Sector Update | 4 June
Metals
2019
Metals
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Metal Trends: Higher RM impacting spreads of steel companies
Indian steel mills are however better placed
Higher iron ore prices impacting steel spreads
Iron ore (China CFR, 62% Fe) prices have shot up in the last few months to
~USD100/t (up ~40% since the beginning of the year, Exhibit 1), which has started
impacting product spreads of steel companies (Exhibit 7). Vale’s tailing dam breach
incident has impacted ~50-60mtpa of sea-borne iron ore supply (Exhibit 2). Chinese
crude production growth, at the same time, continues at a healthy pace of ~10%
(Exhibit 3). While, Chinese local iron ore output has not been able to catch up with
the disruption in the sea-borne market; output grew by just ~1% in Apr’19 (Exhibit
4). As a result, Chinese iron ore stock at ports declined ~16% from its recent peak
and is currently ~15% lower than same time last year (Exhibit 5).
While the outlook for Chinese steel demand growth remains tepid (WSA forecast is
~1% growth in 2019), the readings for the first four months of the year from China is
showing healthy demand growth of ~10% (Exhibit 6). Escalation of the US-China
trade dispute is a worrying trend, but reports suggest that the Chinese government
will support the economy by increasing infrastructure spending and other policy
initiatives. Higher iron ore prices should provide a floor to steel prices, while steady
demand growth and improving visibility can drive product spreads higher.
Ultimately it is the
marginal cost of
production and pull
between demand-supply
that influences
commodities. In shaping
these factors there is often
an interesting inter-play
between the various
variables in the value-
chain. At times, however,
some of the trends are not
conclusive enough to
justify a change in
fundamental view on a
stock. Nevertheless, they
do influence a stock’s near-
to-medium term outlook
and performance. Our
‘Metals Trend’ notes will
highlight on such trend
that are influencing the
sector.
US cutting tariff on Turkish steel could support scrap prices
As global iron ore prices have increased, the spread between steel scrap and iron
ore has narrowed (Exhibit 11). This is favorable for demand of scrap-based steel
making. Also, the recent cut in tariff (from 50% to 25%) on Turkish steel products by
the US, we believe, is positive for prices of steel scrap. Turkey is the largest importer
of steel scrap globally. Scrap (and sponge iron, a substitute for scrap) represents
~30% of India’s crude steel production. Higher scrap (and thus sponge iron) prices
would increase cost of production for such local mills. Majority of the scrap and
sponge iron based steel producers in India produce long steel products.
Domestic iron ore prices immune to global price moves
India local iron ore prices, on the other hand, have increased only marginally since
the beginning of the year (factoring the ~INR400-600/t increase a week ago). Iron
ore export (for >58% Fe) attracts an export duty of 30% in India, thereby limiting
demand. The alternative is to process iron ore into pellet where the duty is ~5%. But
as Chinese steel spreads have corrected over the past few months (Exhibit 7),
preference of Chinese mills for higher-grade ore (and pellet) is waning. Instead of
productivity and efficiency, the focus of Chinese mills has shifted to maintaining
margins. This is visible in the narrowing discount for lower-grade iron ore (Exhibit 8)
and the pellet spread over iron ore prices (Exhibit 9), both at multi-year lows. The
opportunity to export iron ore from India is limited; and with the likelihood of
increasing supply ahead of lease expiry in Mar’20, we believe, local iron ore prices
could remain range-bound (Exhibit 10).
Dhruv Muchhal – Research Analyst
(Dhruv.Muchhal@MotilalOswal.com); +91 22 6129 1549
Aniket Mittal
– Research Analyst
(Aniket.Mittal@MotilalOswal.com); +91 22 6129 1572
Motilal Oswal research is available on www.motilaloswal.com/Institutional-Equities, Bloomberg, Thomson Reuters, Factset and S&P Capital.
Investors
4 June 2019
are
advised to refer through important disclosures made at the last page of the Research Report.
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