Risk & Headwinds are two different concepts both affecting the segment in terms of revenue, profit, costing and sometimes even its existence. Risk is long term, perpetual problems that occurs for the companies within the segment due to which the profitability & revenue is affected. On contrary, headwind is also a type of risk but the impact is for shorter term because businesses come out of the problems and find a permanent solution to mitigate the headwinds.

When for the first time PVC Pipes were developed which were direct replacement for Steel Pipes, it was termed as risk. But, luckily for us, where plumbing market for steel pipes got destroyed, steel pipes application expanded to different industries which saved majorly the ERW Pipes segment. There are many such instances of both Headwinds and Risk, which have possessed threat to this segment, an analysis for the same:

• Risk in Steel Pipes & Tubes Industry.

We know risk is permanent problems arising in companies or segments leading to adverse impact on business and its working. Risk is very common term for cyclical industries, where during cycle downturns the impact on businesses are huge, so huge that it sometimes have led to bankruptcies. Great company like Bhushan Steel and Essar Steel have faced the same situation in the past which led to their dissolution. Rapid expansion plans, followed by cyclical downturns and low capacity utilization leading to very less cash flow generation and finally defaulting in loans were the common roads to failure. Both the companies ramped up capacities during the boom period before 2008 housing crises. With debts reaching at high levels, expansion in capacities at all-time high, the industry was aiming to hit the sky during those periods. This led to immense loans in their books especially when all the bankers were ready to fund their plans at the lowest possible interest rates. Capacities got expanded for some, and for some the expansion was stopped mid-way. The reason? We all know the 2008 bubble. Where companies went for rapid expansion, what they fail to understand is the cyclicality nature of industry. Overly optimistic futuristic view and the assumption of upwards linear growth hit them hard. The cycles soon turned downwards and everything soon started crashing down. Oil prices crumbled to the lowest at $43, infrastructural activities held completely, all expansion plans stopped and GDP’s of countries tumbled to the lowest and it was horrific time for the world, experienced after great depression in 1930s.

Now, that I have explained about the downfall of steel companies, there are not many examples to give especially for pipes & tubes segment, as hardly there have been any disruption here. But, I do have one, and it is the very recent case of “United Seamless Tubular Limited” which is in insolvency process and Maharashtra Seamless have bid for the same. In 2017, United Seamless defaulted on loans and this acted as breakout for the company. In the order copy of NCLT dated 10/02/2017, it is clearly mentioned that due to Industrial Unrest, labour problems, low oil prices and lesser margins led to the default of loans as company could not pay for the dues on time.

For any Steel Pipes & Tubes maker (Especially Seamless & SAW Pipes), Oil Price plays a very important role. Firstly, a larger volume of Pipes & Tubes goes into Oil & Gas Industry for various applications. Oil & Gas Companies are involved in Exploration & Refine Activities of Crude Oil and their transportation. When Crude Oil Prices are higher and stable, it gives Oil & Gas companies incentives in form of greater realizations & profitability leading to higher Capital Commitments. Similarly, they are discouraged to do additional investment if the Oil Prices are lower. You would read the whole Concall FY20 Q4 of Ratnamani Metals, but a small snapshot showing statement given by its M.D. Prakash Sanghvi is:

Hence, all of these have happened in the past and it indirectly leads to lower profitability and revenue, because of which insufficient cash are earned and the thereafter loans were defaulted. I have few lists/points in my mind, which on course of studying and researching have been compiled to perfectly call as Risk of Industry:

1. High Expansion plans funded with debt at unreasonable levels.
2. Rapid expansion through continuous acquisition especially of companies outside core segment/business of acquirer. (A case of Maharashtra Seamless).
3. Not predicting business cycles downturns leading to high expansion and subsequent low capacity utilization.
4. Growth of Economy & user industry i.e. Oil & Gas, Exploration & Production, Automobiles, Infrastructure & Construction, etc.
5. High Dependence on few industry/companies for revenue.
6. Falling Steel & Oil Prices leading to losses and inventory drawdowns and lesser margins.
7. Foray of International Players in Indian Markets along with cheaper importing options leading to adverse impact for domestic producers.
8. Land Acquisition issues leading to delay in Underground Pipeline Projects could affect Large Diameter (SAW) Pipeline demand.
9. A higher currency volatility leads to expensive Coal Import that could in turn make our Raw Materials (Sheets, Plates, etc.) expensive.

