The steel industry in India.
Contents
Introduction 2
Recommendations 4
Company initiatives 4
Short Term Recommendations 5
Long Term Recommendations 6
Alternatives considered 7
Plan for Implementation 7
Timetable 8
Contingency plan 8
Conclusion 9
Annexure 1 10
Industry Structure Analysis 10
Annexure 2 17
SWOT analysis 17
Strengths 18
Weakness 19
Opportunities 20
Threats 21
Annexure 3 22
Industry Outlook 22
Annexure 4 28
Company Initiatives 28
Annexure 5 31
Analysis against competitors 31
Annexure 6 33
Key Ratios 33
Annexure 7 35
Budget (2002 - 03) Implication on Steel 35
Introduction
The steel industry in India is going through a difficult phase. There is excess capacity in the system and that has been the case worldwide, leading to a fall in prices. The international prices remain volatile and the excess capacity is estimated to be 80 million tonnes. India is the eighth largest producer of steel and it currently has an excess capacity of 4 mtpa. Over the last 10 years, the worldwide CAGR has been at 3.2% and in India it has been 6.9%, thanks to the general pickup in the economy post liberalization. This period also saw the entry of many private players including Essar Steel Ltd which is studied in this report.
The Indian steel industry is plagued by the following problems:
* Excess capacity of 4 to 5 mtpa.
* Sluggish growth in the domestic market.
* Restrictive Trade policies affecting exports to the US and the European Union
* Declining international prices and high volatility leading to low price realizations
* Reducing cost competitiveness due to poor labour productivity and high expenditure on power, fuel and freightage even though India has the advantage of cheaper labour.
* Adverse capital structure of most companies leading to high financing costs that in turn is the reason for the companies maintaining high operating levels to service interest burden and reduce per tonne fixed cost. This is not helping the situation of glut in the market.
* Steel imported for the purpose of value-addition should be re-exported in the form of consumer products within 18 months. But many of the imported items find their way into the local market.
* Cost disadvantage due to locations: The proximity to raw materials and the policy of the government has led to many players being concentrated in east India while the major consumption centers are in south and west India. This has put most companies in a difficult situation with increasing freight costs.
* Declining duty protection by government has increased the difficulties.
* Attitude of financial institutions: FIs are very cautious in lending to the sector given the recessionary trend faced by the sector.
On the whole the industry is unattractive. Refer to Annexure 1 for detailed industry analysis.
Essar Steel Ltd is a relatively new company that was established post liberalization. The company has been successful in reducing costs and is one of the low cost producers of HR coils at the operating level. It is also the largest exporter of HR coils. Essar exports 42% of its total sales volume and holds an 8.2% market share in the domestic market. Refer to Annexure 2 for detailed SWOT analysis.
The per capita consumption of steel in India is way below the world average (Indian - 25 kgs; world - 121 kgs; China - 87 kgs; South Korea - 830 kgs). This projects a huge potential in the Indian market in the years to come and indeed the excess capacity is expected to be wiped out in the near to medium term. Exports showed a strong growth in FY2000 but were stagnant in FY2001 and declined marginally in FY2002. Several other global markets may get closed since countries may retaliate against the US move by imposing restrictions in their domestic markets. The domestic demand will be a function of the growth prospects of the end user sectors like construction/infrastructure, consumer durables and automobiles. The outlook is hence not very bright. Refer to Annexure 3 for industry outlook based on CRISIL and ICRA industry reports.
Recommendations
The company has taken a number of initiatives to improve its performance. Refer to Annexure 4 for an elaboration of the company initiatives.
Company initiatives
* The company has successfully restructured most of its debt
* Technological and process improvements has led to a saving of 6% over the previous year
* Natural gas contract with Gujarat state petroleum corporation and GAIL has reduced its Naphtha intake and this has led to lowering of energy costs
* The company focuses on high value added products that command a premium and also result in better realizations
* A CRM module for order and despatch status has been implemented to ease interactions with customers and the Group also has an internet venture clickforsteel.com, the online steel portal for Asia.
* Co-branding with Kirby building systems and Essar 24 carat steel has led to some brand consciousness
* New product development has resulted in at least 6 new product enhancements which the company plans to commercialize
* To improve distribution, Web enabled distribution centers have been setup and an experimental foray of two centers in ahmedabad has been initiated
* Many energy conservation measures have been undertaken successfully
* Export focus on Iran, Iraq and China due to increased tariff barriers for exporting to the US
* Reduction of freight costs by opting for Pipavav port for inbound and outbound freight movement, and by introducing articulated barges that will integrate operations that bring in raw materials and export HRC.
Short Term Recommendations
There is a need to make the company profitable, cut finance costs and increase capacity utilization. The company has been making a loss for the past four years. This is largely due to its high leverage and the subsequent finance costs and high depreciation. The following are the short-term recommendations. Refer to Annexure 5 for analysis against competitors over various factors.
For the following analysis, refer to Annexure 6 for key ratios of various companies wherever necessary
* Fine-tune Inbound Logistics to release working capital from raw material inventory. Currently the Raw material turnover ratio is 158 days while for TISCO it is 69 and the average is 75. This can be done by looking into its pellet procuring and storing systems
* Reduce finished goods inventory through establishment of Steel Service centers by incorporating build to order rather than build to stock. Refer to Long-term recommendations for steel service centers
* Distribution in small towns and rural areas and other consumer regions to improve domestic sales using Steel Service centers. Around 71 per cent of Essar's domestic sales are in the western region, 23 per cent is in the northern and eastern region and 6 per cent is in the southern region. The market share can be increased in the south by careful thrust in distribution.
