Steelco Gujarat Ltd Management Discussions.

INDUSTRY STRUCTURE, DEVELOPMENTS, OPPORTUNITIES AND OUTLOOK

The Steel Industry plays a dynamic role in the development of any modern and emerging economy. The demand for steel industry is driven mainly from industries like infrastructure, automobile, engineering, aviation, construction. The per capita consumption of steel is a normally accepted measure for socio-economic development of the people of the country. Consequently, the steel sector has been a major contributor to Indias manufacturing output.

During the year, the global steel industry continues to face headwinds of weak demand and overcapacity, gradual slowdown and downward pressure on prices of energy commodities.

Global Steel Industry -

In 2016, Global Crude Steel production stood at 1.63 Billion Tonnes with a growth of 0.8% over 2015 and the consumption grew by 1.0% to 1.52 Billion Tonnes in 2016. The countries with export focused steel industry like China, Japan, Korea & Russia continued to flood global steel markets with exports at predatory prices. The World Steel Association has forecast that the global steel demand will increase by 1.3% to 1.54 Billion Tonnes in 2017 over 2016. The demand in developing economies excluding China, which accounts for 30% of the world total, is expected to grow by 4.0% and 4.9% in 2017 and 2018 respectively.

Indian Economy -

The Indian Economy registered growth of 7.1% in FY 2016-17, with the Agricultural sector growth of 4.1%, industrial sector growth of 5.2% and service sector growth of 8.8%. For FY 2017-18, GDP has been forecast in the range of 6.75-7.5%. The governments strategies & plans to reform will benefit the growth of the nation and various policies and initiatives take by the Government in areas like Demonetization, Taxation (GST), Foreign Direct Investment (FDI), Make in India, ease of doing business, etc. will further thrust the growth.

Indian Steel Industry

The Indian steel sector has been affected adversely due to intense competition pressure with a surge in domestic steel production and elevated level of steel imports at predatory pricing. During 2016-17, crude steel production stood at 97.4 Million Tonnes, with growth of about 8.5% over 2015-16. The Finished steel production also registered growth of 11.3% in 2016-17 over 2015-16. The total finished steel import, with decline of 36.6%, stood at 7.5 Million Tonnes and against that, the exports grew by 102% to 8.24 Million Tonnes and this led India to emerge as a net exporter of total finished steel. However, the consumption of finished steel grew only by just 3%.

The overall steel industry is not doing well due to facing various headwinds like fluctuations in raw material prices & currency as well as the increasing NPAs and stressed Assets. The Minimum Import Price imposition after the safeguard duty on certain steel products, have provided relief to some extent to the industry. With Governments focus on manufacturing & industries occupied with spending on infrastructures (roads, rails, ports, etc.), it is well expected that the demand is going to increase in coming years. The data of steel consumption for various sectors, viz. construction & infrastructure, engineering & fabrication, automotive and parts, other transportation, packaging & others has current demand (2016) of 81.5 Million Tonnes and its projected demand in 2030 is 230 Million Tonnes (almost 3 times) and this will help drive the growth. The industry looks optimistic with higher GDP growth and expected improvement in pace with public & private sector projects with Government focus on infrastructure projects.

The new Steel Policy, 2017 (NSP) released by the Government aims to increase steel production, with the objective of making the country self-sufficient in steel production The main core elements of the policy are :

- 300 million tons finished steel-making capacity by 2030;

- 160 per capita steel consumption by 2030;

- Preference for domestically produced steel in Government procurement

- Export 24 million Tonnes steel (10% of production) by 2030

- Reduction of imports to zero by 2030;

- Domestically produce value added steel-CRGO, special steel, and alloys;

- Reduce import dependence on coking coal to 65% by 2030-31;Focus on palletization and installation of slurry pipelines and conveyors including BF/BOF technology

Certain highlights of the Steel Industry in India are :

- 3rd largest consumer of finished steel globally (2016)

- 3rd largest producer of finished steel globally (2016)

- 2nd largest producer of sponge iron in the world (2016)

- Constitutes 2% of GDP of the nation

- Providing more than 6 million jobs.

