Research Speak - 14-05-2010
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Transcript of Research Speak - 14-05-2010
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Market Commentary
After a unidirectional move that we have witnessed in the market over the period of last 9-10 months, the marketseems to have moved in a zone where it is taking a breather. We expect that the market is going to remain lagardfor next couple of weeks and can go down to test 4800 or there about and as such investors are expected to remaincautious for the time being and are advised not to take aggressive position in stocks. The latest development in the
EU is likely to act as sentiment dampner in the short term and as consequence there can be some profit booking inthe Emerging countries driven by risk aversion. As we have seen in last week that Greece bail out plan has beensanctioned by the EU and IMF and a total dolout for the country has been pegged at upto 750 billion, of whichtwo thirds will be provided by eurozone members and one third by the IMF. Of the eurozone's 500 billion share,
60 billion are readily available since they draw on an existing facility. The remaining 440 billion are to besourced through an SPV and are subject to the same conditions and approval process as the joint loan to Greece.The underlying assumption is that the total financing needs for Portugal, Ireland and Spain were to be covered until2012, the size of the package would need to be about 600 billion. In this regard, the 750 billion packageinaddition to the ECB liquidity facilities and Quantitative Easing (QE)comfortably covers the worst case scenarioand should thus help fight contagion. In addition, the relatively high interest rates on joint loans should serve as anincentive for eurozone members to put their fiscal house in order without recurring to the facility. However, in thisrespect PIIGS as a whole has to adopt adequate austerity measure with imposition of higher tax rate and cuttingdown on government expenditure.
What we understand is that even with this debt replacement plan Greece will still continue to contract for at least 2-3 financial year and optimistically speaking after that they will be able to return to growth if at all. Which meansthat for the time being there is going to be demand contraction that will happen in the near term. In the mediumterm this replacing of one debt with that of the other kind of strategy will not succeed and eventually morequantitative easing will have to happen. This means Euro as a currency will undergo rapid devaluation due tocontagion and eventually the scenario that Euro will disappear and a total collapse of EU does not look far fetched.We feel that the current step is just going to delay the process of this plausable eventuality.
The emerging market in Asia (fundamentally speaking not so much in case of India) and the commodities space isgoing to get hit by this phenomenon as people in the near term will have this perception that export for thesecountries to EU region is going to go down substantially and commodity prices would correct significantly.
However, in our opinion as more QE happens all over the world over a slightly longer time horizon (4-5 years) theprice of all commodities in nominal terms will have to adjust upwards to reflect the depreciation of currencies. Assuch post correction resource companies can be a good buy for strategic portfolio.
Coming back to Indian Market, in addition to the overseas headwinds there are couple of these things which aremore country specific that one has to recon while taking investment decision. 1) the monsoon expectation,2)international commodity prices 3)valuation & earning expectation and 5)Foreign Fundflows
Research Speak Week Ended 14 th May, 2010
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Monsoon Expectation
This year monsoon in the Indian peninsula is expected to be normal to above normal as per the meteorologicalprediction. According to the study, the El Nino event of 2009-10 has concluded, with all the major indicators nowbelow the threshold levels. Historically, about 40 per cent of El Nino events are immediately followed by a LaNina. The Current conditions below the surface of the Pacific Ocean show large volumes of cooler than normalwater, indicating that further cooling of the surface is likely. The majority of climate model predictions suggest thetropical Pacific will cool further during the coming months, with possible development of La Nina conditions.
As far as the Indian Ocean behavior is concerned it now favours the development of a weak positive dipole event(Indian Ocean Dipole, or IOD). The IOD replicates El Nino-La Nina locally in the Indian Ocean. It is positive
when the warming takes places in the West Indian Ocean relative to the east, and vice versa. A positive IOD hasbeen found to propel the Indian monsoon, with surplus rains for the west coast and northwest India. As per theTokyo-based Research Institute for Global Change (RIGC) the outlook for the monsoon suggests surplus rain oreven floods to India, Indonesia, East Asia, parts of Australia, northeast Brazil and East Africa. June-July-Augustwould see surplus rains over northwest India, east India and the northern reaches of northeast India. However, rainsare likely to be weak over central India, and only slightly better along the coast even as the coastal Arabian Sea istipped to witness heavy rains.