* Currently 52% of the company's sales come from domestic sales, which constitute 8.2% of the market. Focus on more domestic share as the realizations are better and the capacity utilization can be increased. For this apart from value added products, the company should not abandon the standard products, which it is doing now and hence its sales has shrunk.
* More Branded products in the lines of TISCOs branded galvanized sheets and corrugated sheets etc for aggressive marketing. The company has Essar 24 carat steel. More products in the flats segment can be brought out.
* Maximum capacity utilization to improve efficiencies and spread fixed costs
* Minimizing freight costs by using more of sea transport and concentrating on markets that are close.
* Proactive and aggressive management to implement the many recommendations.
Long Term Recommendations
The outlook for the steel players over the next 3 years is positive. The excess capacity is expected to be wiped out and growth rates will increase with a recovering economy and a supportive budget. For a treatment of the budget with regard to the steel industry, refer to Annexure 7
Essar should be in a position to exploit such a situation. The following recommendations are made with such an orientation.
* Focus on domestic market must be increased to take advantage of the higher realizations. Further domestic markets are more stable given that the exports are under pressure due to tariff barriers. The company is in a strong position in exports and building on the domestic market can help maximum capacity utilization and better profits.
* Establishing new chains of distribution for increasing reach and streamlining outbound logistics. The proposed steel service centers will take orders from customers and will have their own slating and shearing machinery which helps them fine tune the length and other physical properties required by the customer. The company will be busy producing standard grades for supply to the service centers. This is a very successful concept followed by American companies. This also increases operational efficiencies because the task of separating various grades is being pushed to the service centers.
* Long Products thrust. India is poised to face a big demand in infrastructure. Long products are used in infrastructure. The company could boost its sales by producing Long products that it is lacking now.
* Forward integration with CR and galvanizing facilities to save on energy like TISCO. The company is very competitive in HR coils. Integrating it with CR mutually reinforce its CR products range.
Alternatives considered
* Mini mills: These have been successful in the US, but in India it is not viable because these mills use scrap metal and are situated near large consumption centers. India has to import scrap metal and it is hence not viable.
* Capacity increase: The current glut in industry and the huge investments required make it a non-viable route. The companies are expected to focus on de- bottlenecking and process efficiency gains to increase output.
* Divest: Since most of the companies are highly leveraged, the return on equity is negative. Also the prospects are not that rosy. It would not be possible to find investors for this option
* Equity funding: The company is in a precarious debt equity position with leverage of over 6. Equity capital at this time is very attractive but there will simply be no investors. The bonds are junk status and equity will not move.
Plan for Implementation
For the short-term recommendations, a core team should be formed for each implementation. The teams will obviously have specialists from each of the function that the recommendations aim to correct. The execution of these will take up management time but will not tie down resources. Hence these are more of a managerial tweaking and do not require investments or will require minimum investments. The aim is to remove the inefficiencies and bring Essar on par with the best companies are at least to the industrial average figures. This will release a lot of working capital.
For the long-term recommendations, the Steel service center concept must be integrated with the company's plan of increasing distribution centers and web enabling them. Some more investment will be required but it will not be much as shearing and shafting machines are not expensive. Domestic market focus is a marketing and distribution execution and the existing capabilities are sufficient. Integrating CR requires substantial investment and can be done only after the company starts to make net profits.
Timetable
The short-term recommendations should be implemented in parallel and aggressive management focus should make it possible to complete ...
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For the long-term recommendations, the Steel service center concept must be integrated with the company's plan of increasing distribution centers and web enabling them. Some more investment will be required but it will not be much as shearing and shafting machines are not expensive. Domestic market focus is a marketing and distribution execution and the existing capabilities are sufficient. Integrating CR requires substantial investment and can be done only after the company starts to make net profits.
Timetable
The short-term recommendations should be implemented in parallel and aggressive management focus should make it possible to complete in six months. The more involving and investment requiring initiatives can take up to one year. It is essential that the company move fast to ride the next cycle of demand improvement.
The most important long term initiative of "Steel Service Centers" should begun immediately and must be integrated with its current plan of increasing distribution centers and web enabling them. This would take around two years to completely implement the concept in its existing centers and new centers that will be started.
Forward integration of CR with HR is a capital-intensive technological change that should be carried out only after the company's balance sheet becomes healthy. Thrust on long products will help the company ride the budget signals of increasing infrastructure expenditure.
Contingency plan
If the industry outlook by various organizations does not work out, the company would be in the same situation for years. Slow turnaround in the steel industry would pose significant problems. The recommended strategy is the best option to improve efficiencies and release working capital from the system. Since the initiatives do not require significant investment, the company stands to benefit regardless of the movement of the industry.
In an extreme situation, the company can consider reducing its workforce and cut down capacity. It can divest its power company and use the proceeds to wipe off some more debt from its balance sheet.
Conclusion
Even though the industry is in a precarious situation, Indian companies have an inherent advantage due to their low cost of labour, high quality iron ore and a large domestic market. As demonstrated by the competitor analysis, many companies are well below average performers in terms of logistics and other factors that can be eliminated through good management. Many companies already are operationally the best world over. With some help from the banks and financial institutions to restructure their debt, we will have a strong industry making decent profits.
Annexure 1
Industry Structure Analysis
Over the last few years the performance of the Steel Industry has been adversely affected due to overcapacity, cheap imports, economic slowdown, declining global prices and also anti dumping duty imposed by the USA on imports. Most major steel companies have been reporting losses. Internationally, the scenario has been the same. Many steel companies are in the red and governments are increasingly imposing tariff barriers to protect their own industries. The analysis of the industry using the Porters five forces model follows:
Rivalry in the industry
> Large integrated players dominate the industry. Some of these producers are located close to the source of inputs, while some are located with an orientation towards exports.
