ChangeinEstimatesRatingTarget

Steel

In transition phase
Global steel market in a transition phase

Sector view: Nifty: Sensex: Weight inSensex:

Neutral 6,583 22,056 4.3%

The global steel market, over the last one quarter, has been in a transition phase; on one hand the demand growth in China is slowing down while on the other, developed nations like US and EU are displaying signs of gradual improvementindemand.EconomicdataemanatingoutofChinaoverthelast two months have accentuated our view that the Chinese economy is slowing downanddemandforsteelwouldremainsubduedintheregionin2014.This impact on overall demand would be offset by a recovery in the US and Europe. We believe that global steel demand growth in 2014 would be in the rangeof34%yoy.

BhushanSteelSELL CMP:Rs449 Target:Rs403 Downside:10.2%

JindalSteel&PowerMP CMP:Rs265 Target:Rs263 Downside:0.8%

Domestic steel prices to decline

JSWSteelSELL
CMP:Rs979 Target:Rs830 Downside:15.2%

Steel prices have been on a downward trend since the start of 2013; however, the decline in steel prices has been quite lower than the fall in its rawmaterialprices.Pricesofcokingcoalandironoredeclined26.7%yoyand 27.6% yoy, respectively, in the spot market since January 13 against a 10% decline in Chinese export HRC. As a result, the spread between steel prices andinputcostshavejumpedsharplytoitshighestlevelinthelast30months. We believe, going ahead, steel prices would be under pressure as the spread would narrow down due to the excess capacity in the system and pull down steel prices in the near term. We believe domestic prices would align with global prices as we have turned into net exporters of steel, which is visible withthesharpcorrectioninthediscountofdomesticsteelprices.
Tata Steel remains our preferred pick in the sector

SAILSELL CMP:Rs59 Target:Rs52 Downside:11.9%

TataSteelBUY CMP:Rs363 Target:Rs430 Upside:18.5%

Horizon:912months PricesasonMarch24,2014

Amongst the domestic steel manufacturers, Tata Steel remains our preferred pick as we expect a revival in its European operation and volume growth in FY16fromitsnewKalinganagarfacility.TheEuropeanbusinessisexpectedto benefitfromthedeclineinrawmaterialpricesandarevivalindemandinthe region. We maintain our negative stand on JSW Steel and Bhushan Steel due to the tight iron ore market in the region and on expectations of a decline in steel prices. We also maintain our SELL rating on SAIL as its expansion plan continues to get delayed and margins would remain under pressure going ahead. We estimate that the impact on JSPLs earnings from the new capacities would to an extent be offset by weaker spot power prices and problems related to excavation of power. We believe JSPL is trading near its fairvalueandmaintainourMarketPerformerratingonthestock.

Financialsummary
Company BhushanSteel JSPL JSWSteel SAIL TataSteel Reco SELL MP SELL SELL BUY CMP (Rs) 449 265 979 59 363 TP (Rs) 403 263 830 52 430 Returns (%) (10.2) (0.8) (15.2) (11.9) 18.5 PATCAGR FY16 FY1316E(%) EV/EBIDTA 4.2 9.5 12 26.8 3.8 167 5.1 5.4 6.7 4.6 FY16 P/E 21.2 6.1 8.8 9.5 5.5

Research Analyst:

Source:Company,IndiaInfolineResearch

TarangBhanushali
research@indiainfoline.com

March25,2014

SectorUpdate


Steel prices declined gradually over the last one year

Steel

Pricesofcokingcoalandironore declined26.7%yoyand27.6%yoy, respectively,inthespotmarketsince January13againsta10%declinein ChineseexportHRC

