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Special report
EconomIc analySIS
rBI continues hawkish stance to battle stubbornly high inflation
Indias inflation continues to remain stubborn despite a good monsoon this year and strong outlook of the Kharif harvest. This has prompted the Reserve Bank of India (RBI) to push up the pace of monetary policy tightening. The apex bank in its maiden mid-quarterly policy review on September 16, 2010 started the rate hike binge and continued the hawkish stance. The RBI so far has raised the Cash Reserve Ratio (CRR) by 100 basis points, and raised the repo rate by 350 basis points in 12 hikes. The effectual tightening has been of 500 basis points as liquidity in the system transited from surplus to deficit. With the recent hike, repo rate, at which banks borrow money from RBI, now stands at 8.50% while reverse repo rate at which, banks park surplus money with RBI is at 7.50%. On the interest rate policy, as pointed out in the second quarter review of November 2010, the RBI had floated a discussion paper on deregulation of savings bank deposit interest rate for suggestions. The paper spelt out both the pros and cons of deregulating the savings bank deposit interest rate. After examining the suggestions, RBI deregulated the savings bank deposit interest rate, where banks are now free to determine their savings bank deposit interest rate depending on following two conditions. First, each bank will have to offer a uniform interest rate on savings bank deposits up to Rs 1 lakh irrespective of the amount in the account within this limit. Second, for savings bank deposits over Rs 1 lakh, a bank may provide differential rates of interest, if it so chooses. However, the banks are not supposed to do any discrimination from customer to customer on interest rates for similar amount of deposit. The mid-quarterly review may not have many surprises as one expected the RBI to continue with its already public concerns on inflation. In what pursues, let us review the macroeconomic background with which RBI went into the mid-policy review, major takeaways from the policy release of the central bank and how the RBI may tackle the emerging inflation scenario going forward.

Date : 21 November 2011

Policy Backdrop
The mid-quarterly review of the RBI was set in the backdrop of slacking GDP growth, decelerating industrial output and stubbornly high inflation. Domestic economys GDP decelerated to 7.7% in April-June quarter of 2011-12 from 8.8% a year ago, and 7.8% in Q4 of 2010-11. From the supply side, the deceleration in growth in first quarter was mainly on the back of slower growth in mining, manufacturing, construction and community, social and personal services. On the same time the Industrial growth, as measured by the index of industrial production (IIP), decelerated to 5.6% during AprilAugust 2011 from 8.7% in the corresponding period of the previous year. This was mainly on account of slowdown in capital goods, intermediate goods and consumer durables. Growth of eight core infrastructure industries during April-August 2011 also slowed down to 5.3% from 6.1% in the corresponding period of last year. Manufacturing sector growth decelerated significantly to 6.0% during April-August 2011 from 9.2% during the corresponding period of last year. The lower growth in manufacturing was on account of negative growth in 14 out of 22 industry groups. As per use-based classification, moderation in growth was evident in all categories except basic goods and consumer non-durables. The persistent volatilities in industrial growth remained a discouraging factor particularly in the rising inflation and interest rate scenario. Although services sector so far has retained the growth momentum, but its sustainability in the long-run will largely depend on the developments in the global economy.
GdP at factor cost
12 10 8 6 4 2 0 Q1 2010-11 Q2 2010-11 Q3 2010-11 Q4 2010-11 Q1 2011-12 agriculture, forestry & fishing electricity, gas & water supply GDP at factor cost mining & quarryin construction manufacturing

key policy rates

9 8 7 6 5 4 3 2 1 0
07-02-2010 11-02-2010 21/4/2009 13/2/2010 27/2/2010 19/3/2010 20/4/2010 24/4/2010 27/7/2010 16/9/2010 25/1/2011 17/3/2011 05-03-2011 16/6/2011 26/7/2011 16/9/2011 25/10/2011

Reverse Repo Rate Repo Rate

CRR

Domestically, inflationary pressures still persisted and Wholesale Price Index (WPI) y-o-y inflation was at 9.7% (provisional) for the month of September 2011. Inflation remained at above 9% over consecutive months in the first half of the year, and price pressures persisted across the range of commodities covered in the WPI. Though in primary food articles, inflation moderated from the levels of over 20% witnessed in the first quarter of 2010-11, it still remains high with the average inflation during 2011-12 so far (up to September) at 8.9%. A breakdown of food articles inflation specifies that the price pressures have been moderated for cereals whereas increases have been noteworthy in the case of protein-

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rich items. Demand has been growing in these items in recent years with rising income and changes in dietary pattern in favour of protein rich items. The recent food inflation numbers breached the psychological barrier and surged to a nine month high level at 12.21% for the week ended October 22. Whereas, inflation in nonfood manufactured products remained at above 7% over eight successive months. Increase in governed prices of fuel products effected in June 2011 led to firming up of fuel inflation. Since then, prices of freely priced mineral oil products have raised partly on account of the recent depreciation of the rupee. Notwithstanding recent increases, the pass-through of global inflation to domestic inflation remains incomplete. The rupee depreciated by about 11% against the US dollar in 2011-12 so far. Indias imports account for about 22% of GDP, and depreciation of the rupee raises the risk of imported inflation. side mainly on account of slowing down of the global economy activity and softening domestic demand. Slower global growth will have an adverse impact on domestic growth, particularly on industrial production, given the rising inter-linkages of the Indian economy with the global economy. Based on these reflections, the baseline projection of GDP growth for 2011-12 is revised downwards to 7.6%. Upside risk to inflation is likely to persist in nearterm before moderating as falling global commodity prices provide limited comfort. Further the RBI also stated that inflation lane will be formed by both demand and supply factors, which will depend on the following: 1. The extent of moderation in aggregate demand. Some signs of demand are evident, though the impact is being felt more on the investment side. 2. The behavior of crude prices will be a vital factor in determining the outlook of domestic inflation in near term. Despite the lethargic growth prospects of the global economy, crude prices have moderated only slightly. Further the exchange rate will also have some impact on the performance of domestic oil prices. 3. The inflation outlook will also depend on the supply response in respect of those commodities where there are structural differences, mainly protein items. 4. Above all there is still an element of suppressed inflation as domestic prices of controlled petroleum products do not reflect the full pass-through of global commodity prices. The recent decline in crude prices has been counterbalanced by the depreciation of the rupee. In addition, there are other items such as coal whose current prices do not reflect the underlying market conditions. Since coal is an input for electricity, coal prices, as and when raised, will also have implications for electricity tariffs. The apex bank indicated that though the inflation has remained persistently high over the past two years, it is important to note that during the 2000s, it averaged around 5.5%, both in terms of WPI and CPI, down from its earlier trend rate of about 7.5%. While the RBI accepted that inflation peaked, it nonetheless added that it would continue to moderate from the high levels for months to come.
movement of food inflation & fuel
18 16 14 12 10 8 6 4 2 0
Nov-10 Feb-11 Oct-10 May-11 Aug-11 Dec-10 Apr-11 Mar-11 Sep-11 Jun-11 Oct-11 Jan-11 Jul-11

