"Going forward, earnings growth will come from capacity additions, economies of scale...
Jindal Stainless, a US$650mn company, is the flagship company of the O P Jindal group. It is the largest integrated manufacturer of quality stainless steel in India and commands ~40% market share. The company?s products range includes stainless steel slabs, blooms, HR/CR coils, plates & flats and value added products such as coin blanks, blade steel, architectural and lifestyle products. It manufacturing facilities are located in Hisar with melting capacity of 6 lac tons.
Mr Arvind Parakh, Director-Finance of the company, is a qualified Chartered Accountant and has done his B.Sc (Hons.) from Delhi University. He joined the company in May 1996 at the designation of Director-Finance. His work experience before Jindal Stainless spans 15 years and includes names like Indorama Synthetics and Bhilwara Group.
Speaking to Mr R Venkatraman and Mrs Prajakta Pradhan of India Infoline, Mr Arvind Parakh says that demand for steel and stainless steel would continue to remain robust in the coming years.
What do you think about the present steel cycle and when do you see it coming to an end?
The market dynamics for steel industry have changed globally. For the first time steel production has crossed 1bn tons. In the last three decades, steel production has never grown by 5% for three consecutive years. Last three years have witnessed steel production growing by 5%. Also a lot of consolidation is happening since last year. Additionally, the industry has turned around globally generating favorable return on capital and high operating profits. Therefore, we feel that going forward things will be very different than what happened in the past. Countries like US, Europe and Japan, where the average consumption of steel is 300kgs per person, are matured economies. There is not much of infrastructure growth in these countries. Historically, the countries that are growing spend a lot of resources to create infrastructure. During the creation of the infrastructure, for 5-10 years the consumption per capita goes up to 800-1000Kgs and eventually settles at 300Kgs per person. India and China are growing economies. In India the consumption is 36Kgs per person (36mn tons) as against 292Kgs per person in China. Therefore the gap is high. Even with such a low consumption there is a hue and cry of availability of material and prices. So with infrastructure developments coming up, demand will continue to be there, market will not collapse. China will continue to grow with more capacities coming in the next 3-4 years. However, that would be in low end applications.
What are your views on the stainless steel prices going ahead and what will be the determinants of it?
The average historical prices witnessed in the last 5 years will not be the same in the next 5 years. This is because of China factor and high raw material prices resulting from shortage of raw materials. So the availability and pricing of raw materials will always keep the prices of the finished products moving up. The only thing that can happen is that going forward, with some more capacity coming up in China, we may not be able to pass on the prices as we are able to do right now. The scenario for companies making value added products ie galvanized, stainless steel, cold roll, etc, which are considered as high end applications of steel, would be relatively easier because China is still an importer of these products. China?s steel production of 295mn tons is mainly dominated by low-end construction steel. The steel prices have increased considerably over the last two years. For instance, construction steel prices have risen from Rs12 to Rs13 per Kg to Rs30 per Kg. Therefore; the steel companies in the last couple of years have made lot of money on price increases. At this level we presume prices will remain firm or maybe drop a little, irrespective of the China factor
How is India placed in the current steel cycle?
No new additions are taking place in United States & most of the capacity additions are taking place in China & other developing countries such as India, Brazil and Russia. These countries will keep making the basic slab of steel for exporting it to US and other developed countries. In countries such as US, Japan and Europe, you have more of replacement demand but infrastructure growth will not happen the way it will happen in India and China. Because of environmental and cost issues the basic steel making facilities will get shifted to countries like India, China, Brazil, Mexico, etc, where we have abundant raw materials. In Europe, one will have to figure out the impact of strengthening Euro. European manufactures are uncompetitive as the domestic currency has strengthened, oil & power cost have risen and overheads including manpower cost are far higher than that in India. Our labour and overheads costs are less than 2% of the total turnover as compared to 7-8% in some of the developed parts of the world. They are shutting down production, reducing capacities and shifting capacities to China. That whole story is that the companies will have to be more competitive and start exporting to US, Europe, Asia and China and also concentrate on the domestic market.