The global steel market, over the last one quarter, has been in a transition phase; on one hand the demand growth in China is slowing down while on the other, developed nations like US and EU are displaying signs of gradual improvement in demand. Steel prices have been on a downward trend since the start of 2013 due to a decline in raw material costs and subdued demand scenario in EU in H1 2013. Prices of its key raw materials, coking coal and iron ore, have declined 17.3% yoy and 12.6% yoy, respectively, in the spot market in 2013. The slide in raw material prices has accentuated in 2014, as prices of iron ore have declined further by 17.4% and that of coking coal have declined by 20% since the start of 2014. However, the decline in steel prices has been relativelyloweronaccountoftherevivalindemandinUSandEurope.Chinese export HRC prices fell 4.5% during 2013 and then declined further by 2.4% sincethestartof2014. Fallinsteelpriceslowerthandeclineinrawmaterialpricesin2013
1,200 (US$/ton) 1,000 800 600 400 200 0 Jan07 Jan08 Jan09 Feb10 Feb11 Feb12 Mar13 Mar14

Source:ILZSG,Bloomberg,IndiaInfolineResearch

Spotironorepriceshavecorrected26%sincethe startof2013
180 (US$/ton)

Spotcokingcoalpricestoohavedeclined33%over thesameperiod
240 220 (US$/ton)

160 200 140 180 160 140 100 80 Dec11 Mar12 Jul 12 Nov12 Mar13 Jul 13 Nov13 Mar14 120 100 Jan12 Apr12 Aug12 Dec12 Mar13 Jul 13 Nov13 Feb14

120

Source:ILZSG,Bloomberg,IndiaInfolineResearch


Global production rose 3.5% yoy in 2013 led by 6% growth in Asia

Steel

Chinaproduced779mntons,an increaseof7.5%yoy,raisingitsshare inworldcrudesteelproductionfrom 46.7%in2012to48.5%in2013

In 2013, global crude steel production reached 1,607mn tons in 2013, up by 3.5% compared to 2012. The growth came mainly from Asia and the Middle East while crude steel production in all other regions decreased in 2013 compared to 2012. Asia produced 1,081mn tons of steel in 2013, recording a growth of 6% yoy. The regions share of world steel production increased from 65.7% in 2012 to 67.3% in 2013. China produced 779mn tons, an increase of 7.5% yoy, raising its share in world crude steel production from 46.7% in 2012 to 48.5% in 2013. The EU recorded a decrease of 1.8% yoy at 165.6mn tons of crude steel in 2013. Production in North America was 119.3mn tons, a dip of 1.9% yoy. India registered a 5.1% yoy growth in steel production, maintaining itsfourthpositioninglobalsteelproduction.

Globalsteelproductionincreased3.5%yoyin2013 ledbystrongoutputfromtheAsiancountries
1,700 (mntons) 1,600 1,500 1,400 1,300 1,200 1,100 1,000 2006 2007 2008 2009 2010 2011 2012 2013 6 4 2 0.1 0 (2) (4) (0.9) (1.8) (1.9) (1.9) 3.2 8 7.5 (%) 4.6

Source:WorldSteelOrganisation,Bloomberg,IndiaInfolineResearch

The steel industrys performance in 2013 was divided into two halves. In 9m 2013, Chinese steel production was quite strong, whereas that of developed nations was weak. However in the last quarter, Chinese steel production growth started to slow down while developed nations showed improvement. Share of Chinese steel production of global production, which touched a high of 51% in Aug 13, declined to 48% in Dec 13. Capacity utilization levels have droppedto74.2%inDec13lowerthan80%achievedinApril13. ShareofChineseproductionfellto48%inDec13
China Restofthe world

GlobalproductionwasflatinFeb14duetolower productionfromChina
140 135 130 125 120 115 110 105 100 (mntons) Monthlyprod yoychng (%) 14 12 10 8 6 4 2 0 (2) (4) (6)

56% 54% 52% 50% 48% 46% 44% 42% 40% Jan12 May12

Sep11

Sep12

Sep13

Jan11

Jan12

Jan13

May11

May12

Sep12

Jan13

May13

Oct13

Feb14

Source:WorldSteelOrganisation,Bloomberg,IndiaInfolineResearch

May13

Jan14

Others

China

EU27

Japan

India

CIS

US

SA

Steel

Chinesesteelproductiongrowthhascooledoffover asproductionhaspickedupinROWduringthe thelastfourmonths sameperiod