Inflation and IIP growth

12 10 8 6 4 2 0
Nov-10 Feb-11 Oct-10 May-11 Aug-11 Apr-11 Dec-10 Mar-11 Jul-11 Sep-11 Jun-11 Jan-11

Headline Inflation IIP

Though export growth outpaced import, the current account deficit (CAD) surged in the first quarter of 2011-12 in absolute terms, reflecting sharp increase in imports of oil, gold, silver, machinery and electronics. Indias export growth has shown unexpected enthusiasm in recent months, despite the slowdown in advanced economies and rising global uncertainty. However, there was a sharp rise in imports as well, which led to the widening of trade deficit. The high growth in imports came from an increase in oil imports and non-oil imports. Further, economic activity in advanced economies destabilized further in third quarter of 2011. Increasing concerns over mediumterm sovereign debt dynamics in the euro area and, in particular, considerable potential losses to banks holding this debt have impacted global financial markets extremely. The unfavorable feedback loops among sluggish growth, weak sovereign balance sheets, large exposures of banks to sovereign debt and political compulsions coming in the way of a probable solution have created a crisis of confidence, which is a potential threat to regional and global financial stability.

Policy review
The monetary policy statement released by the RBI had inflationary concerns spilled all over, be it the global or domestic one. The RBI stated that the risk to the growth projection was on the down-

Food Inflation Fuel

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Date : 21 November 2011
The central bank also put its concern on global outlook that a major downside risk to growth originates from the global macroeconomic environment. Finally the RBI stated that the inflation rate will begin falling in December 2011 and it continued to decline to 7% by March 2012. Notwithstanding current rates of inflation persisting till November, the probability of a rate hike in the December mid-quarter review is comparatively low. Ahead of that, if the inflation trajectory conforms to projections, further rate hikes may not be warranted. However, as always, actions will depend on evolving macroeconomic conditions, which means monetary policy stance is not yet complete. though in selected segments. On the whole, all the lead indicators of services sector like commercial vehicles production, cell phone connections, air cargo, and passengers handled at domestic and international terminals too have witnessed retarding growth. Thus, services sector is also coming under the clutch of slowdown though the extent and strength of slowdown is not yet apparent.
Economic outlook for 2011-12
36.7 34

Going forward
Inflation: Food prices in India have remained high for several months mainly on the back of growing demand for high-protein diets and increase in prices of vegetables, milk, and pulses have restricted the overall inflation from easing. Milk-based products seem to be hardest hit, with the price of milk rising 12-18% over the last 12 months and on the other hand prices of other food items have reached their peak. The persistent high food inflation number reinforces expectations that price pressures wont ease anytime soon, even as the apex bank projects headline inflation to start easing from December to 7% by March. Headline inflation hovered over 9% for 10 consecutive months through September. Steamy food prices could trouble the projections and build pressure on the Reserve Bank to revisit the pause in rate increases that it has indicated it would likely adopt for now. Further on the agriculture side, rainfall during the south-west monsoon reported to be 1% above normal, which in one way could help food inflation to come down, though it may not translate into lower prices at least in the near term. The first advance estimates for the 2011-12 Kharif season point to record production of rice, oilseeds and cotton while, the output of pulses may decline due to a reduction in acreage. Though agriculture prediction remain encouraging, overall growth in 2011-12 is likely to moderate to below trend. Industrial Growth: The hold up in industrial growth is in fact becoming wide-ranging and gaining impetus as evident from the latest trends. Rising interest rates have taken a definite toll on industrial investment as well as consumer demand particularly for consumer durables. The rate hike announced in the month of October 2011 may further reflect on the industrial production costs and may hurt the growth prospects. The continued fall in output as well as sales of major automobiles in the month of October 2011 as per the latest data released by the Society of Indian Automobile Manufacturers (SIAM) hints the further slowdown in industrial output in October 2011. The slowdown observed in general in the industrial sector and manufacturing sector in particular is spreading to automobile sector also. The drop in domestic sales may further add to the slowdown in production in the coming months. Thus, industrial output may become stagnant or post a negligible growth in the next two months particularly due to rising base. Services sector also started viewing a slowdown in activity al3 7.1

10 2.7 Services Investment CAD (% of Savings rate GDP) rate (% of GDP) Projected rates (2011-12)

6.5

6.8

Agriculture Industry

Inflation (March 2012)

