(The following was released by the rating agency)
June 5 (Fitch) Fitch Ratings says that the profit margins of Indian steel producers are likely to remain under pressure in H212. This is attributed to persistent increases in the cost of steel production and steel producers' limited ability to pass on higher costs due to subdued demand from end-user industries given the prevailing unfavourable macro-economic environment.
Fitch also believes steel prices may soften in July through September 2012 as demand for long steel will fall with the onset of monsoons and the consequent slowdown in construction activity.
"Fitch expects steel producers to test the market for any increase in prices during the festival season beginning October 2012. However, the risk of regulatory intervention on prices, given the government of India's priority to tackle inflation, continues to exist," says Ashish Upadhyay, Associate Director, in Fitch's Corporates team in India.
"Despite steel being a deregulated commodity, the government may exert indirect control on steel prices as seen in the past."
The positive impact of softer key raw material (iron ore and coking coal) prices globally has been offset by a depreciating Indian rupee (INR). As the bulk of coking coal is imported, a weaker INR adversely affects the EBITDA margins of steel producers using blast furnaces. As domestic steel prices are aligned to the price of imported steel, a depreciating INR helps in cushioning the impact on EBITDA. However, the prices are contingent on the end-user demand which presently being weak limits the ability of steel producers to increase prices.
Fitch notes that the 10% price hike in May 2012 by NMDC Ltd, India's largest iron ore miner, would increase the cost of producing steel by 3%-5% and thus adversely impact steel producers that are not vertically integrated. Integrated steel producers like Steel Authority of India Limited ('BBB-'/Stable) and Tata Steel Limited ('BB+'/Stable) are unlikely to be impacted, given their captive iron ore mines, and may see margin expansion even in the case of partial pass through of increased cost by the steel industry.
The price hike was preceded by Indian Railways increasing the freight for iron ore import by 20%, which will shave off around 2%-4% from the EBITDA of steel producers. The significance of freight cost in steel production is indicated by the fact that for every one metric tonne of steel produced around four metric tonne of raw material is transported.
Despite margin pressures, Fitch maintains a Stable Outlook on its rated steel producers to reflect its view that most of these entities could keep up with short-term demand slowdown without a material weakening of their credit profiles.