20 15 10 5 0 (5) (10) Jan11 Jul 11 Jan12 Jul 12 Jan13 Jul 13 Jan14 (%) 14 12 10 8 6 4 2 0 (2) (4) (6) Jan11 Jul 11 Jan12 Jul 12 Jan13 Jul 13 Jan14 (%)

Source:WorldSteelOrganisation,Bloomberg,IndiaInfolineResearch

SteelproductioninEuropehasimproveddrastically inQ42013
production yoy chng

USsteelproductionwasstronginQ32013
production yoy chng

17 16 15 14 13 12 11 10

(mntons)

15 (%) 10

(mntons)

20 (%) 15

8 5 0 7 (5) (10) Jul 11 Jan12 Jul 12 Jan13 Jul 13 Jan14 6 Jan11 Jul 11 Jan12 Jul 12 Jan13 Jul 13 Jan14

10 5 0 (5) (10) (15)

Jan11

Source:WorldSteelOrganisation,Bloomberg,IndiaInfolineResearch

Globalcapacityutilizationlevelshavedeclinedfrom Globalsteelproductionsharein2013 80%inApril13to74.2%inDecember13

85 80 5% 75 70 65 60
Sep11 Sep12 Sep13 Jan11 Jan12 Jan13 May11 May12 May13 Jan14

(%)

13%

10% 7% 5% 3% 2%

EU27 CIS US

7%

SouthAmerica MiddleEast China Japan India

48%

Others

Source:WorldSteelOrganisation,Bloomberg,IndiaInfolineResearch


Growth slowdown in China to continue

Steel

China'sfixedassetinvestment,a maingrowthdriver,grewanannual 19.6%in2013,whileretailsalesrose 11.3%

China, overthe last decade has been pushing hard to industrialize thecountry. China has witnessed strong urbanization across the country leading to strong demand for metals. However, Chinese steel consumption growth has been slowing down over the last two years as investments into infrastructure and housing have slowed down. Fears of an asset bubble creation led to interest rates remaining high. China's fixedasset investment, a main growth driver, grew an annual 19.6% in 2013, while retail sales rose 11.3%. The economy expanded at an annual 7.7% last year, lower than its previous years. China's urban fixedasset investment grew 17.9% yoy in the first two months of 2014, down from the 21.2% growth registered in the same period of last year. The growth rate was 170bps lower than the fullyear pace of 2013, as China's economyfacesdownwardpressure. With a slowdown in the economy, crude steel consumption growth in China declined to5% yoy against the 5year average of 9.8%. China produced779mn tons, an increase of 7.5% yoy, raising its share in world crude steel production from 46.7% in 2012 to 48.5% in 2013. However, crude steel production in Februarywasflatat0.8%yoyto62.1mntons. Chinesesteelconsumptionsloweddownto5%yoy againstits5yearaverageof9.8%
Consumption 750 700 650 600 550 500 450 400 350 300 2007 2008 2009 2010 2011 2012 2013 0 5 15 10 (mntons) yoychng 25 (%) 20 70 65 60 75 (mntons)

productioninJanuarydeclined3.2%yoy
production yoy chng

20 (%) 15 10 5

55 50 45 40 Jan11 Jul 11 Jan12 Jul 12 Jan13 Jul 13 Jan14 0 (5) (10)

Source:WorldSteelOrganisation,Bloomberg,IndiaInfolineResearch

Exportshavestartedtocreepupasdomestic demandweakens
7,000 6,000 5,000 4,000 3,000 2,000 1,000 0 ('000 tons)

inventorylevelstoohaveinchedupindicating subdueddemandintheeconomy
10,000 9,000 8,000 7,000 6,000 5,000 4,000 3,000 2,000 '000 tons