Companies venturing into new business segment is often a riskier affair. This is because, the pipes & tubes market itself is complex business to concentrate that it is no easy task to manage business in other segment. Although, Maharashtra Seamless have entered into new business segment i.e. Oil Rig for exploration activities it is just a recent one. It will therefore important to track in future, whether any benefit is derived from this new segment i.e. Oil Rig. However, as per my understanding and referring to few analyst report, the new Oil Rig business which Maharashtra Seamless is entering into is not a good acquisition. A hefty price paid for business with very high debt, similar comments could be checked out in Credit Rating Report dated 24/08/2020.

Now, above listed points are so very obvious and they do possess a greater risk to the industry. As mentioned with crises during 2008, a very rapid expansion by taking debt at unreasonable levels and following downturn in cycles led to lower capacity utilization and lower cash income, thereby threatening to pay off the debt. Expansion is not bad and one should expand capacities to grab the opportunity of growing industry, but one should expand at manageable levels. One cannot predict cycles downturn (if it was predicted, expansion would not have happened), but one can keep a check in their rapid expansion. One should expand at reasonable levels so that their liquidity is remained in check and they have enough cash generation to thrive even at lower capacity utilization that would enable them to pay off the debt easily.

There are few risk which has been for ages with the industry. Input Prices being very volatile is one such risk. Firstly, the input materials i.e. Steel Sheets, Plates and Coils are made through a combination of Iron Ore, Coal and Fluxes. The coal required for this input material is majorly imported. Due to volatility in currency markets, time and again the coal prices have increased considerably leading to higher manufacturing costs of our input materials. This led to higher input costs and not so higher realizations as passing the cost to customer is difficult here.

Steel Pipes & Tubes Prices if fell, led to lot of inventory draw down and write off losses in companies. Also, the user industry i.e. Oil & Gas industry should also have its commodity prices at reasonable levels i.e. Oil Prices. A fall in crude oil prices will led to lesser expansion plans by them and in turn the demand for steel pipes will fall. A continuous fall and subdued oil prices possess a greater threat especially for the companies which are too much dependent on only these user sector’s growth.

Hence, when any of the points above comes up in future, the risk of industry rises a lot. Risk leads to lower revenue and profitability. Hence, during these tough times only one thing that keeps the company afloat is liquidity. Cycles, they go up and down. But it is important companies survive during bad time and take opportunities to grow during good times. And the only one major criteria for companies to stay in business all the time is Money i.e. liquidity. Hence, with controlled debt levels and greater liquidity, the companies are well poised to mitigate the risk arising in the industry and they can sustain long periods of worse industry growths.

• Headwinds in Steel Pipes & Tubes Industry.

Headwinds are the problems which comes to company or segments for a shorter period of time. Companies sooner find a way to mitigate them, and keep the problems at bay. Hence, during such headwinds, although profitability reduces and revenue declines, it is usually a very temporary phenomenon and it is matter of time till everything gets back to normal levels.

There are a very few headwinds faced in steel pipes segment and the regular appearance of headwinds have enabled the companies to continuously monitor and change pro-actively. One such important headwinds is government regulation & technological obsolesce combined. Government in the recent past have made it compulsory for companies to upgrade their plant for BS IV compliant (For Automobiles) and BS VI compliant (For exploration & production activities). This change in compliance requirement has led to demand of high quality Steel Pipe & Tubes from Automobiles and Exploration companies. Hence steel pipes & tubes maker have to upgrade their plant/technology/machinery to make quality products as per requirement of user industry. Barring Gandhi Special Tubes, this issue has been successfully mitigated by Pipe & Tube companies with minimal CAPEX to upgrade their technology and machines to achieve better quality output and as per requirement of customers. Not only that, few companies have seen this as new opportunities and turned the tide in their favour thereby enjoying unexpected tailwinds.

Now, occurrence of these regular headwinds led to companies being proactive in automatically searching and upgrading to newer technologies. This enhances their production output quality and reduces unnecessary processes and costs.