If these predictions stand correct, there is going to be a substantial production of crop that will put a lead in forarticle price appreciating and would keep the inflationary expectation under check. Which might also mean abenign interest rate regime and hence more capacity enhancement. Thus, if monsoon is in line with expectation andthen it really augers well for the market. Assuming if there is not too much flood in crop producing area.
International Commodity Prices
With China consciously slowing down their economy and austerity measure in EU and with the expectation thatUSD vis--vis Euro and other major currencies may strengthen in the short term, the international commodityprices and especially crude oil prices are going to be down for the time being. This augurs well for an economylike India where majority of its import relates to crude oil and lower price of oil will mean less inflation in thesystem and lower subsidy burden for the government which in turn would be able to spend the money forinfrastructure development and other developmental activities. Lower steel and other base metal prices wouldmean lower capital cost for the government and companies based out of India.
Valuation & Earning Expectation
The current market PEs and individual stock PEs appears to be fully valued however if the aforementionedscenario comes to effect, we expect that there is going to be significant amount of earnings upgrade that is going tocome through and post correction the prices may start to look very attractive. However, we do not expect thatgoing forward there is going to be a broadbased rally however 2011 is going to be more of a stock pickers marketand a good selection of large and mid cap stock will lead investors to earn good profit from the market.
Foreign Flows
As discussed earlier we expect that the sentiment are going to be down for the time being as such there is going tobe some kind of selling pressure from the FIIs in the short term. However, with the absence of growth elsewhere in
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the world and with more and more QE, India is going to emerge as one of the most attractive FII destination. Withthe renewed thrust on infra projects and better economic outlook we expect that Indian market may emerge as anoutperformer in the global context
Sector to watch out for
As before we maintain our positive view on sectors like banking, infrastructure, capital goods, cooling solutions,pharma and on selective auto companies in the sector .
Banking
SBI Result Update
State Bank of India, has reported 32% dip in the Net Profit at Rs 1866.60 crore, despite healthy 39% increase inNet Interest Income at Rs 6721.44 crore for the quarter ended March 2010. Higher provisions towards wagerevisions and pension, coupled with spurt in provisions for NPAs have hampered the growth in Net Profit.
Operating expense increased by 41% to Rs 6036.09 crore and pulled Operating profit down by 2% to Rs 5193.88crore. Further 69% increase in provisions for bad loans to Rs 2186.77 crore has deteriorated growth in the Netprofit.
On the consolidated front, the bank has not disclosed quarterly results. However, by deriving results from full year,
the bank has reported 21% dip in the Net Profit at Rs 2619.72 crore on the back of 43% jump in NII to Rs 9672.83crore, for quarter ended March 2010. 46% spike in the operating expenses to Rs 12237.60 crore coupled with 59%
jump in Provisions and contingencies has dented the growth in Net Profit.
Asset Quality:
? For the quarter ended March 2010, SBI has reported sequential improvement in asset quality, but reportedhigher NPA's on y-o-y basis. Gross NPA has increased by 24% on y-o-y basis and 4% on q-o-q basis to Rs19534.89 crore for quarter ended March 2010. The Net NPA has increased by 12% on y-o-y basis anddeclined marginally by 4% on q-o-q basis to Rs 10870.17 crore.
? % Gross NPA stood at 3.05% in Q4FY10 as against 2.86% in Q4FY09 and 3.11% in Q3FY10. The % NetNPA declined from 1.88% in Q3FY10 and 1.79% in Q4FY09 to 1.72% in Q4FY10.
? Provision coverage ratio excluding AUCA stood at 44.36% while including AUCA stood at 59.23% as onquarter and Year ended March 2010.
