Should you invest in steel companies?

Why are stock prices of steel companies going up?

Introduction

Steel Companies have been making a strong comeback. Rapid rise in production, robust recovery in demand and record high selling prices have nudged steel players on a profitable path. The stock prices of major steel producers have been on the up and up. What is the dynamics propelling this rally? Let’s find out!

Should you invest in steel companies?

Steel Industry in India

• It is a cyclical industry.
• What is a cyclical industry you ask. A cyclical industry is a type of industry that is sensitive to the business cycle, such that revenues generally are higher in periods of economic prosperity and expansion and are lower in periods of economic downturn and contraction.
• Automobile, Construction and Infrastructure are also cyclical industries which to a great extent are reliant on the steel industry primarily for raw materials.

Traits of Cyclical Industry

• When the economy is the recovery phase gravitating towards boom, more often than not, companies from various cyclical sectors begin expanding their capacities aggressively as they expect demands to skyrocket when the economic cycle reaches its peak.
• ‘This time it is different syndrome’ blithely stimulates these companies to make substantial investments. Hence, they binge on huge amounts of debt to accomplish their expansion endeavors.
• However, when the economic cycle descends into recession and demand starts to fade away, these companies get trapped and incur heavy losses owing to the massive dues parables on their debts. This sends the debt ridden company’s stock price into free-fall, collapsing like a house of cards.
• The above phenomenon is prominent. Let’s take an example of the same in the Auto sector.

• Tata Motors has much higher debt as compared to Maruti Suzuki. If we compare their respective stock price performance from Jan 1, 2020 to March Lows, Maruti Suzuki slipped 42%, while Tata Motors bore the brunt and plunged 62%.

Production in India

• The production of Steel in India is dependent on 2 key raw materials – Iron Ore and Coking Coal.
• When it comes to Iron Ore, India is self-sufficient. A good amount of Supply is there in India to meet domestic demand and we even export the excess supply to other countries.
• However, for Coking Coal India is almost entirely dependent on imports, majorly from Australia. Our country lacks the requisite mines and resources for Coking Coal. So any disruption in Coking Coal production can disturb overall demand-supply equation and exacerbate the situation.

China’s dependence on Indian Steel Industry

• India is the 2nd Largest Steel Producer, churning out 111 million tonnes of Steel annually and accounting for over 5.5% of World’s Steel Supply. While, China produces around 1 billion tonnes of Steel.
• Despite accounting  for over 50% of World’s Steel Supply, China happens to be importing steel from India does furrow the brow.
• Unlike India, the Chinese steel industry is dominated by a number of large state-owned groups which are owned via shareholdings by local authorities, provincial governments and even the central authorities. Hence, they rarely face problems on the financial front and relatively more buoyant.

Tailwinds of Indian Steel Industry

• Government’s support towards spending on infrastructure development. The Government decided on a capital expenditure outlay of Rs 4.12 Lakh Crore in the 2020-21 budget, which was 18% over the revised estimates of the previous financial year. On top of this, the Center also announced capital spending of around Rs 37,000 crore as part of the Atmanirbhar Bharat packages.
• Incentivization in construction & real estate sector as well as reduction in stamp duty by state government boosted the sentiments for realty sector.
• Strong demand momentum in automobile industry. Robust auto sales numbers in Sep-20, Oct-20 and Nov-20 as compared to last year.
• Strong Demand from China. During April-September, China alone accounted for 30% of India’s Steel Exports. This said to on account of aggressive infrastructure investments by China. However, we still remain in-cognizant on the same.

Tata Steel – Cyclicity in share price movement

• Let’s take a quick look at Tata Steel’s historical price chart.

• Tata Steel’s share price journey is akin to an adrenaline charged roller coaster, filled with wild ups and downs. Same is the case with the company’s profitability trend.

• Tata steel has an all time high of Rs. 887 that it recorded on 4th January 2008, it’s been 12 years since then and the stock has barely made it to Rs 800 levels. These charts epitomize the sensitivity and high correlation of a cyclical company’s stock prices with the economic cycles.

Conclusion

An investor should conduct through research and analysis before making an investment in the steel sector. Investing in companies belonging to a cyclical sector is a completely different ball game and investors should exercise caution at all times and not take arbitrary hasty decisions.