Companies & Sectors
China faces massive steel oversupply

China’s steel trade body fears a rapidly worsening situation in the December quarter and early 2010

While Indian steel stocks are rallying, China Iron and Steel Association (CISA) has warned that oversupply is the major problem that the Chinese steel sector would need to confront. The trade body expects the situation to worsen in the fourth quarter and in early 2010. Steel is a globally-traded commodity and overcapacity in China is bound to lead to lower global prices and pressure on Indian steel companies.

According to CISA statistics, the steel inventories of 26 large and medium-sized cities totalled 11.13 million tonnes (MT) at September 2009, up 5.3MT or 90.9% from the beginning of this year. Further, the 68 large- and medium-sized steel enterprises’ steel and billet steel inventories totalled 11.55MT at September’s closing, up 1.44MT or 14.26% from the beginning of the year. Of the 70 large- and medium-sized steel enterprises, 10 suffered losses in the first nine months as compared to seven in the same period last year. China’s crude steel output was 420.40MT, up 7.5% year-on-year over the first nine months of this year, up 29.37MT. China’s current steel capacity is around 600MT per year, with around another 58MT per year under construction.

Meanwhile, the entire year’s output is estimated at 550MT, up 50MT or 10% from 2008. In the first nine months of this year China imported 1.37MT of crude steel as compared with the 39.47MT of net exports in the same period last year.

As total net crude steel exports reached 47.63MT for the entire 2008, some 47MT will be shifted from the international market to the domestic market. China’s apparent steel demand rose 20% year-on-year in the first nine months, to 421.8MT, mainly driven by the government’s expansion of fixed asset investment, and the growth is predicted to sustain into the fourth quarter and early next year.

China has also imported 1.005MT of stainless steel in the first nine months, up by 4.3% year-on-year and exported 4,76,800 tonnes, down by 45.5% year-on-year. During January 2009 to September 2009 the Chinese stainless steel output was 6.569MT, up by 37.5% year-on-year.

As per reports, the output growth of crude steel and the change in imports and exports would bring the supply of crude steel in the Chinese market at 20% above last year’s figures. In October 2009 alone, Chinese crude steel production growth has sharply grown by 44% year-on-year to 51.75MT.
—Swapnil Suvarna [email protected]

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‘We will continue to focus on improving our cash margin’

Shopper’s Stop reported a significantly higher profit in Q2. Govind Shrikhande, president and CEO, explains to Pallabika Ganguly how he did it. Here is the second part of the three-part interview.

ML: What is the future of organised retail in India? Do big brands see value in this segment?
GS:
Organised retail has only grown to 4% of the market and our main challenge would be to take it to higher levels. Despite huge investments by retailers, organised retail is not going to grow to 15% of the total market over the next five years. At best, it can reach 10%. Over a period of time, big brands have to understand that they have to protect and support the large-scale organised retail sector in a different manner. They will have to help organised retail to drive their top-line so that they make sufficient margins to survive. According to me, it is going to be a battle of wits (between organised retail and big brands) and over a period of time, when both understand each other, things will settle down. In this business, size does matter. When you are dealing with a big company like, say, Hindustan Unilever Ltd (HUL), we may not have leverage. But when an organised retailer of the size of Wal-Mart deals with any company, they naturally have a lot of clout. Secondly, product prices in India are comparatively lower than in international markets. That is the reason why manufacturers want to control pricing. A manufacturer like HUL does everything to promote its products and it enjoys a high operating profit margin (OPM) on the strength of its distribution network. But manufacturers do not want to pass on even a small portion of their OPM to retailers.

On the other hand, we have to generate good margins and then increase sales throughput. A retailer has to focus on maximising sales growth, generating maximum cash margin from the occupied space and controlling overall costs.
Many retailers have cut costs and are doing well now. As the economy starts improving, same-store sales will improve, and then we can look at how to drive higher cash margins through better inventory management and trading models.