? Return on assets for the quarter has declined to 0.69% in Q4FY10 as against 1.1% in Q4FY09 and 0.94%in Q3FY10. For FY10, ROA has declined to 0.88% from 1.04% a year ago.
Business Highlights:
? Total business grew by 12% from Rs 12906.13 billion in March 2009 to Rs 14455.96 billion as on end of March 2010.
? Deposits of the Bank went up by 8% from Rs 742073 crore in Mar 09 to Rs 804116 crore in Mar 10.Deposits growth was driven by CASA growth of 26.76% and retail TD growth of 17.64%, despite
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shedding of high cost bulk deposits by 50.15%. CASA ratio has improved from 39.29% as on March 2009to 46.67% as on March 2010, a growth of 741 bps.
? Market share in total deposits as on Mar 10 was at 16.31% as against 17.70% as on Mar 09, a declineof139 bps on y-o-y basis. The market share in low cost demand deposits stood at 17.51% (17.43% as onMar 09) is up by 8 bps.
? Gross Advances moved up 17% from Rs 548540 crore in March 09 to Rs 641480 crore in Mar 10. Marketshare in advances as on Mar 10 stood at 16.28% as against 15.99% as on Mar 09, an increase of 29 bps ony-o-y basis.
? Credit Deposit Ratio is up to 73.56% as at the end of Mar 10 from 66.63% at the end of Mar 09, anincrease of 693 bps, bucking the industry trend as the credit deposit ratio for ASCB has come down from72.32% as on Mar 09 to 72.22% as on Mar 10. Incremental CD ratio during FY10 was 157%.
? Large and Mid Corporate advances have grown from Rs 193311 crore in Mar 09 to Rs 221892 crore inMar 10 registering a growth of 15%.
? Home loans grew by 32% from a level of Rs 54063 crore in Mar 09 to Rs 71193 crore in Mar 10.? Agri advances have grown by 17% from Mar 09 to Mar 10. Total disbursements under Agri Advances
were Rs 34179 crore during FY 10. Credit extended to 12.32 lac new farmers during the year.? International advances up by 12.49% from Rs 86301 crore in Mar 09 to Rs 97071 crore in Mar 10 despite
hardening of the rupee.? Net Interest Margin (cumulative) improved from 2.56% as on 31st Dec 09 to 2.66% as on 31st March 10;
NIM for the quarter has improved to 2.96% in Q4FY10 from 2.82% in Q3FY10 and 2.39 % in Q4FY09.? Average Cost of Deposits has been brought down by 50 bps to 5.80% as on Mar 10 from 6.30% as on
Mar 09. Sequentially, cost of deposits has come down by 12 bps from 5.92% as on Dec 09.? Yield on advances (YOA ) at 9.66% in FY10 is lower by 49 bps as compared to 10.15% in FY09 driven
by an average reduction of 87 bps in PLR during the year and nearly 70% of the growth in advances beingsub-PLR during the year.
? As per Basel II the CRAR of the Bank is at 13.39% as at the end of Mar 2010 , compared to 14.25% lastyear, with Tier 1 at 9.45%.
? Out of the standard restructured assets of Rs16796 crore restructured under RBI dispensation, Rs 1616crore have slipped into NPA category up to Mar 10, taking the slippage ratio for these to 9.62%.
Quarterly performance:
For the quarter ended March 2010, State bank of India has reported strong growth of 39% in NII to Rs 6721.44crore mainly on the back of 10% dip in the Interest Expended to Rs 11244.15 crore, while the Interest earned hasmoved up by 4% to Rs 17965.59 crore. Interest from advances has increased by 7% to Rs 12967.32 crore whileIncome from investments has moved up by 5% to Rs 4452.33 crore. Other income has declined marginally by 4%to Rs 4508.53 crore owing to 72% dip in profit on sale of investments on higher base. Excluding profit on sale of investments, other income was up by 27%. Thus Net Total Income was up by 17% to Rs 11229.97 crore. Thecontribution of other income to net total income has reduced to 40.1% from 49.4% in previous year.
