CGS-CIMB highlights that the stock valuations are now at the higher levels and it has downgraded the sector's rating to underweight. Tata Steel and JSW Steel are trading near all-time high EV/EBITDA valuations. This becomes even starker if CGS-CIMB accounts for steel prices likely falling in coming months. Thus, CGS-CIMB downgrades rating on the sector to Underweight (from Overweight) and to Reduce on Tata Steel and JSW Steel (from Add). CGS-CIMB retains their Add rating on Jindal Steel and Power Limited (JSPL). CGS-CIMB believes investors will do well to sell SAIL, JSW Steel and Tata Steel.

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Steel is showing a classic inventory cycle, accentuated by pandemic-driven pessimism. Normally the perception by steel users of poor demand leads to destocking. Globally 45% of steel produced remains in the supply chain (Source: Steel Industry), hence, a wrong perception among users could create a severe shortage. This happened in Jun/ Jul 2020 when the global Purchasing Managers’ Index (PMI) rose sharply leading to a rush for the metal. The shortage is feeding on itself and will likely lead to overstocked supply chains, fall in steel spreads and prices in the near term. This sequence has occurred many times in the past and 2021F will be no different, in CGS-CIMB’s view.

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CGS-CIMB says that Indian steel makers coking coal advantage may not last long, Barring China (because of its import ban on coking coal from Australia), steel spread over raw material (spreads = price - raw material cost) is at a decade high in all other markets. CIMB believes steel is in overcapacity and high gross margins will lead to much higher production. Despite current favorable global liquidity conditions, we do not think it can lead to a sustained manufacturing cycle. Indian steel makers are enjoying low coking coal costs now. High prices and shortages in China could push China to reverse its policies, potentially raising production costs for Indian steel companies in near term, in CGS-CIMB’s view.

India will face iron ore shortages if exports continue unabated:

India will face iron ore shortages as pellet exports remain lucrative, in our view. The high cost of production in Odisha is another push factor for Indian iron ore. This iron ore shortage is a good opportunity for SAIL to unload its unused iron ore inventory. However, it is possible that we may see some policy action by the Government of India on pellet exports in the coming months – we could see an export ban or high duty on exports.

Upside risk to CGS-CIMB call:

If steel prices remain strong earnings will be higher than estimated, hence stocks will see higher levels