Fiscal deficit

Credit Growth: Despite the steady rise in interest rates, the credit growth remained high and deposits growth has not picked up the pace to the extent of expectations. The recent policy rate hike by the Reserve Bank of India has so far not been passed on by the banks through rising rates of loans and deposits. However, there is a steady rise in market borrowing rates both in short and longterm, signifying that the banks may raise lending and deposit rates soon. External Sector: Trade deficit rose to record high of $19.6 billion in the month of October 2011 on the back of sharp fall in exports to a 10-month low. Total investment inflows, continued to fall sharply by about 40% on m-o-m and about 95% on y-o-y basis to $616 million in September 2011 due to continued net outflows of portfolio investments and slowdown in direct investments during the month. Similar movements may continue due to the uncertain global economic concerns. Thus, the external sector outlook emerges to be rather gloomy in the coming months. Global Economy: Uncertainties over fiscal weakening are further burdened by the stagnant unemployment situation and signal towards a grim outlook of the US economy. Though the economy would jumble along at about 2.5% to 3% annual growth, which is not enough to meaningfully lower the unemployment rate. Moreover concerns over the European debt crisis are threatening larger as the bond yields are rising steadily and many more countries are coming under the strap of debt crisis. Further, the crisis has been leading to political turbulence in the region particularly in Greece and Italy. The yields of gilts have also gone up considerably in France and Germany. On the other hand, the emerging economies the growth drivers throughout the financial crisis are also seeing a slowdown stressed by strong inflationary pressures. As a consequence, the recovery in global economy may observe a further slowdown and the possibility for a double dip recession now appears to be rising. On the whole, global growth prospects appear to be weakening, even though recovery has not delayed.

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comPany rESEarcH Steel authority of India - Hold Investment overview

SAIL, one of the five Maharatna is the leading steel-making company of the country having a huge marketing network. Its average product price during the last quarter was around 16% higher at Rs 36,230 a tonne from the previous quarter. The company plans to invest Rs 35000 crore to build a factory at a shuttered fertilizer plant in Jharkhand. The company in principle has received approvals for Rs 60,000 crore approximately for moderanisation and expansion.

Stock Data
Current Mkt Price (Rs) 52 Week High 52 Week Low Mkt Cap (Rs. in Cr.) Return in last one Month (%)

21/11/2011
88.35 197.05 88.40 38701.85 -16.73

Share Holding

Business overview
Steel Authority of India Limited (SAIL), a fully integrated iron and steel maker is a Maharatna and the leading steel-making company of the country. It was formed in 1973, as a holding company, for Hindustan Steel Limited, Bokaro Steel Limited, Salem Steel Limited, BCCL and NMDC. Later in 1978, SAIL became an operating company and Steel making subsidiaries were dissolved and merged BCCL and NMDC were spun off as independent companies. SAIL has triggered the secondary and tertiary waves of economic growth by continuously providing the inputs for the consuming industry. SAIL manufactures and sells a broad range of steel products, including hot and cold rolled sheets and coils, galvanised sheets, electrical sheets, structurals, railway products, plates, bars and rods, stainless steel and other alloy steels. SAIL produces iron and steel at five integrated plants and three special steel plants, located principally in the eastern and central regions of India and situated close to domestic sources of raw materials, including the Companys iron ore, limestone and dolomite mines. SAILs product quality is established in the international market-Exports to around 20 countries including EU, Middle East, SE Asian & Neighbouring countries. The company is having huge marketing network spread all over India with 37 Branches, 67 Warehouses, 26 Customer Contact Offices and over 2500 Dealers covering all districts of India. SAIL has its own R&D centre & Management Training Institute at Ranchi with state of art facilities.

Performance in last one year

Y-o-Y Performance
(Rs. in Cr..)

Financial Health
For the quarter ended September 30, 2011 SAIL has reported net sales of Rs 10979.62 crore, marginally higher by 2.16% compared to Rs 10747.44 crore in the same period last year. Other income for the quarter was up by huge 30.61% to Rs 490.28 crore from Rs 375.38 crore Y-o-Y. Net profit of the company declined sharply by 54.62% to Rs 494.64 crore in the quarter compared to Rs 1090.01 crore mainly because of foreign exchange loss of Rs 508.72 crore against a gain of Rs 152.52 crore in the corresponding previous quarter. Raw material costs rose 15 percent to Rs 5610 crore in the quarter, while employee expenses rose 16 percent to Rs 1980 crore. SAIL had gross debt
Particulars Net Sales Other Income Total Expenditure Operating Profit Interest Profits After Tax Reserve & Surplus Reported EPS(Rs) Core EBITDA Margin (%) Mar 2011 43251.65 1589.84 35686.43 9155.06 474.95 4904.74 0.00 11.87 15.84 Mar 2010 41230.27 2035.81 31394.80 11871.28 402.01 6754.37 0.00 16.35 22.01

Change(%) 4.90 -21.91 13.67 -22.88 18.14 -27.38 12.86 -27.38 -28.02

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of Rs 23518 crore and a cash reserve of Rs15142 crore as of endSeptember. The company sold around 3.0 million metric tons of steel in the second quarter, almost unchanged from the year-earlier period. Its average product price for the quarter was around 16% higher at Rs 36,230 a tonne. For the half year period the company reported a 10.26 % rise in its net sales to Rs 21921.04 crore from Rs 19880.76 crore. Net profit declined by 41.16% to Rs 1333.62 crore against Rs 2266.66 crore in the same period last fiscal.
Q-o-Q Performance
(Rs. in Cr..)

Particulars Net Sales Expenditure Other Income EBITDA Interest Net Profit EBITDA Margin (%) NPM (%) EPS