The Operating expenses have increased by 41% to Rs 6036.09 crore in quarter under review. Employee cost hasleaped up by 53% to Rs 3591.6 crore on account of salary of new employees, increase in DA, Provision from wagerevision and additional provision for pension. The other operating expenses have increased by 26% to Rs 2444.33crore owing to higher expenses incurred in opening of new branches and ATM's, financial inclusion and HRinitiatives. As a result cost to income ratio has spurred up by 890 bps to 53.7% and dented growth in operatingprofit down by 2% to Rs 5193.88 crore. Further, 71% jump in provisions and contingencies to Rs 2349.40 crorehas pulled down PBT by 27% to Rs 2844.48 crore. Loan loss provisions constituted 93% of the provisions and
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contingencies at Rs 2186.77 crore up by 69% on y-o-y basis. Finally 470 bps increase in effective tax rate to 34.4%has made Net Profit stand down by 32% to Rs 1866.60 crore.
Yearly Performance:
For the year ended March 2010, Net Profit of the bank has reported flat growth at Rs 9166.05 crore over 13%increase in the Net Interest Income to Rs 23671.44 crore. Cumulative NIM, which had declined from 2.93% inFY09 to 2.30% in June 09 has improved sequentially to 2.43% in Sep 09, 2.56% in Dec 09 and 2.66% in Mar 10.Interest income on advances has increased by 9% to Rs 50632.64 crore, despite fall in yield by 49 bps from10.15% as on Mar 09 to 9.66% as on Mar 10 owing to reduction in peak PLR by 200 bps and average PLR by 87bps during FY 10 over FY 09. Income from resource operations increased by 13% as yields was low during FY 10
due to liquidity overhang. Growth in Interest expenses on deposits was contained at 14% during FY 10 against40.13% growth during FY 09, through strategic shedding of high cost bulk deposits, which are down to just 1.79%of total deposits as compared to 10.74% a year ago and growth of 26.76% y-o-y in CASA deposits. Other incomehas increased by 18% to Rs 14968.15 crore, despite profit on sale of investments coming down by Rs 451 crore.Fee income is up by 27% on y-o-y basis. Forex income has increased by 35%. Other Income (excluding profit onsale of investments) is up by 27%.
The operating expenses have leaped up by 30% to Rs 20318.68 crore mainly driven by five key costs given below:(a) During Q4FY09, nearly 27,000 new employees came on board in various categories, the full impact of whichon staff expenses was felt during FY10. The Bank has recruited 3,350 employees in FY10.
(b) Rs 627 crore arrears were provided during FY10, for wage revision pertaining to previous years
(c) Additional contribution for pension at Rs1998 crore against Rs1469 crore last year.
(d) Additional expenses of Rs 59 crore is provided on Financial Inclusion.
(e) An expenditure of Rs 347 crore incurred on opening of 1,049 new branches and installing 7,788 new ATMsduring the year.
As a result, Operating profit has been up by meager 2% to Rs 18320.91 crore. Further the total provisionsincluding taxation has increased by 4% to Rs 9154.86 crore. This includes 6% dip in provision for taxation at Rs4960.03 crore and more than double loan loss provisions at Rs 5147.85 crore (up by 108%). Thus Net Profitreported muted growth at Rs 9166.05 crore.
Consolidated yearly performance:
For the year ended March 10, consolidated Net Profit has increased by 7% to Rs 11733.83 crore on the back of 15% rise in the Net interest Income to Rs 33443.22 crore. Other income leaped up by 58% to Rs 33771.10 croreand led Net total income up by 33% to Rs 67214.32 crore. Operating expenses shot up by 62% to Rs 42415.39crore and restricted operating profit to marginal growth of 2% at Rs 24798.93 crore. Total provisions includingtaxation remained flat at Rs 12785.29 crore. The bank has accounted Nil EO as against Rs 370.57 crore and ledPAT before minority interest up by 8% to Rs 12013.64 crore. Finally, Minority Interest has increased by 28% to Rs279.81 crore and left Net Profit up by 7% to Rs 11733.83 crore.