What will be the long-term earnings drivers for the industry considering that the prices are market determined and could decline or stabilize in the future?
Going forward, the earnings growth will come from capacity additions, economies of scale and cost reduction. It will be more internal growth driven rather than external. So it seems that more or less the commodity cycle has peaked out. The companies who would focus on these internal factors will only be able to grow. The key drivers of profit in stainless steel are capacity additions, value additions & cost control. At present, all these three things are controlled by the company. As far as prices are concerned, we have very little control over prices and we can only hope that prices will remain stable.
The other challenge facing the steel industry is managing both the availability of raw material & the pricing. So another important thing that will help companies drive earnings growth will be backward integration. Companies, which are considering linkages, going for backward integration ie acquiring mines, etc will be the biggest beneficiaries. Integration is key for value additions and to that extent TISCO is very well positioned.
What are the company?s backward integration plans and how would these impact the operating margin going ahead?
We are putting up a Rs9.5bn project in Orissa, which will meet our entire ferro alloys requirement. At present, nickel is completely imported. Once the backward integration project is implemented, then we shall see margin expanding from current level of 17% to almost 35%. The benefit will start coming from FY07. The key raw materials are ferro alloys (lends corrosion resistance and luster), nickel (lends drawability) and scrap. Sponge iron can also be alternative to scrap. Scrap is largely imported, nickel is 100% imported and ferrous alloys-chromium & manganese are available in India. In ferro alloys, chromium & manganese comes from the ore. We have our own 80 hectares of chrome mines, so we take 2.5 ton of chrome ore for every ton of output and oxidize it to make ferro chrome. Nickel prices in last one year have gone through the roof. Stainless steel can be made without nickel but not without ferro alloys.
Additionally, we are setting up 250MW power plant in Orissa, the production cost of which would be Rs1.3 to 1.5 per unit (kwh) depending upon coal prices. Currently, we have a 38MW power plant based on waste gases, where cost of production is under 50paisa per unit. So the average cost would be ~Rs.1.40 per unit. Further, our margins would be boosted by shift in product mix. Earlier 80% of our products were high volume-low margin and now it has reversed with 70-75% of products being high margins-low volumes.
How would you source the coal required for the power plants?
Coal linkages are extremely critical. We have not yet been allocated mines, we are working on it. Today the state policy has changed & what the Government has done is that they have allocated mines to the people who have invested. We have already invested in manufacturing and are much ahead of our competitors in this aspect. Once we get the rights for coalmines, our model will be similar to that of Jindal Power, but in our case the value addition is much higher.
How would you combat with the rising nickel prices?
Nickel prices have gone up to US$15,000 per ton, which makes it a big cost component. Hence we have launched a new series 200, which is hybrid between 300-400 series, which consumes only 1-4% of nickel unlike 8-16% of nickel in the 300-400 series. The 400 series has no nickel. Worldwide most of the steel is sold in the 300-400 series. At present, 200 series comprise 10% of the total stainless steel consumption and is the fastest growing grade.
Could you give us details of the capacity expansions undertaken at Hissar plant?
At Hissar we have gone ahead with forward integration. Three projects lined up are increasing melting from 5 lac to 6 lac tons, hot rolling capacity from 4lac to 5lac tons and eventually to 7.5 lac tons and cold rolling capacity to 2.5 lac tons. On all the above projects, we expect 20-30% returns. Typically, steel companies that are totally integrated would make money irrespective of the commodity cycles. Within the value chain, maximum value addition is in the melting stage, almost 50-60% of the value addition takes place during the melting stage. We are one of the few companies in the world, where in the last five years, the topline has grown by 20-25%, exports by 100%, profits by 20-25% and capacity utilization has been in excess of 100%. Out of the last five years, two years were the worst for the steel industry. This was possible because we started expanding capacity when the cycle was at the low phase. We were 1-1.5 lac tons company five years back and now our capacity stands at 6 lac tons. See the process is like we buy raw materials, do the melting, make the slabs, do the hot rolling, then the cold rolling and then sell it.
