Much has been said about the need for packages for reviving the manufacturing of iron and steel products businesses in the country. There are various reasons ascribed to the stress that one sees in this industry. Reasons vary from low priced imports from Chinese peers, high input costs like power prices, reasonably priced coal and iron ore, lack of availability of adequate bank credit, high interest costs, etc.
So if we are talking about changing the fortunes of businesses in this sector (manufacturing of iron and steel products) one will have to address these issues in any case and then other local or specific factors could be also put into the viability equation for determining the likely prospects of a specific business. I am sure everybody will agree that only businesses which make money have a future; others will face certain closure (willing or induced).
It is important to understand the above issues. Since iron and steel industry is one of the basic materials industries, it is very important for this industry to remain healthy for sustaining a long term growth in an economy like ours (India). Availability of iron and steel products at competitive prices is extremely important for the success of many key industries and sectors like infrastructure, defense, housing, capital goods, automotive and engineering sectors. Suffice it to mention that structurally, this sector’s viability is very important from a strategic perspective for India to remain a self-reliant and healthy economy. More so, when one considers that India has abundant reserves of natural resources of basic raw material inputs (coal, iron ore and man-power) for being a competitive manufacturer in this sector.
Rising Protection and Large Structural Imbalance of Capacities in the World
It is fairly well documented that steel manufacturing capacity in the world is ~2 billion tonnes annually and of the same, ~1.3 billion tonnes is in China. Capacities are being snowballed in China gradually and the pace of such closure is being determined by the Chinese government. It is not going to go away fast and one has to live with the fact that there is likely to be a situation of oversupply of steel products in the world and therefore there will be a rise in protection policies by different countries. Most large steel manufacturers in Europe and US are not making enough money to justify large capital pools invested in them and for this reason one gradually sees industry being relocated to lower cost manufacturing regions or being heavily subsidized by the state just to maintain jobs as alternate jobs are not available and large communities are dependent on survival of these industries. The social impact of closure of such businesses in these regions is deemed to be very high on the local governments. This is also not going to change very soon.
The interest rates in India have come to a level where any significant downward movement is less than likely hereon. Whether we talk about term lending interest rates or working capital borrowings, average interest rates in India for a large corporate like JSW/Tata Steel would be about 10% and for mid corporates would be about ~14%. Well capitalized and efficient players in the mid-corporate level would be having effective interest rates of about 11-11.5%, which is a clear advantage that these units are enjoying to remain viable for the mid to longer term. The goal for most borrowers in this sector therefore would be to structure their borrowings to a level where average borrowing costs are contained to a certain metric depending on the stickiness of their customers and also the level of value added products that they produce from their operations. Key aspects of evaluation of business risk would be the level of indebtedness and risk profile of the business as gauged from stickiness of its customers, and portion of value added captured by the enterprise in the overall value chain of conversion of ore to finished product.
There is significant amount of stress in the sector. There are some key macro factors that have contributed to this situation, having gradually evolved in the past 2-3 decades. Some individual units have been able to recognize these aspects and have weathered the storm reasonably well and therefore, these businesses have become clear leaders. Others who could not cope with the changes around them lagged and high levels of indebtedness are clearly pushing them further down the proverbial barrel to bite the bullet of sale or get merged. It needs to be mentioned here that some of the principal factors at the macro level that have a bearing on the fate of a business are not going to change significantly overnight.
Long Term Outlook for the Steel Sector in India is considered to be Favorable
Given the favorable macro-economic environment one would therefore have to drill down to the level of viability assessment of individual sectors and units in the sector and analyze what kind of path will the businesses need to follow to make them reach decent levels of competitiveness. Such that their survival capability is not questioned on a quarterly basis by key stakeholders.
Industry Moving towards Consolidation
The industry would definitely move towards consolidation and the number of players would come down so that the individual units have some kind of pricing power vis-a-vis customers or input suppliers. We are witnessing the same situation in most industries. Case in point is cement, where capacities are getting consolidated among 4-5 large players pan India. This is largely to maintain reasonable margins on sale of cement. Most players are targeting increase in sale realization per bag of cement. And one may notice that most input costs for manufacturing cement remain constant. Here too we are talking of a commodity business where large capex is involved and there is not much of differentiation at the product level, therefore size and distribution strength matters to bring in economies of scale. Another case in point is the telecom industry, which is also going through a phase of consolidation. The number of important players is gradually reduced from more than 20, pan-India, to now less than 10. Everybody is targeting increasing share of ARPU (average realization per user and increasing the user base). The point is players are realizing that to bring in efficiency and consistency of return on capital employed, one has to become an industry leader in some aspect (quality/cost) and keep on increasing scale. This, therefore, creates a distinct barrier to entry over time and therefore value for the incumbent. Hence, it is gradually becoming a business where focus and strategic thinking is becoming increasingly important, and unless one has a long term orientation, one does not see a visible path for making money consistently and therefore the future of the unit in question appears bleak. To achieve that level in business, one has to invest in achieving a reasonable scale, efficient operations, consistent performance and sustained engagement with customers. In effect, shortcuts won’t work and only committed players will be able to create value for themselves and their stakeholders in such businesses.
M&A opportunities will be available and accessible only when the acquirer sees a path to make money from an acquisition opportunity and have a decent return on capital employed. Unless one is able to put forth so convincingly, there will be no foundation for an M&A to be workable. So effectively, a running assets and cost of putting up a business etc may be relevant arguments but they are not sufficient to determine fair value. The most important parameter in such situations would be really an ability to make money from such opportunities over a reasonable period and a reasonable measure of the same on a risk adjusted basis. A seller has to be very clear that a business asset is bought only when it has an ability to generate returns in a defined time frame. The buyers and sellers have to take stock of such issues at a hard level and debate them within the ownership group so that realistic solutions are achievable. The same principles are applicable on other important stakeholders like banks/lenders/ARCs who are in fact today controlling the destiny of many important assets in this sector. If timely decisions are not taken, it is a real possibility that valuable capital may be permanently destroyed. That will be a loss not only for the key stakeholder or the owner but a collective loss for the nation.