Tuesday, April 28, 2009

>India Steel (Deutsche Bank)

Global steel production down 24% YoY

Global crude steel production declines for the seventh consecutive month...
The cavalry of global steel production cuts continued for seventh consecutive month with a 24% YoY decline in global crude steel production in Mar'09 taking cumulative decline for 1QCY09 to 23% YoY. EU and North America continue to stand out as regions with the most aggressive supply response with YoY production decline of 45% and 52% respectively in Mar'09. China is the only major region that has defied global trends with only a marginal decline of 0.3% YoY in crude steel production in Mar'09.

…But global steel pricing remains weak
Though the global production response has been very aggressive, we are yet to see any sustainable recovery in global steel prices. Our global steel pricing table (Page 3) shows a WoW decline across all major world geographies. Our global team recently cut the HRC price forecasts for U.S. and Europe by an average of 14% in 2009 and 7% in 2010 to reflect market surpluses and reduced costs.

Demand scenario in Europe remains weak; more production cuts required
While Europe has been quite aggressive in reducing steel production – down 44% in 1QCY09, our global steel team believes that it lags US in the inventory destocking cycle and more production cuts are likely required to restore the demand supply equilibrium. Arcelor Mittal has already guided for the continuation of its steel production cuts in Europe into the second quarter in response to the exceptionally weak economic conditions.

Marginal capacity in China remains the key focus area
China continues to stand out as the only major region in the world that has not participated in the global steel production response. The importance of China in the present scenario can not be over emphasized given that its contribution to global crude steel production has increased to 49% in 1Q’CY09 from 38% in CY08. The flexible excess capacity in China remains nimble in responding to the fluctuating cash margins. Though our Chinese steel analyst estimates that the cash margins are negative now, he also expects the cycle to repeat itself over the
course of 2009.

Reiterate SAIL as top pick
We continue to prefer SAIL (SAIL.BO, INR108, BUY) as our top pick in the Indian steel sector. The high exposure to domestic demand and low risk government funded projects provides visibility over SAIL’s ability to push volume sales. Also, strong balance sheet and net cash position removes any refinancing risk. We value SAIL on a FY10 EV/EBITDA of 2.7x leading to a TP of INR108/share. Tata Steel (TISC.BO, INR263, HOLD) remains a Hold with its high exposure to the weak. European steel market through Corus and highly levered balance sheet. We have a TP of INR192/share for Tata Steel based on SOTP valuation. A protracted downcycle in steel remains the biggest downside risk factor. (See page 4 for details on valuation and risks).

To see full report: INDIA STEEL