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Performance of associates and subsidiaries:
? Associate Banks' net profit increased by 17.74% from Rs 2774 crore to Rs 3266 crore in FY10. Operatingprofit of all associate banks increased by 20% from Rs 5495 crore to Rs 6598 crore.
? SBI Life has recorded a profit of Rs 276 crore in FY10 as against a loss of Rs 26 crore in FY09. AUM of the company as on March 31, 2010 stood at Rs 28703 crore, a YOY growth of 94%. Market share of SBIlife amongst private insurers increased to 18.34% from 16.00% as on March 09.
? SBI Capital Markets has posted a PAT of Rs150 crore during FY10 as against Rs 75 crore in FY09(excluding extraordinary income of Rs 74.98 crore), a y-o-y growth of 100%, driven by an increase of 73%in Fee income. SBI Caps has crossed the milestone of Rs 100000 crore in syndication.
? SBI DFHI has recorded a net profit of Rs 89 crore during FY 10 which is the highest in last six years.?
SBI Cards has Net loss before tax during FY10 to Rs.154 crore against a loss of Rs 185 crore during FY09,a decline of 17% on y-o-y basis.
As our readers must have noticed, we have never recommended SBI, though we have been positive over thebanking industry. We remain bullish on the sector as a whole, however, differentiating between sector under andoutperformers is very important. We believe that the huge sub standard book and massive high cost deposits thatthe bank was sitting on has played a significant role on its profitability and will continue to put downward pressureon the banks results. We expect the stock to be sector underperformer and would instead recommend investors toswitch to better positioned lower valued banks like PNB, J&K Banks, Indian Bank, Federal Bank, HDFC Ltd andBank of Baroda.
Considering annual Standalone EPS of FY10 at Rs 144.4, the PE stands at 15 times. On standalone basis, at a Book Value (BV) per share of Rs 1038.8 and Adjusted Book Value (ABV) of Rs 801.4 for the year ended March 2010,the P/BV and P/ABV of the bank works out to 2.1 and 2.7 respectively
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Sector and Stock Updates
Bajaj Auto
Bajaj Auto came out with splendid set of numbers for FY10 and Q4FY10 on the back of strong performance of allits businesses motorcycles, 3-wheelers and exports. Domestic motorcycles of the company have witnessed agrowth of 40% at 17,81,768 during the year as against the industry growth of 26%.As a result the company hasmanaged to improve its market share from 21.9% in FY09 to 24.3% in FY10. Exports has also shown a goodgrowth of 23% during the year at Rs 3246 crores.Net sales has grown strongly in Q4FY10 and FY10 by 84% and34% respectively on account of robust volume growth. However, the average realisation/vehicle declined by 1.8%YoY on account of the product mix tilting towards the 100cc bike. On a sequential basis, the average realization
was up by 3% on account of higher production at Pantnagar and better product mix (lower volumes of Platina andhigher volumes of Pulsar sold during the quarter). Other expenditure/vehicle declined by Rs490/vehicle QoQ dueof better cost control and benefit of lower advertisement and promotional expenditure on account of robust demandfor its newly launched products. As a result, EBITDA margins expanded by nearly 1% QoQ at 22.9% andEBITDA/Vehicle im proved by 7% QoQ. Due to lower tax rate at 28.1% in Q4FY10, compared to 29.8% inQ3FY10, the Adj. PAT grew by 12% QoQ and 300% YoY, thereby, resulting in the highest ever quarterly profitfor the company.
