13 October2014
Metals
Sector Update
Metals
Steel mill spreads under attack from scrap prices
Scrap demand is getting crowded out by expanded BOF spreads
We had highlighted the risk to steel pricing in our report
Risk to steel prices dated Sept
17 2014.
Thereon, we noted further correction in HRC prices without a
corresponding correction in input prices such as iron ore and coking coal. Scrap
prices, which held up well while iron ore and coking coal prices were in a free fall,
are seen suddenly nose diving. Thus, the steel mill BOF spreads (which were
expanding over the last 12 months) have come under pressure.
Slowing steel demand growth in China is forcing Chinese mills to boost exports.
Expanding BOF spreads are crowding out demand for steel scrap. Turkey, which is
the largest importer of scrap, saw its electric route steel production declining 4%
YoY to 2mt, while BOF steel production surged 47% YoY to 872kt in August. Europe
(ex Turkey and Russia) is now exporting more steel scrap, while finished steel
imports surged 30% during April-August 2014. Electric route steel production in
RoW (Rest of World) has started to decline. Thus, scrap prices have started falling to
catch up with the fall in BOF RM basket (described later in the report). We believe
that the correction in scrap prices still has some distance to cover, thereby leading
to further correction in steel mills’ spreads.
WSA has cut the forecast for world demand growth by 110bp to 2% and 130bp to
2% for 2014 and 2015 respectively as emerging economies have lost growth
momentum, especially China. Chinese steel demand growth forecast is lowered by
200bp to 1% for 2014 and by 190bp to 0.8% for 2015. North America and Europe
have done better in the first half but second half growth is weaker-than-expected.
We expect the divergence in Chinese HRC export prices and European HRC prices to
not sustain with a fall in scrap prices and continued export pressure from China. We
believe that our estimate (
report “Downhill Run” dated August 2012
) of HRC prices at
USD423/t for 2014 will be achieved as the prices of coking coal, iron ore and rebar
are already in line with our estimate.
Compression in BOF Steel Mills’ spread will have a corresponding impact on the
margins of Tata Steel Europe and Indian integrated steel mills. Tata Steel is the most
sensitive to lower realization among our covered steel names. We estimate for
every INR1,000/t decline in spread, it would impact Tata Steel’s valuation by 28%.
This is followed by JSW Steel, with 21% impact to our valuation on every INR1,000/t
decline in spreads. Further, we also expect the risk of multiple de-rating, with a
decline in profitability for these companies. We believe JSPL’s valuation would be
the most sensitive to a 1x decline in EV/EBITDA multiple, impacting its valuation by
27%. Safeguard duty on imports could provide near-term relief, however it would be
difficult to insulate domestic steel prices from volatility in global scrap prices.
Sanjay Jain
(SanjayJain@MotilalOswal.com); +91 22 3982 5412
13 October 2014
Investors are advised to refer through disclosures made at the end of the Research Report.
Dhruv Muchhal
(Dhruv.Muchhal @MotilalOswal.com); +91 22 3027 8033
1

Metals
Expanded BOF spreads erode scrap demand
Scrap prices are melting
Globally traded steel prices witnessed a correction of 16-26% over the last 12-18
months, yet the correction is lower than the fall in iron ore (down 39%) and coking
coal prices (down 28%). Hence, spreads between HRC prices and its raw material
basket have expanded. This is slightly unusual that spreads expanded along with a
fall in steel prices. Although spreads expanded for flat products globally, spreads for
Chinese long products were largely unchanged. The prices of long products in China
fell sharper (than flat products) on a slowdown in local demand and global over
supply of raw materials (China is the largest consumer of steel and the largest
importer of iron ore and coking coal). Flat product market though behaved
differently as the demand recovery in RoW (Rest of World) absorbed the
exponentially increase in net steel exports (largely flat products) from China. Thus,
steel mills spreads expanded across the world and prices of steel scrap
outperformed in comparison to BOF RM basket -- blast furnace raw material basket
(1.6x iron ore prices cfr China basis + 0.7x prime hard coking coal prices on FOB
Australia basis). The demand for scrap is now getting crowded out by cheaper
billets/rebar from China.
Although, spreads
expanded for flat products
Exhibit 1: European steel mill spreads (USD/t)
Spot
3 month lagged RM cost
5m lagged RM cost
475
375
275
175
75
Source: MOSL, Bloomberg
Spreads for Chinese long
products (rebar) never
expanded
Exhibit 2: Spreads for Chinese steel mills (USD/t)
320
275
230
185
140
HRC
Rebar
Source: MOSL, Bloomberg
13 October 2014
2

