne, have been looking at measures to improve operating efficiencies by way of coal dust injection, lower specific energy consumption, coke rate and blast furnace productivity, along with improving the product mix.
Survival of the fittest
Over the longer-term akin to a cyclical industry, only the most efficient producers will survive. The global sector will witness closure of outdated and polluting steel plants. Till date, the sector has seen limited consolidation as the ability of the sector to generate surplus cash and access capital markets has been low. However, the same could change. The steel industry will become increasingly globalised with production shifting to most efficient and low-cost centres. The other outcome could be strong protectionist policies by governments the world over, thus forcing re-looks at the free trade agreements (FTAs) and making steel industry more regional than global.
Even though the domestic per capita consumption of steel stands at 60 kg compared with the global average of 217 kg and 510 kg for China, offering huge potential of growth, the domestic demand has continued to remain muted.
Only if infrastructure and real estate sector revive would domestic steel demand see higher growth rates. Second, the rate cut by the RBI and consequent transmission of the same by banks to end-consumers could revive the capex cycle of corporates. The combined effect of both the government and private sector investment revival could lead to demand growth of five per cent to seven per cent beyond H2FY17, which stood at 3.9 per cent in FY15.
(The author is Associate Director–Corporates, India Ratings & Research.)
The stress in the sector was precipitated by the confluence of a multitude of factors with the key ones being muted domestic demand, imports, capacity expansion, decline in prices, negative operating leverage and high exit barriers. If the price and demand recovery do not happen by FY17, the sector would slip into further stress.
In such a situation, the ability of the sector to raise funds could be jeopardised, thus constraining refinancing. The domestic finished steel consumption over the period FY10-FY15 grew at a slower pace of 5.3 per cent compared with the finished steel production CAGR of 8.6 per cent, thus leading to oversupply. The problem was further exacerbated by the increase in quantum of imports, which reached 9.32 million tonnes (MT) in FY15, from 7.38 MT in FY10. Therefore, despite having sufficient domestic capacity, the imports into India have increased.
The China factor
The increase in imports has been a result of slowdown in China, thus forcing the Chinese to look outside their home market. China is the largest producer of steel with a capacity of 1,250 MT, production at 823 MT, and a domestic demand of 711 MT in 2014. The quantum of exports from China stood at 62.1 MT during January to July 2015, slightly higher than the 61.4 MT steel produced by the second largest country, Japan over the same period. Additionally, the depreciation of the Russian Ruble has also led to an increase in Russian imports into India. As per the ministry of steel, the private sector has brownfield capacity and greenfield expansion plans of 9.46 MT and 21.9 MT respectively by FY17. Though some of the capacity expansion plans by the private sector may be shelved, the public sector capacity expansion plans of 14.9 MT are likely to be completed by FY17. The trinity of higher imports, low domestic demand, and capacity expansion led to a drop in capacity utilisation levels from 88 per cent in FY10 to 81 per cent in FY15.
Steel being a capital intensive industry has a high per million tonne capital cost at Rs 50 billion. The interest and principal repayments annually alone would amount to nearly Rs 5 billion with 50 per cent debt funding. Therefore, the plant needs to run at high capacity utilisation (90 per cent) and generate sufficient EBITDA/T of nearly Rs 5,500/T to break-even. A more aggressive funding could push up the break-even EBITDA/T. However, given that utilisations in India have declined and so have EBITDA/T, the possibility of the plants making returns on their investments looks difficult.
Companies, in order to ensure healthy EBITDA/tonne, have been looking at measures to improve operating efficiencies by way of coal dust injection, lower specific energy consumption, coke rate and blast furnace productivity, along with improving the product mix.
Survival of the fittest
Over the longer-term akin to a cyclical industry, only the most efficient producers will survive. The global sector will witness closure of outdated and polluting steel plants. Till date, the sector has seen limited consolidation as the ability of the sector to generate surplus cash and access capital markets has been low. However, the same could change. The steel industry will become increasingly globalised with production shifting to most efficient and low-cost centres. The other outcome could be strong protectionist policies by governments the world over, thus forcing re-looks at the free trade agreements (FTAs) and making steel industry more regional than global.
Even though the domestic per capita consumption of steel stands at 60 kg compared with the global average of 217 kg and 510 kg for China, offering huge potential of growth, the domestic demand has continued to remain muted.
Only if infrastructure and real estate sector revive would domestic steel demand see higher growth rates. Second, the rate cut by the RBI and consequent transmission of the same by banks to end-consumers could revive the capex cycle of corporates. The combined effect of both the government and private sector investment revival could lead to demand growth of five per cent to seven per cent beyond H2FY17, which stood at 3.9 per cent in FY15.
(The author is Associate Director–Corporates, India Ratings & Research.)
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