Higher Production Cost To Squeeze Steelmaker Margin By 500 Bps: CRISIL

Soaring prices of raw materials, especially coking coal, are likely to increase the cost of production of domestic primary steel makers and reduce their operating margin1 by 500 basis points (bps) to 24-26% this fiscal, CRISIL has stated.

The potential for price hikes may be limited because of the low discount between domestic prices and the landed cost of imports, and the likely impact on demand from end-use segments such as construction and automobiles.

Despite the moderation, operating margin will remain higher than the ~21% average between fiscals 2017 and 2021. Further, operating rates are expected to be highest in the past five fiscals at 90%, supported by robust domestic demand and greater export opportunities. These factors will help steelmakers generate healthy cash flows.

Says Ankit Hakhu, Director, CRISIL Ratings, "While coking coal prices have moderated to ~$450-500 per tonne in April, they are expected to be higher by over 50% this fiscal on-year. This assumes a gradual easing of prices, in line with expected supply ramp-up from Australia, and gradual abatement of the Russia-Ukraine conflict. We expect other costs, including that of iron ore, to remain stable. Net-net, the cost of production of domestic primary steel makers will still rise by over 20% this fiscal to the highest level in a decade."As against this, average domestic steel prices are not expected to rise more than ~5% on-year. That's because these prices are influenced by the landed cost of imports. Currently, the discount is negligible at ~2%4, compared with an average ~3% over fiscals 2019 to 2021. This limits the cushion for domestic producers to take material price hikes.

Further, global steel prices are not expected to rise significantly from here due to concerns over demand in China following a rash of Covid-19 infections leading to lockdowns there. Also, prices could even moderate if geopolitical tensions ease, given Russia is the second-largest steel exporter in the world.

Says Ankush Tyagi, Associate Director, CRISIL Ratings, "Limited cushion to hike the steel prices, along with increased cost of production, could reduce operating margins of players by 500 bps to 24-26% in fiscal 2023. However these will still remain well above the average of ~ 21% for fiscals 2017-21 and support cash accrual generation. Further support to cash accruals will come from five-year-high operating rates at ~90% driven by increased spending on construction and infrastructure projects; and export opportunities unlocked by the sanctions on Russia."