Metals
Prices of long products in
China fell sharper than flat
products…
Exhibit 3: Steel prices in China (USD/t)
900
800
700
600
500
400
HRC
Rebar
Source: Company, MOSL
…on a slowdown in local
demand
Exhibit 4: China's steel consumption growth (%)
18
12
6
0
-6
-12
Source: MOSL, Bloomberg
Exhibit 5: China - iron ore supply (mt)
Ore Imports
Ore Prod
Pig iron prod (RHS)
68
62
56
50
44
Iron ore supply has grown,
while pig iron production
remained stable
150
120
90
60
30
Source: Bloomberg, MOSL
Exhibit 6: RoW's steel consumption growth (%)
12
Demand recovery in RoW…
8
4
0
-4
Source: Bloomberg, MOSL
13 October 2014
3

Metals
…absorbed the
exponentially rising net
steel exports from China
Exhibit 7: China’s net steel exports (mt)
7.0
5.5
4.0
2.5
1.0
Source: MOSL, Company
Prices of steel scrap
outperformed in
comparison to BOF RM
basket
Exhibit 8: Scrap export prices (USD/t) v/s BOF RM basket (USD/t)
590
490
390
290
190
Rottterdam Scrap
BOF RM
Source: Company, MOSL
Scrap demand is getting
crowded out by cheaper
BOF steel
Exhibit 9: Steel production (mt) through electric route* in RoW (ex-China)
34
32
30
28
26
* calculated at as the difference of crude steel and 96% of pig iron production
Source: MOSL, WSA
Exhibit 10: Europe Rotterdam Shredded scrap (USD/T)
420
395
Scrap prices nose dive
370
345
320
Source: Bloomberg
13 October 2014
4

Metals
Cross border scrap supply eases
Peaking scrap collection had tightened supply
Over the last decade, cross border trade of scrap has failed to keep pace with
world’s steel production through the electric route. Scrap collection has definitely
increased to feed 28% growth in steel production through the electric route. But
most of the growth in scrap collection has been locally consumed. Cross border
trade plays a key role is scrap price discovery. Share of cross border scrap trade in
world steel production through the electric route consistently fell between 2009 and
2013. A tighter supply played a key role in pricing of scrap and thereby steel pricing
in RoW (ex-China).
Exhibit 11: Global steel production through electric route v/s cross border scrap supply
500
375
250
125
0
2004
2005
2006
2007
2008
2009
2010
2011
2012
2013
cross border scrap supply unchanged
Electric route steel production
up 28% in 10 years
Source: WSA
Exhibit 12: Share of cross border scrap in world’s electric route steel production
25.3
23.5
23.3
25.2
22.9
20.5
23.4
22.5
22.2
21.6
19.9
Scrap supply became
tighter in last 3 to 4 years
2003
2004
2005
2006
2007
2008
2009
2010
2011
2012
2013
Source: WSA, MOSL
Although the cross border trade of scrap remained stagnant ranging 90-100mt on
gross basis, the cross border trade (after netting off imports) increased from an
average of 35mt during 2003-08 to an average of 51mt over 2009-13 -- an increase
of 47% driven by demand growth in Turkey, South Korea and India.
13 October 2014
5

