Steel Sector Update: Jan-Mar 2008 earnings

With an unprecedented increase in raw material (iron ore and coking coal) prices in the last few years, the steel industry is witnessing a structural upward shift in cost structures. Iron ore and coking coal contract prices have surpassed all estimates and are up by 65% and 210% yoy respectively for 2008. However, despite concerns that the US may be slipping into a recession, steel manufacturers have globally demonstrated strong ability to pass on the incremental costs. In addition, Indian steel manufacturers are bearing the brunt of rising inflation in the domestic market and grappling with government intervention to control steel prices in the country. Even as we see the measures announced/ proposed by the government having a limited impact on numbers, investor sentiment has been hurt badly. Reacting to these concerns, Indian steel stocks have seen a sharp correction in multiples and the valuation discount to global peers has further widened. Even as we believe that this gap is unlikely to narrow in the near term, investors should use the opportunity to invest into these otherwise strong businesses. Once the dust settles, we see a bounce-back in steel stocks.