> From 1998, the finished steel consumption growth in the Asian market has remained steady at around 8.5%. However the American and other markets have widely oscillated from positive to negative growth.
> The fixed costs are very high and the capacity addition is chunky.
> There is no differentiation between the different products.
> The terms of the sales are tracked and published worldwide.
> Some players are highly diversified. Strategic stakes are high due to the high investment in the business and also due to the fact that India represents a huge market that will ripen with time.
Rivalry among Competitors
Attractiveness
Remarks
2
3
4
5
No. of Competitors
Large no of competitors.
Industry Growth
Growth in Asian markets and India.
Fixed Cost
Very high fixed cost. Even the new mini plants have high cost.
Differentiation
No differentiation between products
Openness of Terms of Sale
Sale terms are open. Market prices are published and tracked worldwide.
Excess Capacity
Excess capacity of around 4 mtpa
Strategic Stakes
High strategic stakes due to huge investment.
OVERALL RATING
to 1.5
Barriers to Entry
> There are large economies of scale. Mini mills have been successful but since scrap steel is hard to come by and also since the ore is of high quality, it does not make much sense in the Indian context.
> No product differentiation and the brand identity depend on reliability and consistency.
> Switching costs of users are practically none as it is a commodity product.
> Distribution plays an important part because the locations of the plants are either raw material favorable or export favorable. Many plants are located in the east and the northwest and western and southern regions have to be reached via efficient distribution. Also availability of ports is a critical factor for exports.
> Significant changes are not expected and the technology has stabilized and easily available. Capital investment in older technology also prevents companies from adopting the latest technology.
> Some have captive ores and some buy ore with long-term contracts. India is the sixth largest producer of ore.
> Government protection has waned over the years and with US and other countries stepping up protection, Indian companies are demanding more protection.
Barriers to Entry
Attractiveness
Remarks
2
3
4
5
Economies of Scale
High economies of scale. Mini mills have been elsewhere, but are not suited to India.
Product Differentiation
No product differentiation
Brand Identity
Brands are recognized but commodity product
Switching Cost
No switching cost. Same quality of product available with competitors
Access to Channel Distribution
Access not tough. Competition based on price
Capital requirement
High capital requirement to start a steel plant.
Access to Technology
Pre liberalization access to tech was tough. Now it is relatively easy.
Access to raw material
India 6th largest producer of ore at competitive prices.
Government Protection
Some government protection against imports.
OVERALL RATING
Around 2 to 2.5
Barriers to exit
> Asset specialization is high, with specialized or obsolete furnaces.
> Exit costs are enormous, given that the capacities are high, employee retrenchment is not easy given the Indian labour laws.
> The restrictions by the government to exit affect only the PSUs. But the PSU in India is the largest producer. Also laying off a large number of employees to exit will be unacceptable to the government.
Barriers to Exit
Attractiveness
Remarks
2
3
4
5
Asset Specialization
High specialization of furnaces, tech etc
Cost of Exit
High cost of exit, disposing of plant and workers
Government Restrictions
Restrictions in terms of layoffs, PSU's inefficient capacity
OVERALL RATING
Threat from Substitutes
> Availability of Aluminium as a substitute for some industries is a major threat. Automobile industries are increasingly using aluminium wherever they can due to its lightness and machinability. If steel is used in the railway coaches, then there will be a substantial increase in steel usage over the long term. Also use of high strength plastic in consumer durables may affect some demand.
> Switching costs of substitutes prior to the decision doesn't affect the cost. It may be more when retooling is required, but since aluminium offers better strength to weight ratio, it may be desirable and cost less where suitable.
> Substitutes price value and the profitability of aluminium industries indicate that the aluminium is a big threat.
Threat from Substitutes
Attractiveness
Remarks
2
3
4
5
Availability of Close Substitues
Structural steel has no substitutes. However automobile industry tends towards aluminium
Switching Costs
Switching costs for automobiles may be quite high such as retooling, but the cost savings more than cover that
Substitute's Price-Value
Price value is high in automobiles.
Profitability of the producers of Substitutes
High profitability of aluminium industry
OVERALL RATING
2 to 2.5
Bargaining power of buyers
> The number of buyers is large and widely varied. The construction industry, railway wagons and coaches, pipes and consumer durables etc are major consumers.
> The steel industry faces marginal threat from Aluminium and plastic substitution, and the switching costs are not substantial.
> Buyers' threat of backward integration is nil since the industry is reeling from excess capacity and often steel is available below cost of most producing companies.
> Forward integration of industry is not much because of the large number of buyers available. Even if a diversified company such as Essar holds many other businesses, its use of steel is limited and is not a threat to the buyers.
> Quality contribution is high. Automobiles and engineering applications are crucial.
> Cost contribution is very high. An average automobile has 50 to 60% of weight as steel.
> Buyers' profitability varies from industry to industry and the consumers of steel are highly varied.
Bargaining Power of Buyers
Attractiveness
Remarks
2
3
4
5
Number of Buyers
Large no of buyers, both domestic and overseas, but many concentrated buyers present
Availability of Close Substitutes
Marginal threat from Aluminium and plastic.
Switching Costs
Buyers' Threat of backward Integration
Very minimal, given that the industry has high entry barriers
Industry's Threat of Forward Integration
Low threat. Some steel companies are diversified, but presence in a forward integrated sense is not there.
Contribution to Quality
High contribution to quality, both in structural and other industries
Contribution to Cost
High cost to buyer
Buyer's Profitability
Widely varies depending on consuming industry.
OVERALL RATING
Around 3
Bargaining power of Suppliers
> Suppliers of ore are low in number. Some plants have their captive ore supply, steel scrap has to be imported, and India is the 6th largest producer of ore making it easy to get iron ore.
