“The sharp increase/ramp-up of blast furnace-based steel capacity in India over the next three years is likely to weigh on spreads and shift incremental margins from steel conversion to raw materials,” said the brokerage’s analyst Indrajit Agarwal in a note to clients.
On Monday, Tata Steel fell 1.5% to ₹153 and JSW declined 2.2% to ₹826. JSPL gained 0.3% to ₹840.60.
CLSA said historically, the steel sector has generated returns if bought when industry spreads (or margins) are at trough levels, which are generally accompanied by low valuations.
“…unlike the past, valuation (P/B) multiples for Indian steel companies have risen in the past 18 months while steel prices/spreads have corrected,” said the analyst. “This is likely driven by a better demand outlook, the expectation of a stimulus in China and overall elevated valuations in Indian markets.”
In the previous two trading sessions, JSPL surged almost 11%, Tata Steel gained nearly 10% and JSW rose about 6%.CLSA said a broad-based demand-driven stimulus in China is a key risk to its cautious thesis on the sector. The world’s second-largest economy has been the biggest consumer of metals.”A sustained higher demand in China, driving up spreads, is the best outcome for Indian mills given the self-sufficiency of iron ore in the country,” said the brokerage’s analyst. “However, if China production remains elevated, with weak demand, spreads could remain lower for longer.”
CLSA said spreads of Chinese steel makers are currently at decadal-low levels, which “we think is unsustainable”.
“If spread improvement is driven by lower iron ore/coking coal cost (favourable sourcing from Mongolia), Indian mills are likely to be worse off.”