Metals
North America and Europe (ex-Russia &Turkey) boosted scrap net exports
North America and Europe (ex-Russia & Turkey) are key contributors to growth in
exports and now account for more than 2/3
rd
of supply. Russia, which once
accounted for more than 20% share, has lost its share to just 8% during 2011-13.
Post 2008, North America and Europe (ex-Russia & Turkey) witnessed a major jump
in net exports driven by increased collection and lower consumption.
North America and Europe
are key providers of scrap
to world trade
Exhibit 13: Region-wise share in cross border net exports of steel scrap
North America
100%
75%
50%
25%
0%
2003
21
17
22
24
35
18
18
20
2004
34
21
7
28
2005
26
20
14
33
2006
22
17
5
46
16
14
12
40
2
18
25
5
13
30
8
9
29
8
15
30
8
16
32
Europe (ex-Russia & Turkey)
Japan
Russia
Others
45
42
46
37
2012
35
2013
2007
2008
2009
2010
2011
Source: MOSL, WSA
Net exports from North
America and Europe have
peaked
Exhibit 14: Cross border exports of scrap on net basis
(mt)
60
45
30
15
0
7
6
7
8
2003
13
7
6
7
2004
12
7
2
10
2005
10
7
5
12
2006
8
6
2
16
2007
North America
Europe (ex-Russia & Turkey)
Japan
Russia
4
5
15
25
Others
4
8
17
20
2012
1
9
5
5
4
13
2008
13
23
2009
2
6
14
20
2010
4
8
16
17
2013
2011
Source: MOSL. WSA
Net exports from North
America have started to
decline due to shrinkage in
scrap collection
Exhibit 15: Implied scrap collection in North America
Source: MOSL
13 October 2014
6

Metals
Net exports from Europe
(ex-Russia and Turkey) have
peaked due to a sharper fall
in collection, despite
reduced consumption
Exhibit 16: Implied scrap collection in Europe (ex-Russia and Turkey)
130
120
110
100
90
Source: MOSL
EU28 is already witnessing a
surge in scrap exports…
Exhibit 17: Quarterly trend in scrap exports (mt)
8.0
6.0
4.0
2.0
0.0
US
EU28
Japan
Russia
Source: MOSL, ISSB web site
…due to shrinkage in local
demand as vindicated by
the declining trend in steel
production through electric
route
Exhibit 18: EU28 monthly steel production through electric route
10
9
7
6
4
Source: MOSL, WSA
13 October 2014
7

Metals
World steel demand outlook lowered
Growth in emerging economies disappoints
Chinese steel demand has continued to slow down, with a de-growth in recent
months. The World Steel Association (WSA) recently (on October 6, 2014) lowered
the Chinese steel demand growth forecast by 200bp to 1% for 2014 and by 190bp to
0.8% for 2015, compared to its own short term outlook issued six months ago in
April 2014. The demand growth forecast for RoW (although raised by 30bp to 3.4%
for 2014) has been lowered by 50bp to 3.1% for 2015. The world steel demand
growth forecast has overall been lowered by 130bp to 2% for 2015.
Exhibit 19:
Demand for finished steel: Outlook lowered
2011 YoY 2012 YoY 2013 YoY 2014 YoY 2015 YoY Growth for 2014
Growth for 2015
m tons (%) m tons (%) m tons (%) m tons (%) m tons (%)
( w.r.t. Apr 2014 release)
EU (28)
153 5.9
139 -9.3
140 0.8
146 4.0
150 2.9
raised 90bps
cut 10bps
Other Europe
33 12.7
34 3.0
37 8.2
38 1.9
39 3.8
cut 200bps
cut 40bps
CIS
55 13.8
57 4.7
59 2.8
57 -3.8
58 1.9
cut 490bps
cut 180bps
NAFTA
121 9.0
133 9.8
130 -2.4
138 6.4
141 2.2
raised 260bps
cut 120bps
Cen. & S. America
46 2.6
47 2.9
49 4.2
48 -2.4
50 3.4
cut 580bps
raised 70bps
Africa
24 -3.4
31 28.4
34 10.8
35 2.8
37 8.0
cut 200bps
cut 150bps
Middle East
48 2.9
50 3.5
50 0.2
52 2.3
55 6.0
cut 350bps
cut 350bps
Asia & Oceania
901 5.9
984 9.2 1,032 4.9 1,050 1.7 1,064 1.4
World
1,381 6.2 1,475 6.8 1,531 3.8 1,562 2.0 1,594 2.0
cut 110bps
cut 130bps
China
624 6.2
698 11.9
741 6.1
748 1.0
754 0.8
cut 200bps
cut 190bps
World (excluding China)
757 6.0
777 2.6
790 1.7
814 3.0
840 3.2
BRIC
760 6.4
838 10.3
884 5.5
893 1.0
904 1.3
cut 200bps
cut 170bps
World (ex. BRIC)
621 5.8
631 1.6
647 2.5
669 3.4
690 3.1
raised 27bps
cut 51bps
Source: WSA short range Outlook Oct 6, 2014
Regions
The pressure on Chinese mills to further boost exports is mounting. On the other
hand, the seasonally weak demand periods in Europe and the US are unable to
absorb the Chinese surplus and lend any support to prices. Recently, steel mills’ BOF
spreads have started to shrink with the sharply falling Chinese HRC export prices.
Scrap prices too have come under pressure. If this is a seasonal phenomenon or
beginning of a return to normal lower spreads needs to be monitored. Melting scrap
prices are definitely a risk to world steel prices and BOF spreads.
Divergence in HRC prices
among the West and China
is not sustainable
Exhibit 20: HRC export pricing (USD/t)
800
700
600
500
400
CIS
China
Source: Bloomberg
13 October 2014
8