> No substitutes for ore.
> Industry threat of backward integration is average with some companies having their captive ores. Ores are location specific.
> Supplier of ore may forward integrate, but given the state of the industry and its cutthroat competition and high entry barriers make this possibility remote.
> Substantial contribution to quality because the better the quality the lesser the cost associated in reducing the ore and processing it.
> The raw material costs stands at more than 50%.
> Supplier has a handful of steel companies and also India exports around 35 to 40% of its ore. Hence each customer is important to the supplier.
Bargaining Power of Suppliers
Attractiveness
Remarks
2
3
4
5
Number of Suppliers
Low no of ore suppliers
Availability of close Substitues
Literally none. Otherwise supply should be sourced from outside the country
Switching Costs
Industry's Threat of backward Integration
Some companies like tata and sail have captive ores.
Supplier's Threat of Forward Integration
This also may be feasible
Contribution to Quality
High, the ore quality increases or decreases the costs of production
Contribution to Cost
High, the material costs stand at greater than 50%
Industry's importance to Supplier
Each producer forms a substantial part of the supplier
OVERALL RATING
2
Government Actions
> The industry has some protection in terms of antidumping duties. The sops extended by the government to the housing sector will boost the structural steel demand.
> The thrust towards infrastructure projects (budget increased by 25% this year and the previous year) will help the industry.
> Low regulation, except in cases of retrenchment and in the case of PSUs.
> The vagaries of the importing countries' governments highly affect the industry. The export tap may be turned off anytime. This combined with the glut is leading to losses to the companies that have been unable to cut costs.
Government Actions
Attractiveness
Remarks
2
3
4
5
Industry Protection
Some protection in terms of antidumping duties etc.
Industry regulation
Regulation low, except in layoffs and in PSU's
Customs & tariff restrictions Abroad
Highly dependent on the vagaries of importing country governments
OVERALL RATING
2
The overall rating is thus around 2 and the industry is unattractive. No new entries are expected and capacity additions will be rare because the companies are operating below capacity.
Annexure 2
SWOT analysis
The financial analysis and analysis of strategies implemented by Essar, indicate a number of strengths and weaknesses. The external analysis has thrown in a number of opportunities and threats. We give below a summary of the SWOT followed by detailed discussion on the implications of each of these:
Strengths
Weaknesses
* Diversified Business
* Technology and Research & Development
* 'Positive Attitude' Philosophy
* Distribution Network
* Cost Reduction
* Integration
* Largest exporter of HR coils despite difficult export market
* IT Investments
* Heavy R&D investment
* Own power Generation Company supplying 95% of requirement.
* New generation steel mill
* Employee Caring
* First company to receive both ISO 9002 and ISO 14001
* E-commerce Initiatives
* Low Reserves
* High Leverage
* High Interest Costs
* High Input Costs
* Power consumption 7-9 giga calories per tonne compared with 4-6 giga calories in developed countries
Opportunities
Threats
* Focus on growing export markets
* Forward Integration by installing CR mill with HR coil to get cost benefits
* Infrastructure spending
* Focus on restructuring debt
* UTI's initiatives
* FI's revival plans for ailing steel companies.
* High potential of Indian market due to its low per capita current consumption
* Bagging of orders showcasing quality of its HR coils
* Infrastructure bottlenecks
* Economic Slowdown
* Loss of export markets
* Marginal threat from aluminium in some sectors
* Increase in Natural gas prices adversely affecting the economical viability of sponge iron production
* Overcapacity
*
Strengths
. Diversified Business: The Essar Group is well diversified with its presence in businesses like steel, power, telecom, oil and gas, and transportation.
2. Technology and Research & Development: State-of-the art steel complex in Hazira, Gujarat. The company spends heavily into R&D because of its commitment to reduce cost. It has recently developed the hot directly reduced iron (DRI) technology, which has helped Essar Steel save on energy cost.
3. 'Positive Attitude' Philosophy of the company : Its 3,400 employees really live out its philosophy of a 'positive attitude', to turn every challenge into an opportunity and every benchmark into a baseline. Coupled with its uncompromising focus on technology, this achievement-oriented attitude allows Essar Steel to reap value through better quality control and gives all its businesses some of the lowest staffing numbers and highest productivities not just in India but worldwide.
4. Distribution Network: Essar ensures excellent customer service through a modern distribution network. Essar aims to provide a transparent, delayered buying experience offline. So it has to set up its own retail network of 64 dedicated dealers, set to rise to 200, who will sell directly to customers. It is now building a web of 60 warehouses, so that dealers will not have to stock inventory.
5. Cost Reduction: Essar Steel has the best steel plant technologically in the country with the highest yield. The company has adopted cost cutting measures and has its presence in value added products.
6. Integration: High emphasis on Backward and Forward Integration in the last decade to ensure world class products.
7. Exports: Essar is the largest exporter of hot rolled coils and sheets in the country.
8. Branding: To help its customers choose the best steel every time, it became the first Indian company to brand flat products, under the name "24-carat steel." When customers ask for 24 carat steel, they are assured of the world's best steel, backed by the strength and promise of Essar Steel's technology, quality and distribution.
9. IT investments: To ensure superior value for customers by saving them time and effort, Essar Steel has connected its operations to all major customers using its ERP system. These customers can simply go online with Essar to check their order status; despatch details by order, size, grade or date, complete with truck numbers and invoice numbers; the status of accounts and due payments; and a host of other factors. Regular customers can also place orders online.
0. Employee Caring: The company has invested heavily into the development of a township near the plant for it employees. This will help the company to attract and retain the best talent.
