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Steel industry on the path of a deeper decline

Global demand remains weak due to an uncertain economy, putting pressure on the profit margins of steel makers

Posco, a South Korea-based company, Asia’s third-biggest steelmaker and the world’s fourth-biggest steel producer by 2011 output according to rankings by the World Steel Association, cut its 2012 sales forecast for the third time this year after quarterly profit missed analyst estimates due to a poor demand and decline in prices. Standard & Poor’s Ratings Services (S&P) also cut Posco’s rating. S&P expects Posco to encounter continued tough steel industry conditions in the region over the next 12 to 18 months as a result of slowing demand amid significant overcapacity.

Macroeconomic uncertainties make it unlikely that the global slowdown in demand for steel will turn around quickly. The recovery is expected to be delayed as the global economy remains gloomy due to fiscal crisis in advanced economies.

This is the case with other companies of the same sector in India, as well. The steel industry’s profitability, which had risen sharply from FY04, is on its way down, according to a recent report from Credit Suisse. In the past eight years, there has been a remarkable surge in mining as well as smelting operating profits, but pressures have emerged on both smelting and mining profits, and are likely to continue going forward. There has been a remarkable surge in iron ore and coking coal prices, which seems to be unwinding now. The slowdown in the Chinese economy and the debt crisis in Europe have restrained the demand growth and profit margins have declined.

As per the Credit Suisse report, over the past years the dramatic increase in profitability was due to cheap raw materials, either through direct ownership (e.g., SAIL and Tata Steel), or just geographical proximity aided by tariff barriers (most Indian steel makers). For Indian firms smelting margins were weak despite import duty protection, and Free Trade Agreement (FTA)-related imports have now brought domestic prices closer to international benchmarks, says the report. Indian steel equities are down, but are not cheap and with rising leverage below the operating line, run the risk of book value erosion.

“In the last four years, however, steelmaking margins, or smelting margins have come down sharply, hurt by the erosion of end-demand, and the lagged commissioning of capacity increases planned during the period of shortage. Over the past few months, as iron ore and coking coal prices have crashed, there are fears anew about the impact on the steel industry of the Chinese economy moving away from investment, and towards consumption.,” says the report.

The sheer scale and growth of Chinese steel demand was the root cause of the remarkable rise in iron ore and coking coal prices over the past five to six years. This is because supply takes a while to come up. The premium of steel prices in India over global prices has started to erode so much so that even without the import duty impact, Indian prices are barely higher than global prices. This has a structural implication on steel company profitability in India.

The report mentions that the Chinese steel production is unlikely to fall from current levels and growth is likely to be slow going forward, as it has been for the past few quarters. Further, the pressure on utilisation keeps rising because of steady commissioning of new capacity. In the past few years Chinese regulators have reacted to surging exports by raising barriers, the agenda being to keep steel prices low so steel-using industries (e.g., heavy machinery, ship-building) could become more competitive globally. This time, however, the need to maintain high utilisations may supersede such concerns.

Worryingly, domestic oversupply concerns are still real and can only further hurt local profitability. The reset on Chinese demand growth expectations have hurt raw material prices, and the continuing capacity growth is creating an overhang on already weak smelting margins. Despite some of the highest steel prices globally, smelting margins for Indian firms have been disappointing.

Steel creates its own demand, this combined with the fact that given its permanence, especially in its use in heavy infrastructure/real estate, there can be long periods of ‘digestion’ of steel use, causing a demand downturn. From a pricing perspective, there is a non-linear impact—when regions with a concentration of raw materials start to see a surge in economic activity, costs start to go up (currency, wages, other operating costs), pushing up the cost curve sharply. When this reverses, the cost curve deflates as rapidly.

Credit Suisse expects that in early years the decline in per-capita steel use globally going forward may not be steep, but even a flattening of demand could have a disastrous effect on both smelting and mining margins of steelmakers.

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    Lupin records 25% growth in net sales despite challenging conditions in US and Europe

    The 3rd largest pharma company in India recorded yet another strong quarter and has managed to expand business in Europe despite challenging conditions

