steel prices: avoid bottom fishing in steel stocks; book profits now: Rakesh Arora

“Investors should book profits, stay away and let the sector stabilize before trying to see where value emerges,” says Rakesh AroraManaging Partner, Go India

Do you think 10-20% steel meter corrections are an overreaction?
No, I don’t think that’s an overreaction. The duties that have been imposed are quite severe and while India was exporting around 20 million tonnes of steel, net imports would be slightly lower because although some imports were, 20 million tonnes when your domestic demand is of about 100 million tonnes is a large number to absorb nationally.

Our export prices are around $820 and our domestic price is around Rs 69,000. So they are tied. Now, if you have to absorb this 20% of production in-house, the domestic prices have to come down and this reduction would be around Rs 10,000 to Rs 15,000 per ton. So what we are seeing is only an initial reaction, but the industry is downgraded much more significantly and is expected to be underperforming for some time.

Could you explain to us how the profitability of exports is likely to be affected and how big the impact could be?
The first impact concerns iron ore. Iron ore duties have been increased from 30% to 50%. I believe iron ore prices would correct by around Rs 1,500 per ton from the current level and that will be the export parity price. Indeed, iron ore was already taxed at about 30% export duty. So another 20% came in.

The impact on steel is greater. Steel prices are expected to correct by around Rs 8,000 to Rs 10,000 per tonne from current levels of Rs 69,000 and steel margins for integrated players that have iron ore and coal Captives are expected to correct by around Rs 8,000 to 9,000 per ton while non-integrated guys who are buying iron ore have an advantage because iron ore prices will go down. So, for them, the margin squeeze will be Rs 7,000.

Back to recommendation stories

So now you can calculate what the impact will be on individual businesses. For example, if you earned Rs 24,000 per ton in India, their impact is Rs 9,000 to Rs 10,000 per ton. This is our calculation. What will actually happen, we have to wait and see whether or not companies are able to maintain domestic prices and to what level of impact there is on reduced exports. But I suspect we will see severe compression on the margins.

Do you think the impact could be partially offset by the potential decline in domestic iron ore prices and the removal of import duties on coking coal?
As I said, the steel price drop would be around Rs 10,000 and that is what I expect. The profit from iron ore and coking coal combined is around Rs 3,000. The net negative impact is around Rs 7,000, according to my calculations.

The reaction that we see on the counters is not an overreaction. We expect a significant downgrade in the future. What should an investor do? Should they consider booking their profits or losses at this stage or should they hold on?
No no. Bottom fishing should be totally avoided. When we talk about a reduction in margin of around Rs 7,000 per ton and in the case of some companies it is Rs 9,000 to Rs 10,000, these companies may be loss making at the expected margins. I don’t think bottom fishing is a good idea at this level. Investors should book profits, stay on the sidelines and let the sector stabilize before trying to see where value emerges.

Given the type of reaction that you expect with respect to domestic prices as well as the impact that these companies may face, do you expect the government to re-examine the situation or try to find common ground? ?
Anything is possible, but if the government is going to meddle in the rights structures to such an extent, investor confidence in this sector will drop dramatically. Nobody likes uncertainty. I think the stocks become untouchable for a while until the policy is clarified.

(Disclaimer: The recommendations, suggestions, views and opinions given by the experts belong to them. These do not represent the views of Economic Times)