Prices Surge as Growing Middle Class Drives Demand

Shares of India's steelmakers are proving buoyant.

Rising global steel prices, propelled by China's demand, have lifted the profit margins for many of India's steel companies. But beyond that, fund managers say it's not too late to look at certain Indian steel stocks, despite hefty gains in their share prices.

The reason: Steel is among the sectors that stand to benefit most from India's own continuing economic boom. Demand at home is surging as members of the widening middle class buy new cars, remodel apartments and replace appliances. In the year that ended March 31, India's domestic steel consumption grew 11%, almost twice the 6% annual growth it averaged over the past decade.

Although there are plenty of steel stocks listed on the Bombay Stock Exchange, the best bet for investors is to think big, say analysts. That, they add, means picking integrated steel companies that offer the potential for better returns.

Industry Goliaths such as top maker Tata Steel and the second-biggest, government-run Steel Authority of India, or SAIL, have their own raw materials readily available, including iron ore and coal. Analysts confirm the assertion by Tata Steel that it is the world's lowest-cost steelmaker.

Another company that some investors favor is JSW Steel, India's third-largest integrated steel-maker by output. It has ambitious plans to more than triple production in the next five years.

JSW produces 8.6 million metric tons a year and it plans to start a 10-million-ton facility in West Bengal by 2009. A similarly sized plant is to begin operations in Jharkhand in 2012. Overall, the company intends to have total capacity of 30 million tons by 2012, according to A. Shekhar, an assistant general manager.

These integrated steel companies have a built-in advantage because they are cushioned from potential supply shortages and price increases for pivotal raw materials. Huge Indian reserves of iron ore, which put the country among the top five in the world, remain largely untapped.

So even if iron-ore prices continue to rise, India's integrated steelmakers are better placed to maintain profit margins. If steel prices go up -- as they have globally for hot-rolled coils by about 10% between February and April -- the companies' profit margins typically widen.

Policy shifts are also boosting Indian steel stocks. In a break from the past, Indian officials, who are usually fearful of inflation, appear willing to allow steel prices to rise. Finance Minister P. Chidambaram said recently that the central government wouldn't move to contain prices of hot-rolled coils used for making such products as pipes and tubes.

Also, while India's Steel Secretary R.S. Pandey has said a monitoring committee will study a recent rise in domestic steel prices, he added that the government has no plans to cap prices.

"Companies that benefit from [price rises] would be the steel giants," says Hitesh Agarwal, senior research analyst with Angel Broking in Mumbai.

The big three have already benefited this year from upbeat views of the industry. Shares of JSW are up 58% since the end of 2006, and those of SAIL have gained 57%. The stock price of Tata Steel, which fell when the company made a $12.9 billion acquisition this year of Anglo-Dutch steelmaker Corus Group, has risen 22% -- still far more than the 30-share Sensitive Index, or Sensex, which has gained 2.4% so far in 2007.

Bhavesh Shah, an analyst at Asit C. Mehta Investment Intermediates in Mumbai, says steel stocks are popular with Indian retail investors, as "they are making new highs regularly."

But given the strong gains, some analysts caution that their share prices may be approaching peaks.

HDFC Securities thinks SAIL doesn't have room to move higher for now; it has a target price of 135 rupees to 140 rupees ($3.32 to $3.44) over the next six to 12 months. Yesterday, shares of SAIL gained 1.8% to 140.10 rupees.

The firm's target for Tata Steel for the same period is 630 to 640 rupees. It closed yesterday at 588.45. For JSW shares, HDFC Securities projects 670 rupees; the stock rose 1.7% yesterday to 611.60 rupees.

Meanwhile, shares of Essar Steel, a slightly smaller steelmaker, have tended to suffer by comparison. The company's purchase last month of Algoma Steel of Canada for $1.63 billion didn't move the share price, mainly because of concerns of slower profit growth, says Mr. Shah of Asit C. Mehta Investment. Essar's stock has been flat since the deal and has risen 15% so far this year.

Still, few other sectors are as well placed as India's steel business to tap strong demand at home and overseas. So it's no surprise they have been shopping for overseas assets, in spite of the debt load that comes with financing new purchases.

Tata Steel's purchase of Corus, which extends its reach into Europe, offers an example of the upside available to those Indian companies that can combine low costs and global reach.

"The acquisition of Corus gives Tata Steel access to high-quality, developed markets, in addition to its existing low-cost, high-growth markets," Macquarie Research said in research note this month.