India: Steel sector outlook remains strong; valuations, deleveraging to drive prospects
Strong demand for steel and, in turn, rising prices since the easing of lockdown restrictions have continued to drive the profitability of Indian steel manufacturers. Analysts expect the cycle to sustain longer and the improved cashflows may lead to deleveraging, providing fresh triggers for stocks. Further, the fresh capex cycle may start with continued strength in demand and prices of the commodity.
Strong rebound in demand in 2021, plus supply-side reforms in China should lead to higher international steel prices, say analysts at Morgan Stanley India.
China remains the largest consumer of commodities and it is accelerating its environment push to control carbon emissions. This is likely to keep a tab on production in many industries. Morgan Stanley in China feels that the country’s efforts to achieve carbon neutrality may lead to an upward trend in the cost curve and supply disruption for heavy power-consuming and high-emission industries such as steel and aluminium, driving more upside potential to these commodity prices.
Continued rise in demand for steel and supply constraints from China may lift international steel prices and also bode well for Indian manufacturers. Firm demand, higher realisations and lower risk of cheap imports from China are likely to accrue benefits for Indian manufacturers.
“With the cycle remaining higher for longer, we believe investor focus will shift to earnings growth over balance sheets,” said analysts at Morgan Stanley. They continue to prefer stocks with low valuation and substantial de-leveraging like Tata Steel Ltd and Jindal Steel and Power Limited (JSPL).
Having increased their F2021-22 realizations by 1-12%, driving 4-35% increase in Ebitda estimates across coverage, Morgan Stanley analysts believe their estimates may have further upside risks. They have also upgraded JSW Steel Ltd, given the strongest volume growth, weakening iron ore prices and solid earnings CAGR (compounded annual growth rate), and expect premium valuations to sustain given a better return on equity profile.
Stock prices of Tata Steel saw intraday gains of more than a percent on Thursday, a day when broader indices were down more than 1%.
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