Valuation Insights and Risk Analysis of Steel Market

 | May 03, 2024 18:29

In the intricate dance of steel prices and market dynamics, Morgan Stanley (NYSE:MS)'s recent report shines a light on key trends shaping the industry landscape.

Last week witnessed a modest uptick of about 1% in domestic Hot Rolled Coil (HRC) prices, with a month-on-month increase of 2.4%, reaching Rs53,500/t. However, Rebar prices saw a slight decline of 1.4%, possibly due to a post-fiscal year-end demand moderation and the central elections. Meanwhile, China's steel prices experienced a slight dip, potentially influenced by moderation in metallurgical coal prices. The import parity premium remained stable at around 7%.

Global iron ore prices surged in April, recording a remarkable uptick of approximately 13%, further bolstered by optimistic sentiments regarding China's macroeconomic recovery. This surge translated into strength in domestic prices, notably by NMDC (NS:NMDC), which hiked lump and fines prices by Rs400/t and Rs200/t, respectively. Despite this, domestic iron ore prices maintain a significant discount of around 50% compared to global prices.

Metallurgical coal prices remained relatively stagnant throughout April but witnessed a sharp downturn last week, dropping approximately 3.4% WoW (Australia HCC).

Domestic steel spreads exhibited positive trends in April, recording a monthly increase of about 3% and a weekly increase of approximately 2%. However, analysts at Morgan Stanley caution against anticipating significant expansion in the near term, indicating a likely plateau in profitability.

March saw robust demand for finished steel, propelled by seasonal factors and central elections, with a year-on-year increase of about 9%. This demand outpaced supply growth by approximately 7%, resulting in inventory de-stocking. However, inventory levels still remain elevated compared to historical averages, with future trends pivotal in predicting the trajectory of spreads.

Despite steel stocks witnessing a commendable performance over the last six months, outperforming the Sensex by approximately 20 percentage points, Morgan Stanley remains cautious. They argue that the absence of substantial improvements in inventory levels and spreads, and consequently profitability, suggests that the current outperformance may be overstretched. With valuations currently at 1.8x (on a 1-year forward P/B basis) compared to a long-term average of approximately 1x, they anticipate a potential de-rating in the coming months.

As investors, understanding the valuation methodologies and associated risks of steel companies is crucial for making informed decisions. Let's delve into the fair valuation assessment provided by the industry-grade investment tool - InvestingPro coupled with Morgan Stanley’s risk assessment.

Jindal Steel And Power Ltd

Probability-weighted residual income model: The assessment is based on a bull (10%), base (70%), and bear (20%) scenario. The higher weighting on the bear case reflects concerns regarding the medium-term demand/supply dynamics and steel price outlook, with a CoE of 12.5%, terminal ROE of 13%, and terminal growth of 3%.