>INDIAN STEEL SUBSECTOR: Shifting sands: Initiating coverage

We argue that sustained hikes in iron ore export duties have subsidised the domestic steel industry at the expense of miners. This, coupled with the ongoing mining impasse, make us negative on the iron ore mining space, even as stock valuations are attractive. We initiate coverage of NMDC and Sesa Goa with a 3-UW. We see the contours of the Indian steel industry slowly but certainly changing in favour of the large steel producers. JSPL 1-OW is our top pick, given its superior business model and strong growth visibility. We rate SAIL 3-UW, given muted volume growth and cost pressures. Tata Steel (1-OW) offers a favourable riskreward trade-off, given that peak debt is down (c20%), ROE accretive India expansion is closer to commissioning and valuations are already factoring in a negative value for its European operations. We rate JSW Steel as 2-EW, as although negatives are already in the price, the mining impasse would delay a rerating.

■ More bullish on the medium-term outlook for Indian steel relative to iron ore mining:

While global iron ore miners have captured value from rising steel prices, rising regulatory costs in India have capped upside for the Indian miners (read export duties). In fact, India now has one of the highest taxation regimes on iron ore globally, and could increase even further if the proposed mining tax and increase in export duties get implemented. We expect NMDC (3-UW) and Sesa Goa (3-UW) to be negatively impacted by this trend. Furthermore, ongoing government probes into potential illegal mining is a further risk to earnings of Sesa Goa (3-UW) and to some extent on JSW Steel (2-EW).

■ See structural changes in the steel sector benefiting the larger, established players: While we cannot ignore the short-term risk to steel pricing in India (which has held up well relative to global prices, due to currency depreciation and supply disruptions), we expect the larger integrated mills to capture further market share in India at the expense of the sponge iron producers (whose survival is threatened from declining coal and gas linkages). The big mills are also forming JVs with technology leaders globally and improving their product specifications, thus improving long-term margin potential. Domestic overcapacity is inevitable, but there is an opportunity in sub- segments such as value-added long products. We see JSPL (1-OW) and Tata Steel (1-OW) benefiting most from these changes, relative to SAIL (3-UW).

■ Further increase in regulatory costs and exchange rate are key risks: Over and above iron ore prices and the risk of increased Chinese exports, we highlight that a further increase in the regulatory burden for iron ore miners and exchange-rate risks on foreign currency-denominated debt are two issues investors need to keep an eye on.

To read the full report: INDIAN STEEL

RISH TRADER