Sep 2011 10979.62 9652.48 490.26 1817.40 200.01 494.64 0.17 0.05 1.20

Sep 2010 10806.17 9111.39 375.38 2070.16 109.04 1090.01 0.19 0.10 2.64

Change(%) 1.61 5.94 30.60 -12.21 83.43 -54.62 -13.60 -55.34 -54.55

Industry Scenario
India occupies a central position on the global steel map. The metal continues to have a stronghold in traditional sectors such as construction, housing and ground transportation; special steels are increasingly used in engineering industries such as power generation, petrochemicals and fertilisers. Till early 1990s, when economic liberalization reforms were introduced, the steel industry continued to be under controlled regime. After liberalization- when a large number of controls were abolished, some immediately and others gradually-the steel industry has been experiencing new era of development. For the Indian steel makers, which mostly buy from the spot market, prices will depend on international prices at which the commodity is supplied to the Chinese and also on domestic policy environment. Hike in import duty combined with ban by the government of Karnataka has boosted domestic supply of the ore and prices therefore are likely to remain stable in near term for Indian producers. In an absolute sense though, iron ore prices are much higher on year-on-year basis while steel prices are only modestly higher. Another key steel input, coking coal, is also witnessing significant price hike. In 2010, prices for the metallurgical coal grew by 75% over 2009. Further growth is possible due to potential increase in Chinese and Indian import during going forward. Steel production in India has been growing at a strong pace for last several years. Though there was a bump following the global slowdown, demand for the alloy recovered early in 2009 and has remained strong throughout the last fiscal. Further, the government is focusing on the infrastructure development to ensure a sustainable 9-10% growth in the second decade of this century. The government is on track to ensure an investment of $500 billion over the current plan that ends in 2012. For the next plan, infra investment target of $1 trillion is being talked about. Also, there is a lot of effort going into the financing aspect of infra projects, which will improve the time implementation of these. Overall, there is immense growth potential in the infra space and steel obviously has a high correlation with the overall infrastructure development. Though, there will be escalation in costs and some pressure on margins, but volumes will remain good. In this wake, we maintain a positive outlook on steel.

Profit & Loss

(Rs. in Cr..)

Particulars Net Sales Total Income Total Expenditure Operating Profit Profits After Tax

Mar 2011 43251.65 44841.49 35686.43 9155.06 4904.74

Mar 2010 41230.27 43266.08 31394.80 11871.28 6754.37

Change(%) 4.90 3.64 13.67 -22.88 -27.38

Balance Sheet
(Rs. in Cr..)

Particulars Share Capital Reserve & Surplus Total Liabilities Investments Current Liabilities Net Current Assets Total Assests

Mar 2011 4130.40 32939.07 57234.96 684.14 11474.86 20733.40 57234.96

Mar 2010 4130.40 29186.30 49827.95 668.83 10918.38 22005.63 49827.95

Change(%) 0.00 12.86 14.87 2.29 5.10 -5.78 14.87

Financial Key Ratios

Particulars Reported EPS (Rs) Core EBITDA Margin (%) EBIT Margin (%) ROA (%) ROE (%) ROCE (%) Price/Book (x) Net Sales Growth (%) EBIT Growth (%) PAT Growth (%) Total Debt/Mcap (%) Mar 2011 11.87 15.84 16.06 9.16 13.94 14.33 1.89 4.90 -27.20 -27.38 0.29 Mar 2010 16.35 22.01 23.57 15.79 21.98 24.63 3.12 -5.59 9.07 9.46 0.16

Latest developments:
Steel Authority of India and Oman Oil Co. S.A.O.C. have signed

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an initial pact to jointly set up a steel plant in Oman with an estimated investment of $3 billion. The two state-run companies aim to set up the plant with a capacity of 3 million metric tons a year once a feasibility study on the project was completed. Steel Authority in August said it plans to invest Rs 35000 crore to build a factory at a shuttered fertilizer plant in the eastern state of Jharkhand, sidestepping land- acquisition hurdles.
* EPS &group comparison: Peer P/E latest (Rs in crore)

Company SAIL Jindal Steel & Power Tata Steel JSW Steel

Year End 201103 201103 201103 201103

Net Sales 43251.65 9573.63 29396.35 23163.24

PBDIT 7565.22 3646.96 11173.09 4573.53

PAT 4904.74 2064.12 6865.69 2010.67

PATM% 11.34 21.56 23.36 8.68

EPS* 11.87 22.09 71.58 88.87

P/E* 9.75 24.84 5.43 7.10

Investment rationale
SAIL reported a worse-than-expected 55 percent drop in second-quarter profit largely due to higher coking coal prices and because of incurring foreign-exchange losses. Coking coal, a key raw material used to make steel, surged 40 percent during the period, compared with a 14 percent increase in the price of steel hot-rolled coils. The company imports about 70 percent of the coking-coal it needs, many other Indian companies too have been hit by a sharp depreciation in the Indian rupees value against the dollar in the past few months. Out of its planned a capital expenditure of Rs 12,600 crore the company has already spent Rs 4,500 crore. The rest will be spent in the second half. The companys debt-equity ratio is in stable state and raising of debt or equity will not be an issue for the upcoming projects. Going further Steel Authority of Indias profitability might see a further dent in the near-term due to an impending wage revision for employees. Wage revision for over one lakh employees, excluding officers, is due for January 2012 and the employee unions are demanding a higher increase. SAILs employee costs for the financial year 2012 are estimated at Rs 8,000 crore. Based on the current revenue, employee wages account for about 20 per cent of SAILs turnover. There is a possibility that the wage costs might increase by Rs 1,000 crore annually and the incremental rise in wage costs would further dent the margins. Its operating profit margins, has been already impacted by the rising input costs such as coking coal which stood at 12 per cent in the July-September quarter. However, the management is confident that wage costs would come down with the increase in production over next couple of years. It is of the view that the output is increasing with the same number of employee. SAIL is in the process of implementing its modernization and expansion plan and the company in principle has received approvals for Rs 60,000 crore approximately for moderanisation and expansion. Rs 10,000 crore approximately for augmentation of raw materials from existing mines and development of new mines. SAILs modernisation plan would increase its capacity from 14 million tonnes per annum (mtpa) to 24 mtpa by 2014. The company plans to start couple of allied units such as cold roll mill in Bokaro and steel wire rod mill in the next quarter. Next year when two of the three blast furnaces in Rourkela and Bokaro will be fired then the company is likely to see quantum jump in output which will increase companys output by about 6 million tonnes in the next fiscal. IISCO unit in Burnpur too is expected to be commissioned in the first half of next year. SAIL, along with 6 leading Steel and Iron Ore Manufacturers of India, under a consortium agreement, has submitted the bid document with Ministry of Mines, Government of Afganistan in September 2011 for exploration concession for Hijigak Iron Ore Deposit, Afghanistan, as consortium leader. The Afghanistans mining ministry has shortlisted the number of foreign investors interested to explore its iron ore rich Hajigak mine, and it has been reported that the mine will go to an Indian firm. Apart from SAIL, mineral giant NMDC and Ispat Alloys too are in the fray. The SAIL consortium had bid for all the four Hajigak mining blocks and the local government has reportedly implied giving preference to companies that could set up a steel plant to improve the value of the Hajigak iron ore project. The iron ore rich Hajigak mine, located in Bamyan Province, contains the best known and largest iron oxide deposit in Afghanistan. The deposit itself extends over 32 kilometers. It covers 16 separate zones, up to 5 kilometers in length, 380 meters wide and extending 550 meters down. At CMP of Rs 88, the stock is trading at an EV/EBITDA of 4.90x and a P/E multiple of 9.75x with an estimated P/E of 13.5x FY12. We would recommend a HOLD in the stock with a price target of Rs 106. Steel Authority of India, the nations largest producer after Tata Steel has shown a good improvement in its product mix. Though, its last quarter numbers were impacted by the rise in coking coal prices and forex loss but the company expects steel demand in India to pick up in the coming months, driven by projects in sectors such as railways, roads and power. It has plans to spend as much as $12 billion developing plants overseas as demand for the alloy recovers. It is in talks to build factories in Indonesia, Mongolia and Oman, as well as South Africa. The company has recently signed a pact to jointly set up a plant in Oman. The country consumes around 4 million tonnes of steel in a year. However, its steel making capacity is under 1 million tonne only hence it offers a good opportunity for SAIL. Going forward, though the export demand is not looking to improve but the rush to achieve targets on various projects in the terminal year of the 12th Five Year Plan would trigger demand for steel in the remaining period of current fiscal.