Jul 10

Jul 11

Jul 12

Jan10

Jan11

Jan12

Jan13

Jul 13

Oct10

Oct11

Oct12

Apr10

Apr11

Apr12

Apr13

Oct13

Jan14

1,000 0 Jan08 Dec08 Oct09 Sep10 Jul 11 May12 Apr13 Feb14

Source:WorldSteelOrganisation,Bloomberg,IndiaInfolineResearch


Key Chinese economic indicators signify a slowdown in China

Steel

ChineseGDPgrowthratehasbeenintherangeof 7.58overthelasttwoyears
25 20 15 (%)

but,Fixedassetinvestmentshavedeclined sharplyto17.9%inFeb14,itslowestsinceDec12
35 (%)

30

25 10 20 5 0 15

Feb08

Feb09

Feb10

Feb11

Feb12

Feb13

Aug08

Aug09

Aug10

Aug11

Aug12

Feb08

Feb09

Feb10

Feb11

Feb12

Feb13

Aug08

Aug09

Aug10

Aug11

Aug12

Source:Bloomberg,IndiaInfolineResearch

Industrialproductiongrowthhasbeenina downwardtrendsinceFeb10
25 20 15 10 5 0 (%)

Aug13

Feb14

Retailsalesgrowthof11.8%yoywasthelowestin thelasteightyears
25 20 15 10 5 0 (%)

Feb08

Feb09

Feb10

Feb11

Feb12

Feb13

Aug08

Aug09

Aug10

Aug11

Aug12

Aug13

Feb14

Jul 08

Jul 09

Jul 10

Jul 11

Jul 12

Jan08

Jan09

Jan10

Jan11

Jan12

Jan13

Jul 13 Jan13 Jul 13

Aug13

Source:Bloomberg,IndiaInfolineResearch

PMIindexhasmanagedtostaymarginallyabove the50mark
65 60 55 50 45 40 35 30

Infrastructureindexhasslidoverthelastthree months
2,500 2,000 1,500 1,000 500 0

Jul 08

Jul 09

Jul 10

Jul 11

Jan08

Jan09

Jan10

Jan11

Jan12

Jul 12

Jan08

Jan09

Jan10

Jan11

Jan12

Jan13

Source:Bloomberg,IndiaInfolineResearch

Jan14

Jan14

Jul 08

Jul 09

Jul 10

Jul 11

Jul 12

Jul 13

Jan14

Feb14

 In 2014, China plans to maintain its economic growth target for 2014 at about 7.5%, signaling that its policy focus would be slanted in favor of reforms and rebalancing the economy. It also targets 17.5% annual growth in fixedasset investment and 14.5% in retail sales growth in 2014. The recent reforms signaled the shift of the world's second biggest economy from investment and export fuelled growth towards a slower, more balanced and sustained expansion.Thecountrywillspeedupconstructionprojectsandothermeasures to support economic growth after a slowdown in industrial output and investment boosted risks of missing an expansion target for the year. As a result of the shift in Chinese policy, we expect some old steel capacities to be closed. However, this would not reduce the overcapacity in the country and would lead to higher exports from China. We expect Chinese steel consumption growth in 2014 would be in the range of 23%. We believe a subdued Chinese demand would keep raw material prices lower in 2014 and wouldkeepsteelpricesunderpressure.
Decline in raw material prices to pull steel prices lower

Steel

Chinaplanstomaintainitseconomic growthtargetfor2014at~7.5%and italsotargets17.5%annualgrowthin fixedassetinvestmentand14.5%in retailsalesgrowthin2014 Thespreadbetweensteelpricesand inputcostshavejumpedsharplytoits highestlevelinthelast30months