THREATS, RISKS AND CONCERN

The per capita consumption of steel in India is very low in comparison to global average as well as in comparison to various other Asian economies. Eventually India has a long way to go in the consumption of steel, which as such, ensures long-term growth and good prospects for the steel sector in long run.

The Indian steel industry still suffers are high cost of power and fuel, which are expected to be addressed by new Government in due course of time. Continuous capacity expansion of integrated steel manufacturer for processing value added products are resulting into increase in their market share at the cost of secondary manufactures and resulting into squeezing margins due to keen competition. To stay ahead your company continues to develop more and more value added specialized products and better product mix and geography mix to ensure its own growth.

As a measure of cost control by saving on power cost, the Company has tied up with private power supplier for purchase of power under Long-Term open access mechanism which has already started significant saving in power cost. However, the Company did not see any development in purchase of open access power through IEX, due to denial by Gujarat Energy Transmission Corporation Ltd as technical issues in Grid line on account of critical loading have been there. The Company is also exploring the other options for further saving in power cost like solar power, wind power, etc.

Your company continues to have high exposure to forex due to significant export and import. The volatility of currency contributes to high risk and to minimize the impact of the same a prudent policy of necessary hedging / forward sales has been adopted to draw the balance between the forex asset and liabilities.

The Board of Directors is being informed periodically in respect of risk assessment and steps being taken by the Company.

FINANCIAL PERFORMANCE WITH RESPECT TO OPERATIONS

The overall sales during FY 2016-17 stood at 109,109 MT, increased by 5% over FY 2015-16 (104,052 MT) and in terms of revenue also, it has increased by approx. 5% from Rs 508.49 crores to Rs 534.99 crores, due to reduction in steel prices. Further, the Company made cash loss of Rs 28.22 crores as compared to Cash Profit of Rs 3.53 crores of FY 2015-16.

The Steel Industry has been impacted adversely during the year and the Company faced various challenges due to the factors mentioned as under:

Global pressure due to structural demand slowdown;

Significant overcapacity in China coupled with the slowdown in its domestic demand has resulted in Chinese Steel producers ‘dumping its production in overseas market at uneconomic rates for others to be able to compete and thus has adversely affected the Companys export market with lower margins;

Lack of adequate working capital assistance from banks adversely affected the SGLs operations. With the support of third party financing, it resulted in a higher input cost, ultimately impacting margins of the Company;

The domestic coated market has moved towards 1220 mm material with rapid growth in the colour coated steel subsector and against that, the company was not able to participate in this high growth, high margin market, due to width concern;

Discontinuance of Open Access Power by GETCO, resulting in considerably high power cost; and

Fluctuation in raw material prices during the year.

There are challenges going forward in FY 2017-18, however, the outlook of the Company is optimistic in view of the following:

The Company is implementing various long-term measures to improve its cash flow and revival of the operations of the Company. The Company is exploring multiple options of financial restructuring and is in discussions with strategic investor to infuse long-term required finance for its critical capex plan and also for revival of its operations. The Company is also in discussion with lenders on its detailed Debt Resolution Plan envisaging proposed critical capex on colour coating line and Alu Zinc lines. On positive outcome of efforts in above direction, the Company and its management is hopeful to make optimum utilization of its resources, renegotiate its contracts and complete the on-going projects to generate future cash flows, meet its financial obligations towards lenders and creditors. The Company believes that these measures will not only generate cash flows for revival but will also result in future orders and consequently sustainable cash flows. The promoters also continue to be committed to providing the required operational support to Company in the foreseeable future;

Strategies & markets with upcoming economy with colour coated products under capex;

Starting of open Access power, which has already started resulting into significant saving in power cost, which is one of the major cost of the Company;

Various steps being taken by the Government of India will help to grow steel industry as a whole;

The value-add capex of Colour Coating Line (CCL) has already started from June 2017 and is in operations with capacity of around 80%;

The proposed value-add capex of Aluminum Zinc (AZ) Line will enable the company to enhance the Companys viability in the market with wider market, both domestic & export, better margin and branding of the Company;

Diversifying the product basket and market;

Forward Integration by implementation of capex adding value added products resulting in higher realization per ton of production; and

With various products, the Company will be in a position to explore and penetrate new markets including domestic markets, which will enable sustained growth.