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SECtor outLook : StEEL InduStry

overview
Indian steel industry plays a significant role in the countrys economic growth. With the governments proactive incentive plans to boost economic growth by injecting funds in various industries is likely to boost the steel demand in future. In 1991, a substantial number of economic reforms were introduced by the Indian government which boosted the development process of a number of industries - the steel industry in India in particular - which has subsequently developed quite rapidly. The Indian Steel sector has been experiencing a new era of development since liberalization, when a large number of controls were abolished - some immediately and others gradually. As a result, the domestic steel industry has since then, become market oriented and integrated with the global steel industry. The steel industry plays a very crucial role in development of Indian economy and it is considered as backbone of sectors like, Auto Industry, Infrastructure etc while it is also used as one of the critical raw material for many manufacturing industries. The Indian government initiated a series of policy reforms which changed the dimensions and dynamics of the Indian steel Industry. Due to the favorable government policies and robust economic growth, Indian steel industry is presently experiencing healthy growth. The prospects of the domestic demand and consumption appear to be excellent driven by the high investment rate, growth in manufacturing industry and expansion in physical infrastructure creation. on creating new infrastructure while the growth in automobile, construction and consumer goods sectors of economy too are giving the demand for steel an additional push. As per the steel ministrys data, the apparent consumption of steel of finished steel stood at 65.610 million tonnes, from 27.350 million tonne in 200102. And this consumption is almost three times from 14.84 million tonnes in 1991-1992. In the last five year Indias compounded average growth rate of steel consumption is above 9%, and this growth in consumption rate is expected to increase in coming years.

Growth drivers:
Steel industry is very important sector of the Indias economy, as per the government estimates, the iron and steel industry contributes around 2% of the Indias Gross Domestic Products and its weight in Index of Industrial production (IIP) is around 6.2%. The steel industrys growth is closely linked to national economic growth. The main drivers for the steel industry are Construction, Infrastructure, Consumer Durable goods, and Automobile and Auto components Industry and government policy. Infrastructure: Indias Gross Domestic Product (GDP) is growing with the 8 to 9% and it is also expected to sustain similar pace of GDP growth in the years to come which is the driver of growth of India steel industry. To maintain this pace of GDP growth Indian government has planned massive investment in the development of infrastructure, government is planning to invest around $1 trillion in coming five years for infrastructure development. This $1 trillion investment which will be used in development of infrastructure such as power, railways, roads, ports and airports, is expected to generate sustainable demand for the steel and consumption for steel, which is presently around 10%. Automobile and Auto components Industry: Apart from infrastructure, Automobile and Auto components Industry also plays a crucial role in the growth of steel sector as it has strong and direct linkages with this sector. With the rapid upsurge in investments in Automobile and Auto components Industry, the demand for steel is also expected rise further in coming years. India is one of the fastest growing automobile markets and it is the hub for small and fuel efficient passenger cars. Indian auto industry was one the rarest industry which swiftly recovered from the financial meltdown of 2008 and registered robust growth. From the negative growth in financial year of 200708, the Indian auto sector saw strong growth of 26% in 2009-10 and almost 27.5% in last fiscal year. This fast recovery in the sector was due to growing demand in domestic market and exports. The Automobile and Auto components Industry has emerged as the prime driver for alloy steel.

Production of finished carbon steel (in million tonnes)

80 70 60 50 40 30 20 10 0
2004-2005 2006-2007 2008-2009 2001-2002 2002-2003 2003-2004 2007-2008 2009-2010 2005-06 2010-2011

Currently, both in terms of capacity and production, India has the fourth-largest steel sector in the world after China, Japan and USA. The production of finished carbon steel in India has increased significantly over the last decade. During 1991-1992 the total production of finished carbon steel was 14.33 million tonnes, which doubled to 30.63 in 2001-2002 and in the last financial year that is 2010-11 the total production of steel was around two and a half times at 75.741. In the, current calendar year, Indias steel production in the first half of 2011 stood at 35.636 million tonne. The demand for the steel in the Indian economy is expected to increase in the medium to long term, as the government is focusing