Could you kindly update us on the progress made by the company on the proposed ferro alloys and stainless steel (1.6mn tpa) projects in Duburi, Orissa?
Jindal Stainless is currently implementing 2.5 lac tons ferro alloys project at Duburi in the state of Orissa. The project also envisages the setting up of coke oven batteries & waste heat recovery power plant. The total cost of the project is around Rs.9.5bn and would be implemented by 30th June?2006 with ferro chrome capacity of 1.5 lac tons being commissioned during first quarter of financial year 2005-06. The company has plans to set up backward integrated 250MW of coal based power plant, which would have linkages with the coal mines. This would further reduce the cost of production of ferro alloys, which is power intensive in nature. The company also plans to transfer the surplus power to existing operation at Hisar.
What are the main demand drivers for stainless steel (domestic & global) that have compelled the company to go for large-scale capacity additions and backward integration initiatives?
The main demand driver of stainless steel globally is architectural, building & construction segment (ABC segment) and automotive, railways and transport segment (ART segment). Globally around 20-25% of the stainless steel consumption goes towards the ABC segment, which for India is around 1-2%. The total consumption of stainless steel in India is around 1.4 mn tons, which is expected to grow 7-8% annually going forward. Considering the fact that India is yet to develop its basic infrastructure in terms of upgradation of rail transport system including focus to develop metro trains for all major metro cities, airport upgradation, shopping malls, multiplexes, residential and commercial complexes etc, the demand going forward for stainless steel is expected to be substantial. However, we feel in order to be competitive in terms of the cost with the global players the company has to integrate its operations right from processing basic ores to stainless steel manufacturing & its hot rolling/cold rolling. The ferro alloy & thermal power project at Orissa is a step towards this way.
The company?s low nickel grade chrome-manganese 200 series has performed very well in China. What is the company?s competitive position in this grade and what has been the response for 200 series from other parts of the world?
Jindal Stainless has pioneered the development of low Nickel Chrome-Manganese stainless steel grade through its continued research and development on this product over last one decade. This various grade in 200series has varying quantities of nickel in range of 1-5% and has proved to be a good alternate product to 8% nickel 304 stainless steel grade used internationally in most of the applications. Higher nickel price of US$16,000/MT has resulted in increase in price of this 304 stainless steel grade, which now sells at around US$2600, which has forced customers globally to look for alternate anti-corrosion products. In China, the demand of chrome manganese 200 series has increased from 1% of the total consumption in 2001 to 22% in 2003.
The share of value added products (VAP) such as lifestyle products, special steel, architectural products, coin blanks, etc is very low (~1.5-2%). What is the company plans regarding these and their targeted share in revenues?
The share of value added products as on date is very low as compared to overall revenue of the company. However, the company has over last 1-2 years laid more focus towards some of the value added items like special steel including precision strips, coin blanks used in mint. The company also set up separate architectural & life style division in order to build the brand image and also educate the Indian markets towards the new applications of stainless steel. Jindal Stainless is also setting up its first service center at Gurgaon in collaboration with an overseas Italian partner to serve the demand from white goods, automobiles and other segments. The results from all these initiatives may take time till the market develops and actual tonnages build up for each of the segment.
As 80-85% of the company?s exports goes to China, what are the steps taken by the company to reduce dependence on the country and thereby remain less affected incase of any unfavorable developments?
Jindal Stainless has complete flexibility in terms of making all grades of stainless steel in 200, 300 & 400 series. The company has also flexibility to switch between the various markets, like historically in 2002, 70-75% of exports were made to USA in 300 series, which over a period of time shifted to China with exports of 1-5% nickel 200 series. During the first half of the current financial year the focus shifted to serve the domestic market demand. However, the company is still planning to derisk its higher exports base to China & the acquisition of 50,000 tons cold rolling unit in Indonesia is a step towards that. This unit would serve the stainless steel demand in the entire ASEAN region as well as Australia & New Zealand as there is no integrated stainless steel producer in this region. The company further proposes to increase the cold rolling capacity at Indonesia.