1. E-Commerce Initiatives: Essar Steel actively participates in the Essar Group's Internet venture clickforsteel.com, an on-line steel vortal for the Asian region. Essar is also a member of e-steel, a similar US-based exchange. Online steel exchanges eliminate multiple distribution layers, making transactions truly transparent.
Weakness
. Low Reserves: Given the size of loans (both Secured and Unsecured), raised by the firm the Reserves and Surplus are relatively very low. (Refer to the Financial Statements). Hence, the financial health of the company is not good.
2. High Leverage: The company is highly levered and hence the cost of raising finance is very high.
3. High Interest Costs: The high leverage and cost of finance significantly affect the bottom line of the company, making it unfavourable with potential investors.
4. High Input Costs: Power and fuel costs are major components of the cost of production. High power and fuel costs in India are affecting the bottom line of the company and making it uncompetitive.
Opportunities
. Focus on growing export markets: Focus on growth markets of South East Asia and Middle East to boost exports.
2. Backward Integration: Backward integration by installing cold rolling mill plant with its hot rolled coil production to achieve a greater cost benefit.
3. Infrastructure spending: Increase in government spending on large infrastructure projects such as the road projects like the Golden Quadrilateral.
4. Focus on restructuring: Analysts say Essar Steel is one of the low cost steel producers and a viable unit, even in the current depressed market conditions. Business restructuring would not only strengthen the operations but also help Essar generate adequate cash flows on a sustainable basis to meet all its financial obligations and service its equity. Essar Steel is negotiating with its lenders to restructure its debt through re-scheduling of high interest loans to market-related rates. At the same time, it is restructuring its debt profile by lengthening the maturity profile of its loan liabilities. This move away from short-term, high-cost debt will bring down our interest costs.
5. UTI's initiatives: As part of its effort to improve the value of its holding in sick steel companies, UTI is planning to strengthen these companies jointly with financial institutions like IDBI, ICICI and IFCI which had lent funds to the steel companies including Essar Steel, JVSL, Ispat, Malavika Steel and Usha Ispat.
6. FI's revival plans for ailing steel companies: The FI's have decided to draft a revival plan for 10 ailing private sector steel companies which include Essar Steel, Ispat, JVSL, JISCO, Malavika Steel, MidEast, Lyods Steel, SJK Steel, Uttam Steel and Bellary Steel.
Threats
. Infrastructural bottlenecks: The domestic industry is plagued by infrastructural bottlenecks and rise in input costs.
2. Economic slowdown: Slowdown in the Indian economy has lead to reduction of private sector spending on large industrial projects.
3. Loss of export market: Slump in demand in South East Asia due to recession and anti-dumping duties imposed by the US on Indian steel exports.
4. Overcapacity: The international market has excess steel that has lead to sharp decline in prices. International Iron & Steel Institute (IISI) estimates global oversupply to the extent of 85 million tonnes. The steel producers are not reducing the production. The steel industry is getting protection in the form of trade barriers, as Governments throughout the world levy high excise duties.
According to analysts, the scenario in the domestic market is not too different. As against the domestic demand for flat products estimated at 8.5 million tonne, capacity exists to produce flat steel to the extent of over 12 to 13 million tonne. Even if the consumption growth is assumed at 6 per cent, the demand-supply equilibrium will be restored in the next 5 to 6 years.
5. Weak Price Levels: Currently steel prices have touched historically low levels at $180 per tonne with no sign of recovery. At the current level of steel prices companies are barely able to notch an operating profit and are unable to service their interest burden.
Annexure 3
Industry Outlook
Based on the structural analysis of the Industry, it is evident that the industry is not an attractive one. The different products are slated to grow at a CAGR of around 5 to 6%, while the HR coil market would grow at a CAGR of 8%. Essar is already the leader in HR coils. The outlook for the industry is detailed below1.
* The oversupply situation is likely to continue during the 2002 - 2005 period. By 2006-2007, the domestic steel industry is expected to have a deficit situation in most categories of flat products.
* Prices of flat steel products are likely to remain volatile, and are expected to move in line with international prices. Prices of long products are likely to increase marginally.
* Operating costs are likely to increase gradually, due to an increase in the cost of inputs. Given the high financial costs, profitability of steel producers is likely to remain low.
* GP/GC
V Demand for GP/GC products is expected to increase at a rate of 6 per cent in 2002-03, and at 6.5 per cent during the 2003-04 to 2006-07 period. Demand is expected to increase mainly from the roofing, paneling, shutters and white goods segments. Demand for GP/GC products is expected to increase from 1.8 million tonnes in 2001-02, to 2.4 million tonnes in 2006-07.
V Production of GP/GC is expected to be around 2.5 million tonnes in 2002-03. During the 2003-04 to 2006-07 period, production is expected to increase at a CAGR of 5.2 per cent, to 3.1 million tonnes. Production is expected to increase due to the addition of new capacities and an increase in operating rates of producers, in line with the increase in demand from the domestic and export markets. The average operating rate is expected to increase from around 80 per cent in 2001-02 to 93 per cent in 2004-05 and further to 97.5 per cent in 2006-07. In 2006-07, operating rates are expected to increase, due to an expected deficit situation in the domestic market. In spite of high operating rates, additional imports (in addition to the quantum of imports assumed) of 0.13 million tonnes in 2005-06 and 0.33 million tonnes in 2006-07, would be required to match the domestic and export demand.
* CR Flats
V Demand for CR flats is expected to increase at 6.6 per cent in 2002-03, and at a CAGR of 6.7 per cent during the 2003-04 to 2006-07 period. Demand is expected to increase from 5.7 million tonnes in 2001-02 to 7.9 million tonnes in 2006-07. Demand is expected to increase from the automobiles, coating and cycles industries.