    Lupin, the fifth largest and fastest growing generics player in the US and third largest company by sales in India, reported good earnings results for the quarter ended 30 September 2012. Its net sales were up 25% year-on-year (y-o-y) at Rs1,754.48 crore. This was particularly helped by an increase in US sales, which grew from $122 million to Rs144 million, an 18% growth. Despite recession in Europe, it managed to grow its business by 36%. Its operating profit grew 37% y-o-y from Rs348.98 crore to Rs478.18 crore. Its net profit grew slower, at 20% y-o-y to Rs321.94 crore.
    According to the Moneylife database, we found out that Lupin had been growing at a really high trajectory in the past three quarters. For instance, its average y-o-y growth rate in net sales in the last three quarters (including the reporting quarter) was 35% while its operating profit y-o-y growth rate for the same period was far higher at 134%. However, this quarter, both have come down to a quite a bit. It remains to be seen how much longer they can sustain this impressive run of numbers. The company is quoting at a market capitalisation of almost 13 times its operating profit, which is slightly towards the premium side and a return on equity of 31%. 
    Material costs, salaries have increased, but not much. Material cost increased by 5.4% while salaries increased by less than a percent. This shows the commitment of controlling cost by the company. Capital expenditure stood at Rs127.70 crore during the quarter. Commenting on the results, Dr Kamal K Sharma, managing director, Lupin, said “We have had a record first half, driven by strong operating performance and sustained growth across all our business segments. Our growth momentum continues.” However, challenging conditions in US and Europe continue to remain and the company’s operating working capital cycle has increased to 87 days from 78 days. If the conditions worsen, this number could worsen.
    During the quarter, The company received approval for three products from the US Federal Drug Administration (US FDA). One is to market a generic version of Teva Branded Pharmaceuticals (Teva) Nordette Tablets, an oral contraceptive for the prevention of pregnancy in women. The other is to market Irbesartan, an angiotensin II receptor antagonist for the treatment of hypertension and nephropathy in Type-2 diabetic patients. 
    Lupin also filed two ANDAs during the quarter. Cumulative ANDA filings with the US FDA now stand at 178 with the company having received 65 approvals to date. The third US FDA approval is the generic version of Forest’s Lexapro Tablets used for acute and maintenance treatment of major depressive disorder in adults and adolescents.
    The company is a significant player in the Cardiovascular, Diabetology, Asthma, Paediatric, CNS, GI, Anti‐Infective and NSAID space and holds global leadership positions in the Anti‐TB and ephalosporin segment. 
    The stock closed down 1.25% to Rs562.70 on Bombay Stock Exchange (BSE) today.
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    Chidambaram wants specific proposals for general insurance business

    Insurance industry representatives are pitching for de-tariffing of motor insurance, development of pricing mechanism for health insurance business and lowering of the MAT

    New Delhi: Finance Minister P Chidambaram has asked general insurance companies to come up with specific proposals so that the government could take measures to increase penetration of non-life insurance business which is at present estimated at less than 1% of GDP, reports PTI.
    "We will get back to the Ministry within the week with specific proposals for boosting general insurance," said the head of a public sector insurance company after the meeting of industry representatives with the Finance Minister.
    To increase penetration of general insurance, Chidambaram has asked CEOs of public and private sector companies to provide suggestions for removing impediments that hamper growth of the sector, said an official release.
    The industry representatives during the meeting raised various issues with regards to taxation, loss-making motor insurance business and health insurance, the public sector insurance company official said.
    He added the Minister wants them to come up with specific proposals.
    Among other things, the industry representatives pitched for de-tariffing of motor insurance, development of pricing mechanism for health insurance business and lowering of the Minimum Alternate Tax (MAT) on the sector.
    "Our (general insurance) penetration rate is low. It is 0.7%. How do we improve it to average standard which is 1.5 to 4%? The road map is to be prepared by all of us," Financial Services Secretary DK Mittal told reporters after the meeting.
    The basic agenda of today's meeting was to work out ways to increase penetration of non-life insurance and promote financial inclusion, Mittal added.
    Chidambaram had earlier in the month held similar exercise with representatives of the life insurance industry with a view to boosting the sector.
    The major challenge before the industry, Chidambaram said in his remarks, was to increase reach to maximum number of people along with growth of investment in the sector.
    Later, talking to reporters, Bharti AXA General Insurance CEO Amarnath Ananthanarayanan said there was a general feeling that a lot is needed to be done to promote non-life insurance sector in the country.
    Among other things, he said, low profitability was also hampering growth of general insurance business in the country.
    "...things hindering the growth of insurance sector is lack of profitability among the general insurance companies," he said, adding the government would also need to pursue legislative changes which are awaiting Parliamentary approval.
    The government's decision to raise foreign investment in insurance from 26 to 49% cannot be implemented without amendment to the Insurance Act. The amendment bill has been pending in Parliament since December 2008.
    The general insurance industry is facing losses mainly due to high claims on third party motor insurance pool and high cost-to-claim ratio in the health insurance sector. The ratio was as high as 140% as on June 2012.
    It was pointed out that motor vehicle insurance, which accounts for 41% share of non-life insurance business, faces major challenges because of regulated tariff, unlimited liability and non-jurisdiction restriction for filing claims.
    The industry suggested de-tariffing of motor insurance and a cap on liabilities of insurers. Suggestions were also made for improving penetration of home insurance business.
    Industry also requested for hike in service tax exemption limit and removal of TDS on payment of reinsurance premium by insurance companies.
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