Metals
Risk to Indian steel pricing and margins
Indian steel demand yet to pick up
There is an expectation that Indian steel demand will accelerate in 2HFY15 on
account of seasonal factors and pick-up in investment cycle under the new political
environment. However, the Indian steel demand growth till now has been far from
improving. Industry sources continue to cite liquidity as an issue.
Exhibit 21: Indian steel demand growth (%)
Apparent Consumption growth
12
6
0
-6
-12
0.4
1.0 0.7
-1.2
Source: JPC
Flat product prices down by USD35-40/t in 2 months
The pricing dynamics in Indian steel market has been a little different for flat
products and long products. Indian flat product market is highly consolidated with
five producers controlling nearly 85-90% of market. Thus, products’ pricing is more
aligned with import parity pricing. Chinese, CIS, Japan and Korea are the major
exporters of flat products to India. Chinese mills have been the most competitive on
pricing in recent years. Japanese and Korean mills too attack the Indian market at
times as they enjoy concessional duties of 2-3% under FTA (free trade agreement),
against 7.5% for other countries. The pricing of HRC and downstream products is
generally aligned with import parity pricing on Indian coastal locations like Mumbai
and the prices rise as one moves away from the coast and towards North to
compensate for freight. Thus, we note that flat product pricing has come off along
with a correction in landed cost of imports (largely from China). There has been a
correction of ~USD35-40/t since the beginning of August.
Exhibit 22: Flat product pricing in India (INR/t, excluding excise & VAT)
41,000
HRC Mumbai (INR/t)
HRC import pricing has
fallen by USD35-40/t to
USD505/t over the last two
months
39,000
37,000
35,000
33,000
13 October 2014
9

Metals
Long product pricing – under threat from cheaper scrap/steel imports
Indian long product pricing has remained fairly insulated from global steel prices due
to lack of cross border trade and stability in scrap prices. Unlike flat products, long
products market is largely unorganized. Long products are easily manufactured by
smaller/micro furnaces/mills. Nearly 70% of 37.5mt of total finished long products
were produced by secondary/unorganized mills. These secondary mills use sponge
iron and scrap as key inputs for melting in electric furnaces (IF/EF etc). Thus, the
pricing of scrap and sponge iron is the key cost drivers for them. Scrap prices have
remained very strong until recently. Sponge iron producers in India are plagued by
shortage of iron ore and coal in the country. Although the cost dynamics of sponge
iron is unlikely to change quickly, the recent correction in scrap prices will have a
direct impact on the cost structure on scrap-based secondary producers in India.
This will eventually lead to a correction in long product pricing in India. Moreover,
the gap between domestic pricing of long products and imports has widened so
much that the threat from imports is rising.
Exhibit 23: Steel scrap prices in Mandi Govindgarh (INR/t) (excl. excise and VAT)
28,000
26,500
25,000
23,500
22,000
Scrap (Mandi)
Source: SteelMint
Domestic costing of iron ore
and coal remains high, yet
cheaper imports pose a
threat
Exhibit 24: Rebar prices in Mumbai (excl. excise & VAT)
42,500
40,000
37,500
35,000
32,500
30,000
TMT Mumbai (INR/t)
Source: SteelMint
13 October 2014
10

