CLSA Downgrades Tata Steel and JSW Steel Despite Rising Volumes

In a surprising turn, despite experiencing significant volume growth, Tata Steel Ltd. and JSW Steel Ltd. have been downgraded from 'buy' to 'sell' by the brokerage firm CLSA. This decision comes amidst forecasts of robust capacity expansion over the coming two years which is anticipated to drive strong volume increases for these steel majors.

Profit Shift from Steel Mills to Miners

India's steel sector is undergoing a significant transformation. Over the next three years, as blast furnace-based steel production sees a rapid increase, the profit pool is expected to shift from steel mills to miners. This change is anticipated due to supply exceeding demand growth and an increased reliance on exports, potentially leading to domestic steel prices not exceeding import prices. Additionally, with this production uptick, the demand for iron ore and coking coal is set to rise, but the scale-up of captive mines might not suffice, especially amid growing exports.

Current Valuations Misalign with Sector Norms

Historically, the steel sector has presented favorable investment opportunities during periods of trough spreads combined with low valuations. Surprisingly, current valuation multiples of Indian steel firms have increased while steel prices and spreads have seen corrections. These valuations are buoyed by optimistic demand forecasts and expectations of economic stimuli from China, alongside generally high valuations in the Indian market. However, with spreads declining recently, current valuations may not be justifiable given the consensus that future profitability could be on par with or exceed recent quarterly performance.

The Role of China's Economic Stimulus

China's demand dynamics play a crucial role in dictating the market spreads. An enduring high demand within China, resulting in increased spreads, would be the ideal scenario for Indian steel manufacturers due to the nation's self-sufficiency in iron ore. Yet, should China's production remain high amidst a lull in demand, it could lead to prolonged periods of lowered spreads. CLSA warns of this dynamic as a potential risk for the Indian steel sector.

Steel, Downgrade, CLSA