Apart from these, companies have faced many such headwinds/risks and a lists of the same are presented below:

1. Environmental norms to control pollution leading to mines stoppage, late plant expansion approval from Environmental and Forest Department, etc.
2. New norms by government for BSVI/BSIV leading to upgrading new technology for quality products.
3. Restriction by government for import of certain Key Raw Materials and political tensions with exporting countries.
4. Financial Distress in domestic & international countries leading to lesser credit availability, higher interest on loans and in turn lower Economic Profitability.
5. Political Changes going on in domestic country and other major countries leading to temporary stoppage in order flow.
6. High competition both within and outside country especially at times of high inventory levels, low capacity utilizations & low demand.
7. Currency fluctuations affecting exchange inflow and outflow of company.
8. Volatile steel prices which are market determined, sometimes does not even beats inflation levels.
9. Other temporary factors/risks.

Now, above mentioned are only temporary issues and companies overcome them and get back to normality. Nowadays, due to environmental issues, clearing plant approval takes much time. It requires tedious process of submitting the required report to concerned department and wait for long time before it gets approved. And hence, although some plants approval gets stuck, but they get cleared more or less in short time.

Apart from that, government has imposed additional duty for import of certain steel products. This led to costly R.M acquisition and it took time to pass the new prices to the customers. Hence, these things keep on coming and industry automatically adjusts to it.

To summarise all the risks i.e. long-term as well as short-term, have a look at the below table for all the risks (majorly covered) the industry faces:

No.	Risk Parameter	Risk Assessment	Near-term Scenario	Future Scenario
1	Low Capacity Utilization & High Debt.	This leads to Lower Realizations & Higher Costs.	Companies find it difficult to survive, running on low cash income.	Very risky, when this continues for few years may lead to serious liquidity outcomes.
2	Business Cycles.	Risk of not predicting the cyclical moves.	Sometimes leads to unnecessary expansion, as during upwards cycles, growth is higher.	When capacities extended and cycles turn downside. Risk at point no 1 arises.
3	User industry risks.	Risk of low growth prospect of user of steel.	Lower growth leads to lesser revenue. Manageable for short periods.	Low growth for long periods may possess serious liquidity issues.
4	Price Risk.	R.M. Price risk & Oil Price Risk.	Leads to serious risk in revenue, costing and inventory.	If risk is for longer term, might question the liquidity of companies.
5	Competition Risk.	Competition leading to low realizations.	For short term, affects the profitability.	Long term completion leads to lower profit and liquidity issues.
6	Approval Risk	Risk of getting permission from govt. and EC/Forest authorities.	Sometimes take time for approval, CAPEX is blocked.	The issue gets resolved sooner and does not possess huge risk.
7	New Policy Risk	Risk of government bring up new policies.	Companies start technology, plant up gradation or adhere to policy norms.	Companies usually comply with the norms sooner.
8	Interest rate risk	High interest rates leads to reduced profit.	Less E.P. for shorter periods of time till interest rates normalizes.	Usually not believed to have greater impact on business.

Hence, I do hope we are all clear with the risk aspect of the industry. It is important to understand the risk parameters so as to be prepared to understand the impact on our industry if any of such risk arises in future. Some risk are very bad for the industry and some risk bring good of the industry i.e. especially headwinds. Therefore, to understand risk is important. If we do understand it properly, we can have a rough idea of future disruptions in the industry w.r.t. upcoming risk factors. And all these risk factors will help us to analyse the feasibility of industry or company which we are invested in, and how such risk factors will impact our investments.

I hope it is clear to you all regarding the risk aspect. Majorly we have covered the whole industry part and its analysis, but yet the conclusion is pending. Do check my next post regarding Industry’s conclusion.

Thank You!!

Source Links:

1. https://www.businesstoday.in/markets/company-stock/maharashtra-seamless-jumps-acquisition-ustpl/story/320529.html
2. http://164.100.158.181/interim_orders/hyderabad/10.02.2017/Kamineni%20Steel%20&%20Power%20India%20Pvt.%20Ltd..pdf
3. https://www.hindustantimes.com/business-news/npa-crisis-the-rise-and-fall-of-bhushan-steel-in-the-great-indian-debt-trap/story-GHrvRRFIBsMLXKJzbqvaFN.html#:~:text=Then%20on%20August%201%202014,Jain%20for%20a%20credit%20extension
4. https://finshots.in/archive/the-essar-steel-saga/
5. https://www.dnaindia.com/business/report-essar-group-a-saga-of-rapid-rise-in-the-last-couple-of-years-1526844

 

Disclaimer: Views are personal and presented through independent research. By no means there is any stock advice. Also, presented content is for learning purpose only. I might be wrong in presenting data and inaccurate data, let me know if you find any discrepancies.