V Production of CR flats is expected to increase at a CAGR of 6.8 per cent, from around 6 million tonnes in 2001-02 to 8.4 million tonnes in 2006-07. Production is expected to increase primarily by an increase in operating rates, as capacity addition during the period is expected to be only at 0.45 million tpa. The average operating rate is expected to increase from 70.5 per cent in 2001-02 to 92.9 per cent in 2006-07.
V Net notional exports (exports net of imports, including downstream products) of CR flats are assumed to be around 0.35-0.65 million tonnes during the 2002-03 to 2006-07 period. The demand-supply situation is likely to be balanced till 2005-06. However, in 2006-07, additional imports (more than the quantum of imports assumed) of 0.18 million tonnes are likely to be required, in order to match the demand from the domestic and export markets.
* HR coils
V Demand for HR coils is expected to increase at 7.7 per cent in 2002-03, and at a CAGR of 8.3 per cent during the 2003-04 to 2006-07 period. Demand is expected to increase from 10.5 million tonnes in 2001-02 to 15.5 million tonnes in 2006-07. Demand is expected to increase from the pipes and tubes segment and from downstream products.
V Production of HR coils is expected to increase at a CAGR of 8.8 per cent, to 16.8 million tonnes during the 2002-03 to 2006-07 period. The average operating rate is expected to increase from 72.2 per cent in 2001-02 to 92 per cent in 2006-07. In 2006-07, operating rates are expected to increase, due to an expected deficit situation in the domestic market.
V Net notional exports (exports net of imports, including downstream products) of HR coils are assumed to be around 1-1.8 million tonnes during the 2002-03 to 2006-07 period. The demand-supply situation is likely to be balanced till 2005-06. However, in 2006-07, additional imports (in addition to the quantum of imports assumed) of 0.49 million tonnes are likely to be required, in order to match the demand from the domestic and export markets.
* Flat products
V Demand for HR flats is expected to increase at 6.9 per cent in 2002-03, and at a CAGR of 7.8 per cent during the 2003-04 to 2006-07 period. Demand is expected to increase from 12 million tonnes in 2001-02 to 17.4 million tonnes in 2006-07. Demand is expected to increase mainly from the pipes and tubes segments and downstream products.
V Production of HR flats is expected to increase at a CAGR of 7.1 per cent, from 12.9 million tonnes in 2001-02 to 18.2 million tonnes in 2006-07. Production is expected to increase due to an increase in capacity and an increase in operating rates by producers. The average operating rate is expected to increase from 77 per cent in 2001-02 to 92 per cent in 2006-07. In 2006-07, operating rates are expected to increase, due to an expected deficit situation in the domestic market.
V Net notional exports (exports net of imports, including downstream products) of HR flats are assumed to be around 0.85-1.7 million tonnes in 2006-07. The demand-supply situation is likely to be balanced till 2005-06. However, in 2006-07, additional imports (in addition to the quantum of imports assumed) of 0.83 million tonnes are likely to be required, in order to match the demand from the domestic and export markets.
* Long products
V During the 2002-03 to 2006-07 periods, demand for long products is expected to increase at a CAGR of 5.1 per cent. Demand for bars and rods, is expected to increase at a CAGR of 5.5 per cent, and demand for structurals is expected to increase at a CAGR of 4.7 per cent. Demand for railway material is expected to remain stagnant.
V Supply is expected to increase in line with demand. Producers are expected to maintain operating rates, in line with demand. Net exports are expected to remain stable at around 0.4 million tonnes.
* International Prices
V In the US, after the imposition of safeguard measures, prices of HR coils increased from $ 220 per tonne in March 2002 to $ 340 per tonne in May 2002, due to a decline in imports and inventories. As a result, prices in the EU and Asia increased by around 20-25 per cent, to $ 250-260 per tonne. In the short to medium term, average price in the international market is expected to remain at around $ 240-260 per tonne. In the short term, prices are expected to stabilise at these levels. In the long term, average steel price is not likely to increase significantly due to the overcapacity in the international market. However, prices would continue to be volatile.
* Domestic Prices
V Since March 2002, prices increased from the levels of around Rs 14,000 per tonne to Rs 16,000 per tonne, due to an increase in international prices of HR coils and an increase in demand for galvanised products. Domestic demand during the period remained stable at low levels.
V In 2002-03, in the domestic market, average price of HR coil is expected to be in the range of Rs 16,000-16,500 per tonne, due to higher international prices and high demand from downstream products (exports of GP/GC sheets are expected to remain high).
* Operating Costs
V During the 2002 to 2007 period, prices of most material inputs, such as iron ore, coke and coal are likely to increase. Prices of energy inputs, such as thermal coal, diesel, fuel oil, natural gas and electricity are also likely to increase. However, labour cost for most producers is not expected to increase significantly.
V Most producers are likely to improve operating efficiencies, in order to minimise operating costs. Producers have increased productivity and reduced consumption ratios for material and energy inputs, by modernising the plants and making process improvements (such as blending of coal, usage of hot charge (hot metal in EAF or hot DRI), coal injection techniques). However, for most producers, scope for reducing cost by improving operating efficiency is limited. Hence, with the increase in raw material costs, operating costs for most producers are likely to increase. The increase in operating costs would vary, depending on the technology used for steel production.
* Financial Cost
V Interest costs of new private sector players, such as Essar Steel, Ispat Industries and JVSL are likely to remain high, due to their high debt burden and high cost of funds. Interest costs of most players are expected to remain high due to an increase in borrowings, as a result of accumulated cash losses incurred by the companies since 1998-99.