Metals
Will safeguard duty really protect Indian steel mills? – at best in short term
Indian secondary steel producers are squeezed between sticky high cost of
production and cheaper imports. Cost of iron ore and thermal coal used remains
high due to closure of iron ore mines and shortage of the latter. High logistics and
electricity costs too are a challenge.
It is difficult to insulate
Indian long product prices
from the volatility in global
markets, in our view
Long products imports (from China) have started trickling into the Indian steel
market as well. With the addition of Boron, the rebars/wire rods get classified into
alloy steel and escape quality control norms in India and attract export incentives in
China. Indian steel producers have been lobbying with the steel and finance ministry
for a safeguard duty against Chinese imports. If implemented, it will give a slight
relief to Indian steel producers. However, oversupplied Chinese billets/rebars are
crowding out scrap demand globally. Hence, scrap prices have started to correct.
Scrap imports are likely to get more attractive, which in turn will exert pressure on
Indian long product prices. In our view, it is difficult to insulate Indian long product
prices from the volatility in global markets.
13 October 2014
11

Metals
Impact analysis on Indian mills’ margins
With Indian steel producers being vulnerable to a contraction in steel prices and
limited savings from likely scrap price correction, we expect the impact of lower
realization (and in turn lower EBITDA) on these companies.
We view Tata Steel as being the most sensitive to lower realization among our
covered steel names. We estimate for every INR1,000/t decline in realization, it
would impact Tata Steel’s valuation by 28%. This is followed by JSW Steel, with 21%
impact to our valuation on every INR1,000/t decline in EBITDA.
Exhibit 25: Sensitivity of target price to change in margins
Company
Tata Steel - India
Tata Steel - Europe
Tata Steel - Group
SAIL
JSW Steel
JSPL
* represents EBIT
CMP
TP
Remarks
Sensitivity of margins (INR m)
EBITDA
EV/Mkt
INR/
impact
INR/t
INR m
at (6.5x)
share (%) on TP
1,000
9,453
61,445
63
10% 9.5mt TSI volumes in FY16
1,000
15,100* 105,700
109
18% 15.1mt TSE volumes in FY16
1,000
24,553 167,145
172
28% 24.6mt TSI/TSE volumes in FY16
1,000
14,705
95,583
23
18% 14.7mt volumes in FY16
1,000
12,880
83,720
346
21% 1mt volumes in FY16
1,000
3,849
25,019
27
14% 3.8mt volumes in FY16
448
74
1,141
156
617
127
1,647
198
Further, we expect the risk of multiple de-rating with a decline in profitability for
these companies. We believe JSPL’s valuation would be most impacted on a 1x
decline in EV/EBITDA multiple.
Exhibit 26: JSPL to be most impacted from de-rating
INR/share
2,000
1,500
1,000
500
-
JSW
TATA
SAIL
JSPL*
At 6.5x
1,647
1,182
617
474
127
104
At 5.5x
198
144
*For JSPL represents at 5.5x (base case) and at 4.5x
Source: MOSL
13 October 2014
12

Metals
NOTES
13 October 2014
13

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In respect of any matter arising from or in connection with the research you could contact the following representatives of Motilal Oswal Capital Markets Singapore Pte Limited:
Anosh Koppikar
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13 October 2014
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