Brokerage firm CGS-CIMB on Friday termed the rally as ‘irrational enthusiasm’, as it thought “unlike the post-Lehman crisis world, there is nothing structural about this rally.”
There may be some merit to CGS-CIMB’s claims when one peeks into the current valuations of India’s top two steel producers –
and . Both the stocks are currently the costliest steel stocks in the world when adjusted for installed capacity, valued at more than four times the largest steel producer in the world, ArcelorMittal.
However, the high prices of Tata Steel and JSW Steel are not the eye-brow raising part. Analysts believe at current levels, the market is counter-intuitively valuing some of the steel stocks on par with growth stocks.
JSW Steel, for example, currently enjoys a market capitalisation that is higher than fast growing companies like Bajaj Finserv. This irrational exuberance may not last for long, analysts claim.
“…such is the flow of liquidity and paucity of ideas that any stock approaching near-term earnings growth is getting high valuations. While we will be the first to admit that nothing is impossible in commodity markets, the usual market is becoming a shade too bullish,” brokerage CGS-CIMB said in a note.
A reflection of the intensity of the rally and the exuberance among investors can also be seen in the fact that over the past two months when Nifty50 has corrected over 6-7 per cent, steel stocks have risen over 30 per cent. Not to mention that most steel producers in India have seen their stock prices triple or quadruple over the past year.
The rally has also come at a time when the second wave of Covid-19 infections has punctured the market’s enthusiasm for cyclical bets, at least in the short term. Much of the action in steel stocks has been driven by the persistent hike in steel prices undertaken by companies and strong December quarter performances.
Since April, steel companies have raised domestic prices four times reflecting the robust demand in the global market.
With many stocks trading at lifetime highs and valuations touching two times price-to-book value, the market appears to be pricing in sustained margins for at least four to five years, CGS-SIMB said.
Globally, the recovery in the US, UK and China from Covid-19 is fuelling strong appetite for physical commodities and that has resulted in backwardation (a situation in which the spot price of a commodity is higher than the forward price) in the commodities market to hit multi-year highs.
At the same time, supply constraints have been magnified by the pandemic and China’s pivot towards reducing carbon emissions on a war footing. Years of underinvestment and the pandemic have left global steel capacity unable to cope with the surge in demand.
Those with a bullish view has their own perspective of it. “If economies are recovering globally and bond yields are going up, then short duration cash flows would obviously be valued more than long duration cash flows. Given all that, we are still positive on commodity stocks,” Manish Gunwani, CIO for equity Investments at Nippon India MF told ETNow.
CGS-CIMB begs to differ, and asserts that if steel production outside of China were to grow at over 15 per cent in the coming months, then the supply deficit in the market could be addressed, leaving sky high steel prices vulnerable to a sharp drop.
Signs are already emerging that global production outside of China is picking up. In March, global production of steel outside of China jumped over 10 per cent. CGS-CIMB believes if that pace continues in April and May, then “we will likely witness a rapid slide in steel prices.”
Investors, who have piled into steel stocks over the past few months, may be compelled to book profit if CGS-CIMB’s pessimism trumps the exuberance of the market.
