February , 2019
The IBC can transform the Indian steel sector
12:15 pm

S. G. Choudhary

The Indian steel industry had suffered in the past from the structural ailment of fragmentation. Consolidation efforts were offset by growth in secondary steel units with low capacities, leaving the steel industry highly fragmented. This resulted in structurally imbalanced industry dynamics where capacity utilisations remained depressed for extended periods and average earnings before interest, tax, depreciation and amortisation (EBITDA) margins remained low. The fallout of the fragmented steel industry resulted in underutilisation of capacities due to high cost of production. Since steel making is a capital-intensive process, the following aberrations crept in gradually.

Obsolete technology

Older technology of smelting and steel making is expensive with inefficient utilisation of raw materials and yield inferior quality products. The old technology could not be updated as the investment needed for modernisation was beyond the means of smaller fragmented industry segment.

Lack of technological innovation

Global standards of steel making requires introduction of eco-friendly technologies in the mining and production process. With the help of technologies like recycling of steel, production efficiency, etc. steel making units can sustain and remain competitive globally.

Scarce resources

Depleting resources and reserves of iron ore and other raw materials is one of the biggest challenges. On one hand, competition is increasing and on the other hand, resources are limited and are being utilised less efficiently.

Lower margins for fragmented players

Margins at global steel-making groups have inevitably contracted as prices have started falling faster than raw materials. Steel prices normally track iron ore, the metal’s main ingredient. But the sharper pace of the steel price’s decline squeezed the ‘spread’ that producers earn. Smaller steel plants use raw materials less efficiently and produce inferior quality of steel thereby losing pricing power.

However, post-implementation of the Insolvency and Bankruptcy Code (IBC) code, India has the opportunity to consolidate, increase competitive advantage for steel enterprises with sustained higher margins through innovation in process, product, business models and scale. Historically, India’s steel industry has been composed of the less capitally intense secondary steel sector whose smaller scale induction furnaces and coal based sponge iron units did not have the scale or the operational efficiencies to support a sustainable business model in the long run. At the same time, steel capacities were set up on unsustainable leverage through bank debts. The industry downturn accelerated the exposure of these fundamental weaknesses and the IBC code based restructuring of these distressed assets is driving the structural transformation of the industry. The resulting buyouts are creating more concentrated and productive steelmaking capacity. A particular case in point is the successful acquisition of Bhushan Steel (BSL) by Tata Steel where the marketing, product mix, operational and procurement synergies could be significant. There have been opinions that Tata’s acquisition of BSL at over Rs. 35,000 crore may have been value destructive. But if one takes the synergies and the replacement value of the BSL asset, including the optionality of expansions and the time value of foregone cash-flows, BSL’s value can be considered well worth the price.

At a time when the steel industry is enjoying a good time in terms of price realisation, the IBC process provides the existing large players with a rare opportunity to acquire working assets at an optimum valuation.

Deleveraging of balance sheet of steel companies due to optimum level of debts backed by sustained margins shall result in a robust steelmaking capacity. At the same time, resolution of stressed companies will lead to debt reduction due to haircut by lenders as well as expected improvement in margin on change of management could reduce the sector leverage. Stressed steel asset acquisitions by large operating companies are expected to lead to an increase in the sector consolidation. Consolidation is an important step that sets the stage by removing the structural impediments that will increase concentration, market power, productivity and industry margins. Consolidation aids a pure operational efficiency play on common available technologies, which eventually results in a more oligopolistic and reasonably profitable market with a steeper industry cost curve. It is most likely that future competitive advantage for steel enterprises with sustained higher margins above the industry average will come through innovation in process, product and business models. Eventually, consolidated steel companies which embrace digital transformation, design intelligent plants, build flexible and resilient capacities, innovate on raw materials and the supply chain and introduce new steel technologies will augment growth for the sector.

The resolution of distressed steel assets under the IBC will alter the country’s steel landscape as more consolidation will take place. Currently, around 22 MT of crude steel capacity is up for restructuring and acquisition under the first round of companies referred to the National Company Law Tribunal (NCLT) for insolvency resolution. This accounts for close to Rs. 3.26 lakh of crore of debt in the sector. In the first round of 12 companies which were referred to the NCLT by the RBI, steel companies like Essar Steel, Bhushan Steel, Bhushan Power and Steel, Monnet Ispat and Energy and Electrosteel Steels were featured. Finance Minister Arun Jaitley recently said that Rs. 80,000 crore has been recovered by creditors in 66 cases resolved by NCLT and around Rs. 70,000 crore more is likely to be realised by March-end. He stated, “In 66 resolution cases, realisation by creditors was around Rs. 80,000 crore... Some of the big 12 cases such as Bhushan Power and Steel and Essar Steel India are in advanced stages of resolution and are likely to be resolved in this financial year in which realisation is expected to be around Rs. 70,000 crore.” 

The IBC is heralded as the biggest reform in the Indian banking sector. Introduced in 2016, the IBC replaced existing schemes such as Corporate Debt Resolution (CDR) and Strategic Debt Restructuring (SDR). Rating agency Crisil in its report said the resolution of these cases will alter India’s steel sector landscape as nearly over half of its outstanding debt of Rs. 3.26 lakh crore will stand resolved and about a fifth of India’s crude steel capacity held by these companies will move to stronger hands.

Road ahead

India is now the second largest steel producer in the world. The National Steel Policy, 2017, has envisaged 300 million tonnes of production capacity by 2030-31. Resolutions under NCLT would be an added benefit. Around 22 million tonnes (MT) or a fifth of India’s crude steel capacity is expected to swing to larger domestic and/or international players as part of the first round of stressed assets resolution under NCLT and will aid the sector’s growth. 

— The writer is an Insolvency Professional having decades of experience in steel Industry.

[The opinions expressed are his own.]


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