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other Sectors Other sectors such as Construction, Consumer Durables and Oil and Gas industry are also contributing to the growth of Indian steel Industry. In the recent time construction sector has registered a healthy growth, especially construction work in metropolitan cities like Delhi, Mumbai etc. has increased the demand for the steel in the sector. Construction sector is expected to maintain its current pace of growth and is estimated to grow by around 12 to 14% as the housing demand is expected to increase not only in metros but also in tier I, II and tier III cities. The consumer durables sector has maintained its double digit growth rate from last few years, and it is expected to maintain this pace of growth in the coming years as well thanks to the burgeoning middle class population, increasing income levels and changing lifestyles. It is expected to grow by almost 13 to 14% in coming years. The domestic appliances markets which includes spin driers of washing machine, almirahs, thermo ware, water filters, dishwashers, microwave ovens, catering equipments, cutlery, furniture etc has created almost a new market for the steel sector. This growth is consumer durables will help in sustaining the pace of steel consumption. Government Policy: Since the start of economic liberalization in 1991, the steel industry has undergone significant change. The rapid growth in the steel industry and changed market dynamic due to economic liberalization made government to change its policy on the steel sector, and in 2005 it introduced the National Steel Policy with the aim to provide a roadmap of growth and development for the Indian steel industry. The National Steel Policy 2005 seeks to remove policy bottlenecks which affect the availability of production inputs, increase in investment, and creating infrastructure such as road, railways and ports. The NSP 2005 seeks to increase Indias production of steel to 100 Million Tonnes by 2019-20, with the compounded annual growth of 7.3 % per annum. further is a complex permitting process that varies by state. Foreign investors have tried to capitalize on the nations growing steel market. South Koreas Posco, the worlds third-largest steel maker, plans to build a $12 billion plant in Indias eastern state of Orissa. But the project has met resistance from local land owners, many of whom are farmers. Unlike China, India is a democratic nation where land acquisition requires more than a nod from a centralized authority. Availability of raw materials: The other major challenge for steel producers in India is access to iron ore. Despite the abundance of iron ore availability, it judicious allocation remains a challenge. Indian government must adopt policies that encourage iron ore mining for domestic use. The government has already taken some steps by imposing a 20% duty on iron ore exports. Indias steel industry also lacks access to coking coal, which is used to produce iron. Coking coal prices fluctuate and supplies are controlled by major mining operations outside of India. underdeveloped Infrastructures: The India steel sector is facing difficulties on various fronts like the underdeveloped infrastructures, environmental & forest clearances and availability of coal and fuel and increasing cost of dry fuel. Most of the mining fields are located in Eastern Indian states such as Orissa, Jharkhand, and Chhattisgarh, were the infrastructures are under developed. Underdeveloped infrastructures such as roads and railways and lack in availability of power and water have been major bottlenecks for the sectors growth. Environment Clearance: The environment clearance has been another major concern for the steel sector. In order to set up steel plants thousands of acres of lands are required, and getting land has been one of the major hurdles. Most of people in rural area are dependent on land and forest for their livelihood, and acquisition of land without ensuring adequate compensation rehabilitation and employment, has created unrest protest from farms for land acquisition. The government needs to work on the issue seriously for the growth of the steel sector.

challenges faced by India Steel Sector

The steel industry plays a significant role in the economic growth of any country, and despite the recent slowdown in the domestic market, the future of the Indian steel industry seems bright. However, shortages of domestic iron ore supply and increasing raw material prices are posing a challenge to Indian steelmakers as they import a majority of essential ingredients for steel production. The Indian steel industry was already under raw material supply pressure, however, and the ban for mining in Karnataka state by the Supreme Court has further ratified the shortage of iron ore supply for the industry. Land acquisition: Land acquisition is a common hurdle steel producers face in India. Oftentimes companies must gain approval from hundreds of land owners to build a new mill. Complicating matters even

Steel Production:
As per the world steel association, the total output for Jan-June 2011 was around 35.636 million tonnes of steel. During 2010 India had produced around 68.3 million tonnes and in 2009 it had produced around 63.5 million tonnes. This indicates that, the steel production in recent years has been increasing with the increase in pace of economic growth. India is expected to become the second largest producer of steel in coming few years. The India government is targeting to expand its production capacity to 120 million tonnes by 2012 from the current level. Currently, India is the fourth largest producers of steel in the first six month of 2011,

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after China, Japan and USA. This brisk growth in production of steel in recent past has been a result of higher production of valueadded products, production capacity expansion, upgradation of production process, achieving cost effective production in an environment friendly manner. The production of finished carbon steel in India has been 75.74 million tonnes (provisional) in last fiscal year as compared to 42.63 million tonnes in 2005-06. In the production of steel, the secondary sector had largest share followed by the primary producers. This increase in the share of secondary sector is because of ample supplies of semis. Intermediate solid steel products obtained by hot rolling/forging of ingots (in conventional process) or by continuous casting of liquid steel are known as semis. These semis are intended for further rolling/forging to produce finished steel products. Along with the finished carbon steel, the production of DRI (Direct Reduced Iron) had increased by around five times from 5.4 million tonne in 2001-02 to 26.7 million tonnes in 2010-11. In 2009-10, India was the second largest producer of DRI after the Venezuela. However, the pig iron saw a decline in production. The total production of pig iron was 5.585 million tonnes in 201011 as compared to 5.976 million tonnes in 2009-10.
70 60 50 40 30 20 10 0
2005-06 (P) 2001-2002 2002-2003 2004-2005 2006-2007 2007-2008 2008-2009 2009-2010 2003-2004 2010-2011

demand. However there was one silver lining that steel prices in Asia were stable during 2QFY12 but the rupee depreciated against US dollar by 9.4% in the quarter putting pressure on the domestic steel companies despite cushioning the drop in realisation in rupee term. Steel consuming sectors like auto, shipbuilding and consumer goods growth showed moderation. In spite of this apparent steel consumption has grew by around 6 Mn tonnes per month during Apr-Sep 2011. Global and Chinese crude steel production slowed in October to the lowest level in 10 months, as a gloomier economic outlook forced many steelmakers to cut production to tackle weakening demand and falling prices.