Steel prices have been on a downward trend since the start of 2013; however, thedeclineinsteelpriceshasbeenquitelowerthanthedeclineinrawmaterial prices. Prices of its key raw materials, coking coal and iron ore, have declined 17.3% yoy and 12.6% yoy, respectively,in the spot market in 2013. The slide in rawmaterialpriceshasaccentuatedin2014,aspricesofironorehavedeclined furtherby17.4%andthatofcokingcoalhavedeclinedby20%sincethestartof 2014.However,thedeclineinsteelpriceshasbeenrelativelyloweronaccount oftherevivalindemandinUSand Europe.ChineseexportHRCpricesfell4.5% during 2013 and then declined further by 2.4% since the start of 2014. As a result,thespreadbetweensteelpricesandinputcostshavejumpedsharplyto its highest level in the last 30 months. We believe, going ahead, steel prices would be under pressure due to the weak input costs and weak demand scenarioinChina.Thespreadwouldnarrowdownduetotheexcesscapacityin thesystemandpulldownsteelpricesoverthenextonemonth. SpreadbetweenChineseexportHRCandspotraw materialpriceshasspikedoverthelasttwomonths
600 (US$/ton) 500 400 300 200 100
Jun11 May09 Sep08 Sep10 Feb12 Oct12 Jun13 Mar14 Jan08 Jan10

andthesamewaswitnessedbetweenrebarand scrapprices
350 300 250 200 150 100 50 0 Jan10 Oct10 Jun11 Feb12 Oct12 Jun13 Feb14 (US$/ton)

Source:Bloomberg,IndiaInfolineResearch


Domestic steel consumption grew a mere 0.7% in 11M FY14

Steel

Withkeysteeldemandsectorssuch asconstructionandautoswitnessing negativegrowthindomesticmarket, steeldemandinthecountrygrewby amere0.7%yoyovertheperiod AprilFebruary14.Indiahad consumed67.3mntonssteelduring 11MFY14against66.8mntonsinthe sameperiodlastyear

Indias steel demand growth over the last three years has been on a declining trend due to the sharp cut in investments in the infrastructure sector. The housing and the construction sectors, which account for ~half of the total demand in the country, have been on downtrend over the last two years. In addition to this, the automobile sector has also shown a decline in domestic sales volume. With key steel demand sectors such as construction and autos witnessing negative growth in domestic market, steel demand in the country grew by a mere 0.7% yoy over the period AprilFebruary 14. India had consumed67.3mntonssteelduring11MFY14against66.8mntonsinthesame period last year. On the other hand, steel production during the period increasedby4%yoyto77.3mntons.Theimpactofthejumpinproductionwas offsetbyadeclineinimports(down31%yoy).Takingadvantageoftheweaker rupee during the year, exports jumped 8.1% yoy during the period of April February14. Steelproductionhasincreasedby4%YTDFY14
12.0 10.0 7 8.0 6.0 4.0 5 2.0 0.0 Jan11 Oct11 Jul 12 Apr13 Jan14 4 Jan11 Oct11 6

however,steelconsumptiongrowthhasbeena mere0.7%forthesameperiod
Consumption yoy growth

(mntons)

(mntons)

(%)

35 30 25 20 15 10 5 0 (5) (10)

Jul 12

Apr13

Jan14

Source:JPCIndia,Bloomberg,IndiaInfolineResearch

Exportshavejumped8.1%yoytakingadvantageof theweakerrupee
12.0 10.0 (mntons)

importshavedeclined31%yoyreducingthe pressureonsteelprices
Consumption yoy growth

(mntons)

(%)

35 30

7 8.0 6.0 4.0 5 2.0 0.0 Jan11 Oct11 Jul 12 Apr13 Jan14 4 Jan11 Oct11 Jul 12 Apr13 Jan14 6

25 20 15 10 5 0 (5) (10)

Source:JPCIndia,Bloomberg,IndiaInfolineResearch


Domestic steel prices to come under pressure

Steel

Thestrengtheningoftherupee againstthedollarandtheslidein globalsteelpriceshasreducedthe discountofdomesticpricestolanded importprices