Result Highlights
Pariculars Q4FY10 Q4FY09 %chg FY10 FY09 %chgNet sales 3290.45 1787.54 84.1 11508.5 8436.94 36.4
PBIDT 772.87 225.81 242.3 2552.66 1106.91 130.6PAT 528.65 130.21 306 1700.11 654.5 159.8EPS 36.7 9 307.8 117.7 45.2 160.4
Particulars FY10 FY09 % chgMotorcycles 2506791 1907853 31.39%2-wheelers 2511643 1919625 30.84%3-wheelers 340937 274529 24.19%Total 2852580 2194154 30.01%Exports( of the above) 891002 772519 15.34%
Bajaj auto continues to ramp up production at excise-free Pantnagar facility which stood at 1.8 lac units duringQ4FY10 and 5.7 lac units for FY10. We expect the company to report robust volume growth in FY11 of 40% at4000000 vehicles as compared to 2800000 vehicles on the back of new launches in Pulsar and Discover brands(ithas recently launched Pulsar 135 and Discover 150 motorcycles) and increase in export volumes. The stock iscurrently reasonably valued at 14(x) FY11E earnings and we remain optimistic on the prospects of the companyconsidering the superior growth prospects as compared to its peers, increasing market share, superior marginprofile and continued success of its twin brand strategy of marketing its motorcycles under Discover andPulsar. In our Research speak of 4 th September we had recommended a Buy on the stock due to pickup in
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volume growth and initial success of Discover 100cc motorcycle. The performance of the company has lived uptoour expectations and we advise long term investors to hold on the stock. For fresh entry we recommend investorsto enter the stock at around Rs 2000 level.
Aban Offshore
Aban Offshore Ltd (Aban) lost its prime asset Aban Pearl that was the only semi submersible rig in the companysasset portfolio. It was the highest revenue earning asset for the company with a rate of $3,58,000 per day and ~80%operating margin with the contract extending up to October 2014. With the loss of this asset the earnings visibility
has been severely impacted. This will also delay the recovery for Aban. The loss of the asset would impact therevenues (11 months) for FY11 by ~ Rs 505 crore and lead to a drop in EBITDA of ~ Rs 404 crore. It has alsowiped out the future earnings potential from the asset.
Cost for ABAN on account of acquisition was Rs 1150 crores in FY08.The company has been following straightline depreciation policy with remaining useful life of 20 years for Aban Pearl. Depreciation per year has beenaround Rs 58 crores for this semi submersible drillship. The balance value of of this particular asset in books isabout Rs 1029 crores. The insurance claim is about Rs 772 crores (i.e 75% of of asset value).Thus net netextraordinary loss to the company in FY11E would be about Rs257cr from damage of this Aban Pearl.
After the loss of Aban Pearl, the present fleet of Aban comprises 15 jack-up rigs, three Drillships and one FloatingProduction Unit. Out of the current fleet, three vessels are idle and contracts for another two vessels are expiring in
May 2010 and June 2010. Hence, five out of its 19 vessels i.e. almost 1/4 of its fleet would be idle. All the idlevessels are currently under marketing and are expected to be placed on long-term contracts during the course of FY11.
Revenue in FY11 for Aban is expected to decline by Rs 505 crore due to the loss of Aban Pearl. However, despitethat, revenue on a YoY basis is expected to rise by 13.4% in FY11 on account of deployment of Deep Driller 1 andDeep Driller 8 both of which have secured long-term contracts at $118000 per day and $115000 per dayrespectively.
The stock has already corrected more than 20% since the news about Aban Pearl broke out on Friday. We believethat the bad news has been more or less discounted at the current market price of Rs820.
After the loss of this asset, Aban Offshore is likely to close FY12E with topline of about Rs3600Cr and PAT of about Rs620Cr. This translates to an EPS of Rs144.Thus at CMP of Rs820, the stock is trading at PEx of less than6.This is perhaps the lowest earmnings multiple enjoyed by a offshore services company globally.
We believe that there are several silver lingings among all these gloomy news. The main trouble spot for thecompany has been very high debt equity ratio of about 11 based on FY09 numbers and around 9 based on FY10Enumbers. This is obviously high for any company. But unlike many other companies in many sectors, contracts forrigs owned by Aban Offshore are fixed for atleast 2-3 years. Hence the company enjoys some amount of leeway asfar debt payment is concerned.Moreover most of its clients have increased its offshore budget in recent times. Thusfew of the ships that are currently idle or near completion of their service contract are likely to be recontracted bysame or different parties at much higher rates. This is a big positive for the company. Rig fleet addition globally
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has been very tardy in last couple of years due to tight schedule on the part of manufacturers. Thus establishedcompanies like Aban Offshore enjoy tremendous entry barrier.