V However, financial costs are expected to decline from the existing levels as interest rates in the economy are declining and most companies who borrowed during periods of high interest rates are trying to replace high cost debt with low cost debt, in order to reduce their interest costs. Most producers are in the process of restructuring debt, in order to reduce their fixed cost outflow. Financial institutions are supporting the debt restructuring initiatives, in order to reduce their NPAs.
V Prices of all steel products have increased significantly since March 2002, (average price increase has been at around Rs 2,000 per tonne) and prices are not expected to decline to the 2001-02 level. As a result, the industry is expected to make cash profits.
V Depreciation charges are likely to remain high as most of these capacities are newly commissioned and modernised capacities.
* Operating profits will continue to be under pressure, with a slight increase beyond 2006 due to the balanced domestic demand-supply situation. Financial costs are expected to remain high due to the adverse capital structure. Interest and depreciation charges are likely to decline with an increase in the capital utilization of the industry.
Annexure 4
Company Initiatives
* Debt Restructuring:
The company has successfully restructured most of its debt. FRN holders have increased the maturity period and reduced interest rates and the domestic lenders have approved the same. This move away from short-term, high-cost debt will bring down the interest costs.
The company has sold a 51% stake in its pellet plant to Stemcor, UK. This move reduced its debt substantially while still ensuring high-quality raw materials at a reasonable price. Its debt will fall further once it divests its 42% stake in Essar Power, first intended as a captive unit but now a profitable, independent power company.
* Technological and process improvements have led to a saving of 6% over the previous year. In-house initiatives launched by way of technological and process improvements at both the Hot Briquetted Iron (HBI) and Hot Rolled Coils (HRC) plants have yielded very favourable results. The power consumption has reduced considerably due to improvement in processes, as mentioned below :
o Increased Hot Direct Reduced Iron (DRI) charging
o Better slag practices resulting in yield improvement
o Hot charging of slabs
At the HBI end, hot DRI has resulted in savings of approx. Rs.100 PMT in the operating cost and at the steel making end, the usage of hot DRI has resulted in savings of approx. Rs.500 PMT in the operating cost of liquid steel. .
* Natural gas contract with Gujarat state petroleum corporation and GAIL has reduced its Naphtha intake and this has led to lowering of energy costs. This has led to significant reduction in fuel cost and power cost to the order of 8%
* The company focuses on high value added products that command a premium and also result in better realizations. The company exports high value products, such as API/SAW pipe, Corten, HSLA grade steel products. In the domestic market the volume has shrunk due to conscious decision to shift from base grade to high value added products. The price realizations have improved 5% due to this. The company also focuses on High silicon steel, LPG cylinder grade, extra deep drawing for CR and galvanizing applications and automobile sector steel to command premium over base grade products.
* A CRM module has been implemented which provides an internet based information system to view order and despatch status for all customers.
* Co-branding with Kirby building systems and Essar 24 carat steel has been introduced to aggressively market the products.
* New product development has resulted in at least 6 new product enhancements which the company plans to commercialize
o Successful rolling of electrical stamping steel & cold rolling application in the ferritic zone.
o Rolling of 1.2 mm thick coils to substitute cold rolled products in certain applications.
o Rolling of coils > 20 mm thick for SAW pipes.
o Successful trial rolling of interstitial free (IF) grade steel for auto body applications.
o Commercial production of high strength low alloy (HSLA) for pre-fabricated building applications.
o Successfully supplied coils for API 5L X70 & X52 (sour gas application).
* To improve distribution, and for online marketing of steel and steel related products to a large number of small consumers throughout the country web enabled distribution centers have been setup and an experimental foray of two centers in Gujarat has been initiated and 17 has been planned.
* Many energy conservation measures have been undertaken successfully
o Hot DRI charging, IBF removal, NG bundle, Hot cone bleed system, Top gas fuel chiller, EAF, Hot Slab Charging, Extra Deep Drawing (EDD) & cold rolling grades, Lime Kiln -1 and Oxygen Plant are such measures
o Hot cone bleed system, CO 2 Removal System, Online Oxygen analyzer, Fuel saver, Water cooled super sonic lances, modular lances and short lances will be implemented in future. These are expected to yield energy savings of 25 KWH / MT of steel.
For more detail technicalities please refer to the Annual Report.
* The company is exploring new export markets, such as China, Middle East, South-East Asia and Far East to counter increased tariff barriers for exporting to the US and Europe
* Essar Steel plans to introduce articulated barges, in order to integrate operations that bring in raw materials and export HRC. The company expects to reduce its cost of freight by around 50 per cent. Cost of freight is likely to be reduced by opting for Pipavav port for its inbound and outbound freight movement.
Annexure 5
Analysis against competitors
Ranking factors
. Operating costs
2. Ownership of low-cost ore and coal and favorable location for raw material procurement
3. Skilled and productive workforce
4. Sales/energy cost.
5. Average days of raw materials inventory
6. Average days of FG inventory
7. Strength of the balance sheet
8. Favourable ratio of borrowed and equity funds
9. Proportion of domestic sales
Factor
BHUSAN
JISCO
JVSL
TISCO
LLOYDS
ISPAT
SAIL
UTTAM
RINL
ESSAR
3
6
2
0
9
5
7
8
4
2
0
4
5
2
3
6
9
8
7
3
2
5
8
7
4
0
3
9
6
4
3
2
6
0
8
7
5
4
9
5
5
6
7
2
3
8
4
9
0
6
6
2
4
6
3
0
4
9
8
7
6
9
2
0
8
4
5
3
7
8
4
5
0
3
8
6
7
2
9
9
3
9
4
7
5
2
0
6
8
Total
37
40
42
42
49
51
52
54
58
68
Rank
2
3
3
5
6
7
8
9
0
The ranking shows that Essar has huge scope for improvement. Even though the ranking does not include the soft issues and management orientation, it does point out to areas where Essar can focus on. Essar's strength of the balance sheet is very bad due to the high cost debts and undesirable current and quick ratios. The energy cost also seems to be high vis-à-vis other players even though Essar's per unit cost of power is low due to sourcing from its group company. It also has high debt and low equity when compared to the other companies. This is affecting its bottom line even though it is one of the low cost producers of HR coil. Its inventory of raw materials and finished goods too are way too high compared to the industry average. Better logistics management would certainly help.
