CLSA stays cautious, lowers Tata Steel, JSW Steel ratings on margin worries

CLSA downgraded Tata Steel to sell from outperform and cut target price to Rs 135 from Rs 145. JSW Steel downgraded to sell from underperform and declined its target price to Rs 730 from Rs 810.

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Metals are on a rally but steel stocks seem to have failed to charm CLSA. The global brokerage maintains caution on the Indian steel sector, citing a shift in profit pool towards miners, anticipation of lower spreads compared to the past, and elevated valuations for stocks despite spread compression, not reflected in consensus estimates.

CLSA has downgraded Tata Steel to ‘sell’ from ‘outperform’ and cut the target price to Rs 135 from Rs 145. It also lowered the rating for JSW Steel to ‘sell’ from ‘underperform’ and revised the target to Rs 730 from Rs 810. Both the companies expected to see robust volume growth due to capacity expansion in the next two years. But, CLSA predicts lower margins due to weaker spreads.

The broker kept an ‘underperform’ rating on JSPL considering it’s relatively better off due to margin expansion projects, even in the face of weaker industry spreads. A potential risk is a China-driven stimulus impacting its outlook. It raised the JSPL target price to Rs 840 from Rs 820 a share.

CLSA warns of the impact of India’s rapid blast furnace-based steel capacity expansion, foreseeing lower spreads and a shift towards raw materials. The brokerage expects FY25/26CL spread at $360 a tonne, below the 10-year average, due to surplus supply, increased exports, and domestic steel prices likely below import parity.

Higher steel production may strain iron ore and coking coal supply, despite efforts to increase captive iron ore mines. India’s role in the coking coal balance and rising demand (18mtpa in two years) could offset China avoiding Australian coal, it said.

CLSA notes a shift in steel sector dynamics, with rising valuations in the past 18 months, driven by optimistic demand outlook and Chinese stimulus expectations. Despite recent spread compression, consensus estimates for FY25-26 profitability seem inflated. China’s potential stimulus remains a key risk, impacting Indian mills based on sustained or weak demand.

The brokerage highlights potential positive surprises in China’s policy continuity, as current spreads in China are at unsustainable lows. If the spread improvement comes from lower costs, favouring Mongolia, Indian mills might face challenges, the report concludes.

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