Consumption:
Historically the Construction, Infrastructure and Automobile & Auto components Industry markets have remained the largest consumers of steel absorbing more than half of the total steel production (Products). Industries such as, automotives and manufactures of consumer durables directly depends on the steel industry for basic raw martial. Other industries such as appliances, agricultural implements, converters, containers, energy, electrical equipment and industrial machinery are major consumer (demander) of steel. The consumption of steel is viewed as the key indicator of economic development. Due to rapid economic development of India, the consumption of steel also has gone up in recent past. The main demand for the steel is coming from the traditional sectors such as construction, housing, auto and related sectors and consumer durables and from nontraditional sectors such as engineering industries, power generation, petrochemicals and fertilizers. However, presently, sectors like infrastructure, automobile and consumer durables are leading consumers of the steel. The increase in disposable income, pushed demand for housing, automobile and consumer durable goods in rural India, which is at present creating additional demand for steel in these sectors.
70 60 50 40 30 20 10 0 2005-06 (P) 2006-2007 2007-2008 2008-2009 2009-2010 2010-2011
APPARENT CONSUMPTION OF THE FINISHED STEEL (CARBON) Gorwth in APPARENT CONSUMPTION OF THE FINISHED STEEL (CARBON)

APPARENT CONSUMPTION OF THE FINISHED STEEL (CARBON) Gorwth in APPARENT CONSUMPTION OF THE FINISHED STEEL (CARBON)

note: Production of Finished Carbon Steel and drI in Million Tonnes

recent trend in Steel Production:

In recent times, the steel production has been steadily increasing with the demand from various sectors. On monthly basis, the production of steel is growth on an average of 8 to 9% from last 12 months. As per the IIP data, the Annual Averages of Steel Production has increased from 3626.1 thousand tonnes in 2004-5 to 5501.1 thousand tonnes in 2010-11. If we consider the recent trend then the world crude steel production was near about 759 Mn tonnes, up by 8% YoY, during Apr-Sep 2011, while supply corrected by around 50 Mn tonnes on an annualized basis in Sep 2011 from its peak. On the same time the capacity utilization has fallen below 80%. The situation is likely to worsen further as the European and US steel producers have announced moderation/shutdowns in the light of weaker

note: Apparent Consumption of finished steel During last five years the apparent consumption of steel (production + importsexports +/- variation is stocks) of finished

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steel has increased from 38.11 million tonnes in 2005-06 to 65.61 million tonnes (Provisional) in 2010-11. The consumption of steel in India saw the highest growth in 2006-07 it grew by 30%, however, during the financial crisis, the growth in consumption of steel reduced to less than 0.5% in 2008-09. As the economy recovered from the global financial crisis, the consumption of steel was higher than the GDP growth, it grew by 13.34% in 200910 and 10.6% in 2010-11, while, countrys GDP growth rate was 8% and 8.5% respectively. As per the Ministry of Steel, the per capita consumption of steel has increased 19.5% in last four years. It increased to 55 kg in 2010-11 from 46 kg in 2006-07. During April to June 2011, the apparent consumption of finished steel registered moderation, it fell by the 1.5 to 17321 thousand tonnes in the first quarter of 2011-12 from 17512 thousand tonnes in the same period of last fiscal year. 10. However, it fell to 6798 thousand tonnes in 2010-11. The import of steel is also dominated by the finished steel. During 2010-11 India imported around 6798 thousand tonnes of finished steel. During the first quarter of current financial year, India remained as the net importer of steel. However, in the April to June 2011 the exports have increased significantly compared to the same period of last financial year. The exports of finished steel surged to 1074 thousand tonnes in the first quarter of 2011-12 as against 625 in the April to June 2010-11. It increased by almost 71.8% in April to June 2011-12. Import of finished steel had decline 52% in the April to June 2011-12. The imports of finished steel stood at 1326 thousand tonnes compared to 2760 thousand tonnes in the corresponding period of last fiscal.

outlook:
Since economic liberalization, the Indian steel industry has come a long way from negligible global presence in production and consumption. Currently, demand for steel in economy is growing by almost 10% and it is expected to increase by 12% in near future and to meet this demand for steel India needs to increase its production of steel by 10% to 15%. By the end of 2011-12, countrys steel manufacturing capacity is expected to reach around 90 million tonnes, and in the next financial year that is 2012-13 it is expected to reach around 110 million tonnes as the Brownfield capacity addition projects of public and private sector projects get approved. Indias steel production capacity is expected to reach over 150 million tonnes by 2020. Indias steel production capacity is going to increase manifold in the coming years. The current abysmally low per capita consumption of steel of 48 kg, compared to the world average of 190 kg, strengthens the argument that the domestic steel industry has a huge growth potential. The Parliamentary Standing Committee (PSC) on Coal & Steel on Demand for Grants (2007-08) of the Ministry of Steel in its 25th report had noted that to achieve this objective, it is necessary to create required infrastructure for steel industry as well as increase per capita consumption of steel. It observed that the biggest challenge in achieving the desired level of consumption is removing the wide disparity between urban and rural areas. The pace of steel expansion in India could be cause for alarm in some parts of the world, particularly the United States where cheap imports from China have been a source of contention for the industry. But currently Indias output is supplying mostly domestic needs, and the countrys political climate is much different than it is in China. Indian crude steel production is expected to grow at a CAGR of around 10% during 2010-2013. The governments proactive incentive plans to boost economic growth by injecting funds in various industries, such as construction, infrastructure, automobile, and power will drive the steel industry in future. The Indian steel industry will have multifold growth in the coming years, with iron ore requirements soaring to much higher levels.

trade:
The exports of steel and iron were stated in 1964 however the trade saw real growth of the opening up of the economic in 1991. In last 20 years dynamics and fundamentals have been changed with the rapid expansion of the economy. In last ten years the pendulum has shifted to import from exports. India was the net exporter of steel till 2006-07, however, after that the import of steel is dominating the external trade of steel. .
8000 7000 6000 5000 4000 3000 2000 1000 0