Annexure 6
Key Ratios
Inventory Turnover Ratios (in days)
Company Name
Avg. days of RM and stores
Avg. days of prod
Avg. days of FG
Avg. days of debtors
Gross working cap cycle
Avg. days of creditors
Net working cap cycle
Gross working cap reqd (crores)
Stock accumulation rate%
Jindal Iron & Steel Co. Ltd.
8
2
9
44
72
76
0
268.4
-6.19
Lloyds Steel Industries Ltd
31
99
6
228
365
43
222
563.5
-54.53
Ispat Industries Ltd
32
0
0
58
00
31
0
784
-5.03
Uttam Galva Steels Ltd
35
22
6
28
01
84
7
62.1
-14.47
Bhushan Steel and Strips Ltd
37
3
32
84
65
54
10
358.8
3.54
Jindal Vijayanagar Steel Ltd
48
0
6
70
35
300
0
367.7
-23.79
TISCO
69
2
32
57
60
93
68
2520
-10.2
SAIL
85
0
80
39
205
43
62
7328
4.28
Rashtriya Ispat Nigam Ltd
27
0
69
7
213
76
36
688
20.95
Essar Steel Ltd
58
6
33
81
277
73
04
551
2.89
Total
75
3
52
50
79
85
95
220
3.87
Liquidity Ratios (in times)
Company Name
Quick ratio
Current ratio
Debt equity ratio
PBIT/Interest
Interest incidence
Bhushan Steel and Strips Ltd
0.8
.55
.28
.74
1.5
Essar Steel Ltd
0.15
0.64
5.61
0.28
6.6
Ispat Industries Ltd
0.06
0.58
4.42
0.1
7.32
Jindal Iron & Steel Co. Ltd.
0.25
0.76
2.47
0.39
6.4
Jindal Vijayanagar Steel Ltd
0.16
0.38
9.13
0.73
4.57
Lloyds Steel Industries Ltd
0.02
0.36
0
-0.46
6.5
Rashtriya Ispat Nigam Ltd
0.16
0.89
0.78
0.18
6.9
SAIL
0.19
0.79
3.34
0.4
2.2
TISCO
0.37
0.92
.18
3.13
8.57
Uttam Galva Steels Ltd
0.06
0.79
3.71
0.3
5.3
Total
0.19
0.74
2.56
0.57
1.3
Profitability Ratios
Company Name
PBDIT/Net sales
PBDT/Net sales
PBT/Net sales
PAT/Net sales
PAT/Net worth
PBDIT/Cap Emp
PBDIT/GFA
Bhushan Steel and Strips Ltd
8.95
1.66
5.39
4.93
9.82
9.66
21.68
Essar Steel Ltd
25.66
-5.77
-22.65
-22.66
-55.1
3.71
9.28
Ispat Industries Ltd
7.71
-4.57
-11.05
-11.05
-21.7
3.84
9.19
Jindal Iron & Steel Co. Ltd.
7.5
-3.57
-6.72
-6.73
-21.4
8.95
3.6
Jindal Vijayanagar Steel Ltd
8.91
2.16
-4.47
-4.48
-7.95
4.89
2.91
Lloyds Steel Industries Ltd
-8.84
-71.05
-91.07
-91.07
-5227
-4.21
-1.95
Rashtriya Ispat Nigam Ltd
5.95
4.6
-9.28
-9.28
-9.65
32
5.8
SAIL
2.11
0.57
-6.97
-6.97
-23.7
2.02
6.84
TISCO
23.64
8.17
1.64
0.99
21.5
22.24
8.26
Uttam Galva Steels Ltd
7.1
-1.9
-6.31
-6.31
-36.4
0.29
7.93
Total
5.26
3.03
-5.23
-5.39
-12.4
2.65
9.07
Annexure 7
Budget (2002 - 03) Implication on Steel2
* Peak rate of customs duty reduced from 35% to 30%;
* Customs duty on refractory raw material, low silica limestone and graphite electrodes decreased to 10%;
* HR SS coils for coin blanks exempted from customs duty;
* Customs duty on Metcoke imported by Corex technology-based steel plant reduced from 15% to 5%;
* Customs duty on steel seconds and defectives increased to the bound rate of 40%;
* Incentives announced to boost activities in the housing and infrastructure sector;
* Marginal decline in railway freight on pig iron and iron & steel;
* Marginal rise in railway freight on coal, iron ore and raw materials for iron & steel;
* The Railway Budget has laid emphasis on tack renewal, construction of new lines and conversion. The proposed investment for FY2003 is Rs.39.19 bn on rolling stock.
Negative Impact
Reduction in the peak customs duty from 35% to 30% is likely to negatively impact the topline growth of the companies due to oversupply in the international markets. Higher customs on seconds and defectives is likely to marginally protect the industry from overseas dumping. The changes in the railway freight are likely to put an additional burden of Rs.250 mn. on the Company. The company would benefit from further incentives provided to the construction sector through an improved offtake of its long steel products. As the duties on HR coil remain unchanged, Essar Steel would be not affected by the reduction in peak customs duty.
INFAC, CRISIL Report, Annual Review, October 2002
2 ICRA Information Services
Strategic recommendations
March, 2001 1