The long term prospects of crude are strong than historic trend despite near term probable weakness. The stock hashigh correlation with rising crude prices though same is not the case in downward revision in crude prices.
We recommend the stock with a BUY rating with a possible target price of Rs1000-1100 in next 6 monthsimplying more than 20% upside.
Commodities Outlook
Steel
Flat Products
The flat market was quiet this week on the back of scepticism regarding the price movement. Most markets eitherremained slow or saw marginal rise. Prices dropped marginally in the Middle East countries and the US.Transaction levels were scanty as the demand failed to recover. Some cheap imports from CIS region have startedto arrive, but the volume was not very large.
Meanwhile, raw material prices continued to be a concern area for steel mills as the market is still trying to adjustto the quarterly contracting of iron. Flat product prices remained soft this week in absence of firm buying support.In the interim, some upward price revisions were seen by some steel majors while others kept it unchanged. Essar
Steel hypermart hiked CR sheet prices by Rs 250 per ton and cut prices of GP sheets by Rs 500 per ton over theirmid-April price. Another prime steelmaker raised domestic prices of hot rolled and cold rolled coils by about Rs500 per ton ($11 per ton) effective May 1 to offset rising raw material costs that it was unable to fully recover withprevious hikes.
This marginal increase contrasted with state -owned SAIL which kept its list prices unchanged for May bookings.Official rebate announcements are expected next week. However, SAIL increased its galvanized corrugated sheetprice by Rs 500 to 600 per ton only in South India compared to the last months price. The prices in other parts of India remained the same. Buyers had already purchased a lot of material in March. Now stockists were trying topush out as much old stock as they can, while end-users are only sourcing for their immediate requirements. Thelowering prices in May would have weakened already dampened market sentiment. But if this bad demandsituation continues, the steel majors may have to cut prices next month.
The Chinese market adopted a wait-and-watch attitude this week owing to the price volatility in the past fewweeks. Given the fact that major Chinese mills will gradually start using high-priced iron ore purchased on long-term contracts in July, some market sources believe mills will start pushing their prices even higher in a bid tocover rising costs. Spot market prices would also be driven higher if they can be accepted by downstream buyers.
Long products
The long products market remained mostly slow this week as demand failed to see any recovery coupled by a dropin scrap prices. The transactions were at a low level. There was widespread skepticism in the market and buyerspreferred to say out as they expected the prices to move further down.
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The Indian long products market plunged last week as the buyers did not accept the increased prices to offset highraw materials cost. However, it is interesting to note that the real demand level continues to be at the same level asit was in March end. The prices saw a dip of Rs 5000 per ton compared to the April level, despite the fact that theend users demand has not seen any change since March. The buying was entirely speculative in March end as themarket was sceptical that prices may move up further once the prime steel producers hike their prices. As the pick-up in the market was not as expected, the traders are lowering their prices to push the stocked-up material in themarket. However, as the real demand is at an average level, the stocks are liquidating but slowly.
Meanwhile, the traders are buying as per the immedia te requirement owing to the volatility in the market.Although the funds for the construction activities have been slowly unlocked, the construction companies areholding back their purchases on expectation that the prices will move down further.
Meanwhile, in tandem with the sluggish market sentiments, the Steel Authority of India Ltd (SAIL) may cut itslongproduct prices in the Bhilai region after the buyers did not accept the hike in the prices made in April beginning.The price reduction will be announced in select products by increasing the discounts as the base price will be keptthe same, as per industry sources. However, no confirmation was received from the company officials. Ingot pricesshot up to Rs 31,000 per ton in March end from RS 23,000 per ton in February, inclusive of excise duty. This wason the back of a high cost push and huge speculative buying, primarily in the secondary market. Thus, to keep theprices in tandem with the market, SAIL announced a marginal hike in prices. However, as per expectation, tooffset the high raw materials cost, SAIL announced a hike of Rs 2000 per ton in April beginning which failed toget acceptance from the buyers.