2001-2002

2002-2003

2004-2005

2006-2007

2007-2008

2008-2009

2009-2010

2003-2004

IMPORT OF IRON AND STEEL (In '000 tonnes) EXPORT OF IRON AND STEEL (In '000 Tonnes)

note: Export and Import of steel During 2001-02, Indias total export of steel was around 3000 thousand tonnes, which reached to its highest level in 5922 thousand tonnes in 2003-04. However, after that the exports of steel have been declining. In 2010-11 it stood at 3811 thousand tones, which is less than previous year due to moderation in exports of Pig iron and semis. Indias export of steel is mainly dominated by finished or carbon steel during 2010-11. India exported around 3461 thousand tonnes which is higher than the 3251 thousand tonnes in 2009-10. The moderation in Indias steel exports in recent past is mainly due to imposing anti dumping duties imposed by the advanced nations, which led Indian steel to lose its market share. On the same time, imports of steel has increased almost 6 times, during 2001-02 imports were just 1375 thousand tonnes which surged to its all time high levels of 7382 thousand tonnes in 2009-

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2010-2011

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STock rEcommEndaTIon
Tata Steel
Tata Steel is the worlds 10th largest steel manufacturer. It operates in more than 20 countries and has a commercial presence in over 50 countries. The company produces crude steel and basic steel products, and makes steel for building and construction applications through Tata BlueScope Steel, its joint venture with Australias BlueScope Steel. Tata Steels Q2 sales stood at Rs 8,212 crores ($1.68 billion) up 15.5% from the Rs 7,107 crores ($1.45 billion) of Q2 FY11 and up 4.5% from the Rs 7,860 crores ($1.61 billion) of Q1 FY12. Q2 sales from European operations were Rs 21,160 crores ($4.32 billion), up by 19.0% from Rs 17,787 crores ($3.63 billion) of Q2 FY11 and 3.0% up from the Rs 20,535 crores ($4.19 billion) of Q1 FY12. For the half year companys sales were up by 17.7% to Rs 16,072 crores ($3.28 billion) from the Rs 13,658 crores ($2.79 billion) in H1 FY11. The Groups steel deliveries in H1 FY12 rose by 1.8% to 12.17 million tonnes compared to 11.96 million tonnes in H1 FY11. Steel deliveries increased by 0.8% to 6.11 million tonnes in Q2 FY12 from the 6.06 million tonnes recorded in Q2 FY11. Tata Steels consolidated net profit fell 89.26% to Rs. 212.43 crore on 11.73% rise in total income to Rs. 32918.33 crore in Q2 September 2011 over Q2 September 2010. The companys performance was adversely impacted by higher global raw materials costs and lower average selling prices at Tata Steel Europe. Deliveries from Tata Steel India and NatSteel Holdings grew, whereas Tata Steel Thailands operations were affected by adverse weather conditions. Despite the slump in the European operation, both turnover and sales of the company were up and delivery volumes between July and September 2011 matched those of the previous period. The actions taken after 2008 to weather the financial crisis have strengthened the European operations ability to cope with market disturbances. But the companys Long Products business had lost money and the marketplace for its steel products continues to deteriorate further. Europe still remains the concern and the management expects EBITDA to be weaker in 3Q vs 2Q. However, its Indias combination of raw material security, operating efficiencies, high value products, and branding helps it earn EBITDA margins of 34-39%. The scrip is currently trading at Rs 381 and EV/ EBIDTA of 5.20 and P/E of 5.43, we would recommend a Hold in the stock despite so many issues and its exposure to the European markets due to its greater integration and relatively higher margins. of installed capacity. It is Indias No. 3 steelmaker in which Japans JFE Holdings owns about 15 percent. JFE is eyeing a larger chunk of JSW Steel hoping to take advantage of a steep fall in the share price and recently eased takeover norms. JSW Steel is one of the lowest cost steel producers in the world. It has established a strong presence in the global value-added steel segment with the acquisition of steel mill in US and a service center in UK. JSW Steel is actively looking to acquire steel companies in India with capacity for value-added products, as it looks to boost margins and expand its offerings. Late last year, JSW had bought a controlling stake in rival Ispat for $476 million, expanding its operations and taking its total steelmaking capacity up to 14.3 million tonnes. But that acquisition has hurt the company in the September quarter, During Q1FY12 JSW Ispat made a provision of Rs 12.5 bn towards towards diminution in value of investments, doubtful overdue advances and debtors and long pending material in transit which in turn has taken its toll on the profit numbers of the company for the second quarter. JSW Steel has been struggling on various other fronts too in recent months after it featured in a report on illegal mining by Karnatakas anti-corruption watchdog. It had to cut production at its Vijayanagar plant to 30% of capacity in September after the Supreme Court limited iron ore sales in Karnataka to online auctions; production revived to 50-60% a month later. There is e-auction going on in Karnataka and JSW Steel is likely to secure the majority of the iron ore from e-auctions as the iron ore being auctioned is majorly of lower grade. However, iron ore situation in Karnataka is likely to improve going forward, even if the supply issue is resolved it will take off much pressure from the margins of the company. During Q2FY12 JSW Steels standalone net sales increased 32.1% YoY to Rs 7630 crore on account of sales volume growth and higher steel realisations. During the quarter, there were mark-to-market foreign exchange losses of Rs 1000 crore. JSW Steel has entered into an equal joint venture (JV) with Japans Marubeni-Itochu Steel Inc. to set up a steel processing facility in north India. JSW Steel currently has only one service centre at Vijayanagar in Karnataka and has been steadily moving into the higher-margin auto grade steel for some years now. The joint venture will give it access to both the technical expertise and the experience that Marubeni-Itochu has in high-end and specialty steels. The stock is currently trading at Rs 568 and an EV/EBIDTA of 4.38 and P/E of 7.10x, we will consider a HOLD in the stock and buying at dips considering slowdown in global demand and various challenges ahead.

JSW Steel
JSW Steel is the largest private sector steel manufacturer in terms

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