What were the reasons behind the sharp decline in exports in the in the H1 FY05 and what will be the optimal mix the company would like to maintain between domestic sales and exports?
In the current fiscal during the first quarter, we diverted sales from exports to domestic, as the realizations were higher in the domestic market vis-?-vis exports. As around 300 varieties of steel are consumed in the domestic market with small order size making import unviable, we are able to charge a premium. Our strategy is to have 50:50mix of exports & domestic. Unlike others we think that China is a very big opportunity and not a threat. Around 70-80% of our exports is to China. We export high grade stainless steel to China that is used in automobiles. China consumes about 4.2mn tons of stainless steel, out of which 2.2mn tons is imported and the balance 2mn tons is from domestic sources.
In HI FY05, despite the significant increase in the prices of Ferro alloys and nickel, the company has maintained OPM at ~17%. What were the levers that were used and are they sustainable till the company becomes fully integrated?
The pricing of final stainless steel product are also linked to the prices of its raw material and the end customers in this market are used to raw material/finished goods price fluctuation. In some of the market the pricing of the final products is done based on certain alloy surcharge formula, which captures the flotation in the raw material prices.
Although, there has been fluctuation in various raw materials including Nickel and other Ferro Alloys over last one year, Jindal Stainless Ltd. has been able to maintain its profit margin on account of its ability to switch between grades and end markets and the company has been able to maintain its EBIDTA margin. The EBIDTA per ton of sales over last 7-8 quarters have grown by over 15-20% on account to cost efficiencies as result of up gradation of facilities and also strong market demand.
What is your market share in the domestic stainless steel market and who are the other players?
We are the largest and fully integrated stainless steel player in the country. In India the total consumption of stainless steel is 1.4mn tons. We manufacture 6 lac tons and rest of all put together ie Shah Alloys, Mukund Stainless, SAIL, etc manufactures the balance. To give you an idea of global consumption in stainless steel, out of the global consumption of 1bn ton of steel only 25mn tons is stainless steel.
Is the company considering inorganic growth opportunities after the successful acquisition of Maspion Steel, Indonesia? What are the future plans with regards to Maspion?
As mentioned earlier, the overall plan is to increase the cold rolling capacity. Since PT Jindal Stainless Indonesia would cater to entire ASEAN region including Australia and New Zealand, it is very strategic for us to expand the capacity in Indonesia and cater to this market with annual consumption of around 550,000 tons per annum. There is no integrated stainless steel producer in the entire region and other stand-alone cold rolling unit is in Thailand.
What are the targeted revenues and earnings for the next two years?
The top line is expected to grow by 15-20% going forward but the profitability would improve more than proportionally as the operating margins would expand on the back of backward integration project. We have already done debt restructuring and the average cost of debt has declined from 16% to below 7%.
What can be the major concerns and risks to the above targets?
Availability of raw materials, China slow down and delay in execution of capex plans could hinder the achievements of above targets. In the process we have created Hissar as sustainable earnings model. So we are not very susceptible to the risks. Once Orissa project is completed we will be in a much better position.
Don?t you think overcapacity would also be major risk factor?
Unlike in the past where any commodity up cycles used to get spoiled because of over capacity, this time banks are not willing to fund. So we expect the steel prices will remain stable for a longer period this time.
From here on which sectors would drive the demand for stainless steel?
Growth would be from three main sectors- architecture, building & construction (AB&C), automotive and railways. The main reason for high demand in these sectors is that stainless steel is capable of handling high temperatures, high impact and is corrosion resistance.
How is your company placed vis-?-vis global players in terms of operating efficiencies?
We have comparable EBIDTA margins. Our exports have increased to 50% of the total revenues, which reflects that we are on the same footing as the global players.
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