Revenues for steelmakers are likely to be down sequentially in Q3FY19E due to a fall in steel prices over the past quarter. Due to the weakness in prices leading to a contraction in spreads, EBITDA margins are likely to shrink ~200bps qoq in Q3FY19E. This, combined with weak Chinese macros, are likely to keep investor sentiment subdued.
Average HRC prices (in rupee terms) for Q3FY19 fell 0.3% qoq as sharply higher Chinese production (up 9% yoy in November 2018) and weak demand impacted pricing. Coking coal prices also rose 9% qoq in Q3FY19 due to supply disruptions in Australia. Thus, domestic steel spreads contracted ~Rs900 per ton qoq in Q3FY19.
Auto sales for Q3FY19 also declined 9-10% yoy due to weak consumer demand. Due to the weakness in auto demand, auto production also declined 10-15% yoy in Q3FY19. The decline in auto production is especially crucial for steelmakers such as Tata Steel, which saw a 10% yoy decline in domestic sales in Q3FY19. However, JSW Steel, due to its higher exposure to long products, was less affected by the slowdown in the auto segment. JSW Steel saw its production rise 3% in Q3FY18, with the production of long products rising 18% yoy.
Base metals: prices for alumina and aluminum fall 15%/4% qoq in Q3FY19; zinc prices rise 12% qoq after a sharp fall in H1FY19
Prices of base metals remained broadly weak in Q3FY19 as the ongoing US-China trade war continued to act as a dampener. LME copper prices fell below $6,000 per ton to close the year at $5,950 per ton as the Chinese economy showed signs of a further slowdown. Zinc prices rose ~12% qoq to an average of $2,613 per ton in Q3FY19E as concerns related to over-supply of the metal in CY19 begin to seem misplaced. Aluminum prices fell 4% qoq to average at $1,967 per ton after alumina prices corrected $80 per ton qoq. Alumina prices are starting to stabilize at ~$400 per ton on developments that Norsk Hydro’s Alunorte facility would soon be allowed to operate at full capacity. The alumina-to-aluminum ratio has shown signs of abating falling to 23% after reaching a peak of ~26% in Q2FY19. This stabilization in the ratio is positive for non-integrated aluminum makers such as Vedanta who are dependent on sourcing alumina from external sources. However, this development is highly negative for Nalco as it is a major domestic producer of alumina. Thus, Nalco could see margin pressure building from Q3FY19 onwards if alumina prices soften further.
Slowing Chinese economy softens pricing and demand; dilution of winter cuts boosts production
Weak Chinese auto sales and manufacturing PMI in Q3FY19 clearly show signs that the Chinese economy is slowing down. Chinese auto sales for passenger vehicles fell 19% yoy in December 2018. Total auto sales for CY18 fell 5.6% yoy, the largest decline in auto sales in the past 20 years. Chinese manufacturing PMI for the month of December 2018 stood at 49.7, indicating a contraction in domestic manufacturing.
The Chinese government also changed the regulatory burden of the winter production cuts from the central authorities to state authorities. The result has been a sharp 7% yoy and 9% yoy rise in steel production in the months of October and November 2018, respectively. This rise in supply combined with lower demand has hit pricing, and thus, the profitability of steelmakers. Furthermore, uncertainty over the outcome of the US-China trade negotiations has also added additional uncertainty to the weakened macro environment. However, Indian steel demand is expected to remain strong as spending on infrastructure activities remains robust so far.
We have a positive stance on Tata Steel, JSW Steel, Jindal Steel & Power, Hindalco, and Vedanta.
|EBITDA margin (%)||17.6||17.0||61||20.5||-284|
|EBITDA margin (%)||20.9||21.6||-69||22.8||-190|
Jindal Steel & Power (JSPL)
|EBITDA margin (%)||21.3||22.6||-129||22.0||-63|
|EBITDA margin (%)||14.6||9.4||525||14.1||50|
|EBITDA margin (%)||26.9||27.8||-82||22.9||401|
|EBITDA margin (%)||9.8||11.9||-213||10.1||-30|
|EBITDA margin (%)||20.8||14.4||637||28.0||-723|
Hindustan Zinc (HZL)
|EBITDA margin (%)||50.5||54.8||-424||48.9||168|
|EBITDA margin (%)||54.6||49.0||563||51.7||297|
|EBITDA margin (%)||19.0||21.3||-235||17.6||135|