At the start of Sept 13, major domestic steel producers announced price hikes intherangeofRs1,5002,500/ton.Priortothis, companieshadbeenunableto raise prices in Q1 FY14 due to subdued domestic demand and threat from cheaper imports. However, with the sharp rupee depreciation and an increase in global steel prices, the threat of cheaper imports has lessened. In Jan 14, steel companies raised prices by Rs1,0001,500/ton to pass on the increase in costs caused by an increase in iron ore prices and higher transportations costs. Post the price hikes, demand has been sluggish and consumers have stayed away from the market. Expectations of price cuts have risen as domestic demand for steel has declined due to the weak automobile demand and lower infrastructure spending. Further, the strengthening of the rupee against the dollar and the slide in global steel prices has reduced the discount of domestic pricestolandedimportprices. Discountofdomesticsteelpricestolandedcostofimportshasreduced
3,000 1,500 (1,500) (3,000) (4,500) (6,000) (7,500) (9,000) (10,500) Jan12 Apr12 Jul 12 Oct12 Jan13 May13 Aug13 Nov13 Feb14 (Rs/ton)

Source:Bloomberg,IndiaInfolineResearch

Webelievefurtherhikeswilldependonthepickupinconstructionactivityand automobile sales, which is quite unlikely in the backdrop of deepening economic crisis and diminishing chances of reduction in lending rates. We believe domestic demand growth for 2014, would be quite lower at ~34% against the 5.6% yoy growth expected by major players and World Steel Organisation. Further appreciation in the rupee would put pressure on steel prices as exports would reduce and pressure from imports would rise. We believe a dip in international prices would lead to lower prices in the domestic marketasIndiahasturnedintoanetexportingcountry.


Tata Steel remains our preferred bet in the steel space

Steel

Globalrawmaterialpricesare expectedtoremainsoftduetolower demandfromChinaandnew capacitiescomingonstream

The domestic steel market is set to pass through a rough patch in FY15 as demand continues to remain subdued, global steel prices expected to remain weak and excess capacity prevails. Global raw material prices are expected to remain soft due to lower demand from China and new capacities coming on stream.However,weexpectthattheslideinironorepriceswouldbemarginal duetothetightsupplysituationinthedomesticmarket.Restrictiononironore mining would restrict the decline in domestic iron ore prices. We believe steel prices would decline from current levels as the rupee continues to appreciate againstthedollar. Amongst the domestic steel manufacturers, Tata Steel remains our preferred pick as we expect a revival in its European operation and volume growth in FY16 from its new Kalinganagar facility. The European business is expected to benefit from the decline in raw material prices and a revival in demand in the region.WemaintainournegativestandonJSWSteelandBhushanSteeldueto thetightironoremarketintheregionandonexpectationsofadeclineinsteel prices.WealsomaintainourSELLratingonSAILasitsexpansionplancontinues to get delayed and margins would remain under pressure going ahead. We estimate that the impact on JSPLs earnings from the new capacities would to an extent be offset by weaker spot power prices and problems related to excavationofpower.WebelieveJSPListradingnearitsfairvalueandmaintain ourMarketPerformerratingonthestock. Financialsummary
Company BhushanSteel JSPL JSWSteel SAIL TataSteel Reco SELL MP SELL SELL BUY CMP (Rs) 449 265 979 59 363 TP (Rs) 403 263 830 52 430 Returns (%) (10.2) (0.8) (15.2) (11.9) 18.5 PATCAGR FY16 FY1316E(%) EV/EBIDTA 4.2 9.5 12 26.8 3.8 167 5.1 5.4 6.7 4.6 FY16 P/E 21.2 6.1 8.8 9.5 5.5

TataSteelremainsourpreferredpick asweexpectarevivalinitsEuropean operationandvolumegrowthinFY16 fromitsnewKalinganagarfacility Wemaintainournegativestandon JSWSteelandBhushanSteeldueto thetightironoremarketintheregion andonexpectationsofadeclinein steelprices

Source:Company,IndiaInfolineResearch

10

Recommendationparametersforfundamentalreports: BuyAbsolutereturnofover+10% MarketPerformerAbsolutereturnbetween10%to+10% SellAbsolutereturnbelow10% CallFailureIncaseofaBuyreport,ifthestockfalls20%belowtherecommendedpriceonaclosingbasis,unlessotherwisespecified by the analyst; or, in case of a Sell report, if the stock rises 20% above the recommended price on a closing basis, unless otherwise specifiedbytheanalyst

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