This time it’s different.

That is what steel makers like Tata Steel and JSW Steel are telling investors and the general public. They are, to use the overused phrase in corporate-speak—cautiously optimistic. Steel manufacturers believe that we are currently under a commodity supercycle. While Tata Steel feels this cycle might last for up to 10 years (as stated in its Q4FY21 earnings call), JSW Steel feels this super cycle  will extend for at least five years.

Predictably, stock prices for companies like Tata Steel and JSW Steel were testing lifetime highs over the past few months, while Jindal Steel and Power and Steel Authority of India (SAIL) shares were testing new 52-week highs. 

But - while it appears that the glass is half full - there are some points that investors should keep in mind.

According to a September 2021 report by Credit Suisse, India’s August 2021 ‘apparent steel demand’ fell 4% YoY, despite last year being severely impacted by Covid-19 headwinds. To top it off, even on a month-on-month basis demand is down, according to Credit Suisse.

So, what does the rest of FY22 portend for investors who are looking to dabble in this cyclical industry?

Lull before the storm

In Q1FY21, all seemed lost. Factories were shut, and when they reopened, domestic demand was floundering. As a result, many steel manufacturers looked to the international market and this helped them sustain their business. This helped them lessen the pain of the lockdown months, and post respectable revenues in FY21.

Then came the resurgent demand as the Centre ramped up its infrastructure spend. There was a surge in demand for steel in FY21 because of scarcity as many steel consumers had led to a surge in demand. China, which is the largest producer of steel in the world, clamped down on steel output as it has imposed strict curbs on emissions. To curb runaway domestic steel prices, China has imposed export duties. This has also led to a general fall in iron ore prices and as a result, steel prices have also cooled off across the world and in India.

The fall in domestic steel prices in India comes after a rise in coking coal prices across the world. This played out in multiple phases. Due to geopolitical reasons, China stopped buying Australian coal (coking coal is used in steel mills). This led to a fall in coking coal prices, which led to a rise in margins of steelmakers across the world, including India.

The fall in coking coal prices, coupled with rising steel prices due to a sudden surge in steel demand in the second half of 2020, led to a huge expansion in the EBITDA of steelmakers. 

But the rise in demand for steel also brought with it a rise in iron ore prices. And till China took measures to cut its domestic production of steel in 2021, iron ore prices were surging. There is also the fact that the Indian automotive sector is grappling with a shortage of key semiconductor components, which led to a fall in production in August and September across the industry. This is bound to eventually lead to a fall in EBITDA.

Indian steelmakers took advantage of rising steel prices from mid-2020 to June-July 2021, which led to higher realisations on sales, to cut their debt. They also took on cheaper debt to fuel capacity expansion to cater to higher demand.

Some investors would be left confused with the companies deleveraging and also piling on debt to expand their capacity at the same time. But the four companies—Tata Steel, JSW Steel, Jindal Steel & Power, and SAIL ended FY21 with their capacity utilisation near their installed capacity. So much so that SAIL was operating at 100% capacity. With interest rates at record lows in India, these companies are replacing older expensive debt with cheaper debt using their huge profits, and also expanding capacity to meet the future demand for steel.

Many headwinds persist

JSW Steel believes that the current focus on building infrastructure that enables the switch to green energy will mean there is enough demand for steel over the next half-decade. The company believes that this green energy transition will lead to a 5-6-fold rise in demand for steel from the energy sector, to 90-100 million tonnes across the world.

This comes on the back of the monetary and fiscal stimuli infused into economies across the world to help countries get back to growth after Covid-19 knocked them down in 2020. Europe for example is imposing a green tax to make sure this transition happens as quickly as possible. This is leading steelmakers to hunt for different fuels to run their steel mills to avoid the penalty for using fossil fuels.

For domestic Indian steel, the price of coking coal is rising and China is tapering its embargo on Australian coal (Australia being the largest producer of coal in the world). The rising coking coal prices have already led to a compression of earnings multiples of steel companies across the world, according to a report by ICICI Securities. Indian steelmakers are the outliers here, despite a fall in steel prices, iron ore prices, and a rise in the price of coking coal imports.

Investors looking to play in this cyclical industry will need to follow the commentary from steel producers during the coming Q2FY22 earnings season, especially with domestic steel demand impacted due to the automotive original equipment manufacturers curbing production.

There are many headwinds swirling around, and in a way 2021 is definitely different from 2020. Investors should watch out for the fine print in the Q2FY22 earnings reports of steelmakers.