Regarding outlook of the capex, phase I, i.e. Colour Coating Line, which has already started its commercial production from June, 2017, the Colour coated steel demand has increased at a CAGR of 21% in 2006 to 2014 and in last 3-4 years, the demand has significantly increased. The total capacity of Colour Coated Steel in India in 2017 reaches to 2.4 million tonnes per annum.

The phase II, the Aluzinc Line (proposed), the market of Aluminum & Zinc coating is a global trend adopted by various finished steel manufacturers as the same has various advantages. It has been proven to stand the test of time as it is designed to withstand the rigors of various climatic conditions. The product is 4 times more durable than galvanized finished steel and in addition, it is light, heat resistan, and extremely thermally reflective. As the Al-Zn coating steel uses less zinc as compared to Galvanized Steel, margins are expected to be higher and markets for the product looks more attractive.

The long term outlook, in view of capex is positive.

INTERNAL CONTROL SYSTEM AND THEIR EFFICACY

The Company has in place adequate systems of internal control commensurate with its size and the nature of its operations. These have been designed to provide reasonable assurance with regard to recording and providing reliable financial and operational information, complying with applicable statutes, safeguarding assets from unauthorized use or losses executing transaction with proper authorization and ensure compliance of corporate policies.

Internal Audit covering the key areas of operations and Audit on Internal Financial Control covering areas including operations having Financial Reporting impact are conducted at regular intervals. It is an independent assurance and functions responsible for evaluating and improving the effectiveness of risk management control and governance processes.

An Audit Committee consisting of three Independent Directors, one Nominee Director and one Non-Executive Director is in place. The Internal Audit Reports are placed before the Audit Committee. The Audit Committee deliberates and advises the Management on improvements/compliance and the management provides complies with the same to the said Committee, from time to time.

STATUTORY COMPLIANCES

After obtaining confirmation from the various departments of the Company in respect of compliance with all the statutory requirements, a declaration regarding compliance of the provisions of various statutes is made by the Managing Director at each Board Meeting and deviations, if any, are brought to the notice of Directors with reasons and remedial measures taken to comply with the same. The Company Secretary, as a Compliance Officer, ensures compliance of the Companies Act, SEBI (Listing Obligations and Disclosure Requirements) Regulations, 2015 and other various SEBI Regulations.

QUALITY

Your Company believes in branding its products for sustainable and long term growth, through customer satisfaction that goes beyond contractual obligations, improvement in quality, resolution of customer complaints with a target of improvement in reduction of complaints from time to time. In todays global competition and open economy, quality plays a vital role in marketing the products and in staying ahead of others. Therefore, more emphasis is being given to manufacturing of products that meets high standards of quality in the global market and customers satisfaction. Proactive efforts are directed towards determining customers requirements and achieving all-round customer satisfaction. This is primarily achieved through automated systems, high attention to complaint resolution, online communication, and information exchange, at various levels.

MATERIAL DEVELOPMENTS IN HUMAN RESOURCES / INDUSTRIALRELATIONS

Industrial and employee relations with the company remain cordial throughout the year. It has been with the fulfillment of our market commitments, prompt communications, and participation in social activities and to provide challenging and safe environment in the company, where every employee can develop its own strength and deliver its best expertise in the companys interest.

The Board of Directors on record conveys thanks to all the employees for their valuable contribution towards their support in performance of the company in this difficult situation.

Your Company encourages employees to go beyond their scope of work, initiated various employee engagement activities and encourages them to participate, undertake voluntary projects and training and developmental sessions enabling the employees to learn and contribute innovative ideas in line with the vision, mission and core values of the Company.