ML: What kind of trading models are you looking at?
GS:
Over the past two quarters, we have changed our trading model. Earlier, we used to invest about 58% of our capital in buying. I brought it down below 50%, so the 8% consignment concession that we managed to get helped us to reduce our working capital, interest and manpower costs. In our Q2 results, as you can see, the percentage (operating profit) margin hasn’t risen, it has actually dropped by 20 basis points—but at the same time, our cash margin has increased significantly. This was possible because we were able to manage the matrix between the models of merchandise versus the margin.

ML: Shopper’s Stop’s same-store sales moved back into positive territory with a growth of 1.8%. Do you think it will continue over the forthcoming quarters as well?
GS:
We should report good growth in same-store sales over the next two quarters due to the ongoing marriage and festival season. However, it is difficult to predict numbers. I do not expect high, double-digit numbers which we used to witness earlier, but I think we should see single-digit growth in the coming quarters. We are also expanding rapidly. Last year, we opened our first store in Hyderabad and it was followed by another one in May. Last month, we opened our third store in the city. So, in a way, you can say we are trying to grow 100%, but at the same time you cannot expect the market to grow at the same level.

ML: Your gross margins remained flat on account of a decline in your private-label mix and higher sales of branded products. What is your strategy on private labels?
GS:
We have mentioned that during Q3FY10 and Q4FY10, we will continue to focus on cash margin rather than percentage margin because we are still not trying to drive the share of private labels. We will try to push private labels along with exclusive launches only in the next financial year. Unless overall sales rise dramatically, there is no point in increasing stocks at your end. With private labels, you have to pile up stocks. Next year, you will see some focus coming back to private labels. We have plans to reinvest in private labels. Next year should be a great year for private labels. In any case, private labels constitute only 18% of our sales mix right now, which clearly shows that we are not trying to compete with any big brands. We have plans to extend private labels to only 20%-22% (of our total product mix) by the next financial year. For us, private labels are a niche segment which supports existing brands or where no major brand is present—like women’s ethnic wear. In the case of some of our competitors, 80% (of the total brands on offer) are private labels. So, we are not in that category. We are not going to copy & paste somebody else’s design and rename it as our own brand.

ML: Interest cost continues to remain on the higher side in retail. What is your plan to combat this situation?
GS:
During the second quarter, our interest cost was flat and we should be able to hold it at that level. We don’t see it going up; if you see our current ratio, we are currently under 1x in terms of debt-to-equity ratio. We should be able to maintain this level.

ML: What are your expansion plans? And how would you manage your expenses while expanding?
GS:
When you take a property totally on rent, for the initial 12-14 months you cannot expect robust business. This can be termed as the ‘testing’ period. So, if after some 18 months the business does not ramp up, you end up with huge losses if you are on a high rental base. So, the most important step we took was to take new properties mainly on a revenue-sharing basis (about 5%-7%), with a lower rental component. As the rent is capped, I can save on my expenses. Today, I spend about 35% of my total expenses on rentals. So, if I can bring it down to around 10%, it is a huge saving for me. A business risk also goes away. In some of our existing properties, I was able to get rid of the escalation component in rent. Some of these lease contracts had an escalation component of 10%-12% for every three years. I negotiated with some of our landlords and was successful in waiving the escalation component for this year. So, my occupation cost will remain flat even as my sales go up, and so my occupation cost as a percentage of sales will drop. I think this is the key methodology by which you can work around the escalation component. Our occupation cost in Q1 and Q2 was 11% of sales. Every 100 basis points drop in occupation cost adds directly to the EBITDA.

In the first stage of our expansion plan, Shopper’s Stop will reach 30 additional cities and we will be opening about 60 new stores over the next five-six years. In December 2009, we will open our stores in Ahmedabad and Amritsar. By March next year, there will be another store in Bengaluru. We are also planning to open new stores in Coimbatore, Vijayawada, Visakhapatnam and Durgapur. At Kochi and Vadodara, we are still scouting for good locations. Currently, we are present in 12 cities and we are working towards reaching 14 cities more within the next three years.  

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