Tata Tiscon also lowered its Fe 500 and Fe 500 D series TMT bar prices by 4% over their April price. Thecompany raised TMT price by 6% over their March 23 prices. Market participants feel that slowdown inconsumption has forced the company to cut rates. Interestingly, the market is yet to see such cuts from otherleading players.
In the steel segment however we are very bullish on the JSW Steel and advise investors to add position if theprices correct to the level of Rs. 900-950 levels. The recent acquisition of a coking coal mine in the US isgoing to bring down its dependence on external supply of the raw material to the extent of 30% and thecompany expects that even after importing coking coal from US the landed cost is going to be significantlyless compared to the ruling price of the raw material. Keeping in view its expansion plans and the highergorwth in output we maintain our Buy rating on the stock with a rtarget price of Rs. 2000.
Iron Ore
Two consecutive drops in iron ore prices in the week gone by is not good enough reason for iron ore buyers in theglobal market to heave a sigh of relief. Though prices are near acceptable limits now, the fact that Chinese buyersconsiderably reduced their purchases during the month of March and carried it through April, there is little doubtover the inventory levels at the Chinese mills.Falling steel prices in the Chinese market triggered a second fall in prices within a span of seven days. The lowsteel prices have prompted many buyers to wait and watch rather than start making bookings just as yet. Chinesetraders have indicated that steel mills in China have no intention of stocking up the ore and prefer to keep theirstocks as low as two weeks under the given circumstances.
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Earlier when the prices were moving up rapidly, there were some steel mills which continued to buy the ore. Thisthey managed to do by blending the high cost iron ore with the low cost ore which had been procured earlier.However, this was not a sustainable option and the transactions have slipped drastically ever since the steel millsran out of the low cost ore.
There have been some iron ore supplies coming in from Chinese domestic mills as well, which is being used bymills there to control the cost of production since the domestic iron ore is cheaper than the imported material. Thedull state of the steel market in China has raised a number of questions over the countrys economic growth overthe second half of the year. There is a mixed sentiment however, which looms over the fate of the iron ore marketin the coming days. The steps taken by the Chinese government to maintain balance in the economy may,according to some market participants, affect the steel demand in the coming months from the real estate sector.
Moreover, the growing focus on domestic iron ore would further affect the demand for imported ore. However,there is another section which feels that steel mills would soon return to the market. As far as importing Indian ironore is concerned, the Chinese may not waste much time owing to the approaching monsoons which would renderthe ports located in western India inaccessible starting end of May and extending right up till September.
Meanwhile, Vale, which finally won the battle in favour of quarterly pricing, has put its foot down while signingcontracts with Chinese buyers. Keeping in mind the market volatility, Vale has devised a formula and would setaside one month between each quarterly period to settle prices with buyers. For instance, prices for the July-September quarter will be settled in June using the average published price of the ore during the period March-May.
In instances when prices witness an acute drop in comparison to the retrospective price which is used as base, thebuyers may be tempted to default on the contracts and instead buy at a cheaper rate from the spot market. To avoidsuch occurrences as far as possible, Vale has indicated that those customers who default on the contract wouldhave their names removed from Vales customer list and the mining company would not be obliged to supply ironore to the defaulters. Freight rate on the Brazil-China route has dropped marginally during the week gone by andwas recorded at $29.408 per ton on May 4, against $31 per ton recorded during the previous week. On the sameday, the freight rate on the India-China route was recorded at $22.7 per ton. Prices of Indian iron ore finescharacterised by 63.5% Fe content dropped twice last week. Prices for the grade in the Chinese spot market wererecorded between $182 and $185 per ton down from the previous weeks prices which ranged between $185 and$187 per ton cfr.
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8/9/2019 Research Speak - 14-05-2010
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