India's Steel Demand to Decline by over 20% in FY21: ICRA

Domestic steel demand is likely to drop by upward of 20% in financial year 2021 (FY2021) due to the 47-day lockdown in the first quarter (Q1) and any extension will result in a further weakening in demand, says an ICRA note.

Notwithstanding news of intermittent exports of steel products by domestic steel makers in April 2020, COVID-19 is likely to result in a demand destruction in both the domestic and exports markets during the lockdown period. As per ICRA's assessment, "Even if we consider a lockdown period of 47 days in Q1 of FY2021 (April 1-May 17) and a gradual demand revival because of various challenges..., India's steel demand is likely to decline by ~23% in FY2021."

For every 14-day extension in the lockdown period, steel demand is expected to decline further by 2-3 percentage points as per ICRA's assessment.

Further, a sharp rebound in steel demand from Q2 also does not appear to be a strong possibility, the note says, given the prevailing weak consumer sentiments, expected higher priority of the government's expenditure allocations on augmenting healthcare infrastructure and social security programmes over capital projects amidst dwindling revenue collections and tight systemic liquidity and mass labour migration issues impacting the steel-intensive construction and real estate sectors.

Importantly, the note says, as the full impact of the lockdown plays out during the current quarter, India's GDP growth is expected to plunge, contracting by an estimated 10-15% year-on-year (Y-o-Y) in Q1 FY2021.

Consequently, domestic steel demand remains on slippery ground in Q1 FY2021, when steel makers are likely to witness customer enquiries trickling to a bare minimum.

Liquidity management

Following a near complete halt in domestic sales for steel mills at the moment, liquidity management would take centre stage, and in this context, steel companies with stronger balance sheets, large cash and liquid investment balances, and high financial flexibility would find it easier to manoeuvre during this period of stress, says ICRA.

The RBI's loan forbearance till end-May, 2020 is likely to provide some respite for steel makers. Importantly, in the broader context of cash conservation in an environment when mill margins would remain under pressure in FY2021, ICRA foresees many steel makers deferring earlier committed capex plans and conserving cash.

Demand destruction

Given the reported high inventory build-up before the imposition of the lockdown and an expected slowdown in steel consumption, domestic production is expected to register a decline of about 19% in FY2021. As a result of this and an expected capacity addition of about 10 million tonnes (MnT) during the year (JSW Steel Limited - 6 MnT and NMDC Ltd - 3 MnT being the major ones), India's steel capacity utilisation rate is likely to fall to 61% in FY2021 from 79% in the previous year.

Being a highly capital cost-intensive business, burdened with high capital charges, the steel industry's fixed cost intensity remains high, and in an environment of slow mill offtakes, the industry bottom-line would remain under pressure in FY2021, ICRA says.

Steel makers having a diversified product offering and deep market penetration would leverage the flexibility to calibrate their product mix to tap segments which may witness greater traction in demand in FY2021.

However, the operating environment for steel makers having concentrated product portfolios, like alloy steel makers having a high exposure to the automobile sector and secondary long steel producers having a high exposure to the real estate sector, could be more challenging, if the health of the end-user industries they would be catering to remains weak throughout FY2021.

Muted government capex, weak credit flow and auto sector degrowth remain the key headwinds for the domestic steel sector.

After registering healthy rates of 7.9% and 7.5% in FY2018 and FY2019, the domestic steel consumption growth rate decelerated to 1.4% in FY2020 because of sluggish demand from infrastructure and construction, capital goods and the auto sectors, which together contribute about 75-80% to the total domestic steel demand.

In fact, ICRA notes that demand decline would take place for the first time in the last three decades in case of the Indian steel industry, as the demand data available since FY1992 has shown a sustained growth every year. Also, the sharp drop in demand growth in FY2021 would trim India's steel consumption down to FY2015 levels.

After restocking for several months starting November 2019, end-users would be in no hurry to place fresh orders to mills as demand recovery remains uncertain.

Given the high shutdown costs, blast furnace operators kept operating during the lockdown, albeit at a sub-optimal capacity utilisation of about 50%. However, ICRA's channel checks suggest that most secondary steel producers have closed production during the lockdown, given their lower lead time and costs to restart operations.

Inventory rises

ICRA notes that domestic steel players witnessed a steady fall in mill inventory holding period from 53 days in November 2019 to 43 days in February 2020 as customers started replenishing inventories. However, as sales dried up following the imposition of a lockdown from March 25, 2020, the declining trend in mill inventory holding period has sequentially increased in March 20 to 62 days.

Given the uncertain demand environment, which could potentially extend for the entire first half of FY2021, end-users would not be in a rush to place large orders to steel mills even after the withdrawal of the lockdown.

Prices to be under pressure

ICRA observes that sluggish demand and inventory pile-up will keep steel prices under pressure; anti-dumping duty and the steeply depreciated INR will provide some support.

After touching a low of about INR 32,250/MT in the first week of November 2019, domestic hot-rolled coil (HRC) prices witnessed multiple hikes and are currently ruling at about INR 38,000/MT, implying an increase of 18% in the last five months. Price hikes by domestic steel makers were largely a function of supportive international prices as domestic steel demand declined by around 9% in Q4FY2020.

However, China's export HRC prices, after increasing to about USD 500 levels in January 2020, witnessed a 19% fall since mid-January due to a slowdown in China's steel consumption following the virus outbreak.

Domestic steel prices are currently trading at a discount of 8% each to landed offers from China and Japan. While theoretically this provides a headroom to domestic steel makers to increase prices, demand destruction in both the domestic and the export markets due to the COVID-19 pandemic and high inventory holdings by large steel players are likely to pressurise domestic steel prices in the near term.

However, a weaker INR and anti-dumping duty notified threshold level of USD489/MT for HRC would provide some relief to domestic steel makers.

~ By Madhumita Mookerji