June 27 (Bloomberg) -- Steel Authority of India Ltd., besieged by falling demand and prices, is bracing for a further erosion in earnings after a government panel recommended an increase in royalty fees for iron ore, a key raw material.
The nation’s second-largest steelmaker, whose mines deliver all its iron ore needs, will pay 50 percent more royalties to provinces where its quarries are located should the proposals be implemented. The tax will rise to 15 percent of sales from 10 percent, according to the panel report, to be submitted to Mines Minister Dinsha J. Patel this month and later for Cabinet approval, two people familiar with the matter said yesterday.
“We’re already hard-pressed and an increase in royalty will make things worse,” Steel Authority’s Raw Materials Director Kalyan Maity said in an interview. “Looking at the demand situation, we’ll have to absorb the cost.”
While higher ore costs will also hurt other Indian steelmakers including Tata Steel Ltd. and JSW Steel Ltd., Steel Authority will be the hardest hit as it produces lower-margin products and incurs higher wage and fuel expenses than its peers. Indian iron ore being cheaper than imports, miners such as NMDC Ltd. and Sesa Goa Ltd. are likely to pass on the increase in cost to their customers, said Prasad Baji, an analyst with Edelweiss Financial Services in Mumbai.
“While mining companies will be able to increase their prices, steelmakers will find it difficult to do the same because of waning demand,” said Baji, who changed his rating on Steel Authority shares to hold from buy this month. “We were counting on a demand growth of as much as 4 percent this quarter. In the first two months, it was just 1 percent.”
The decision to increase the tax was taken considering the profitability of iron ore miners at current prices, one of the officials said. The royalty is calculated on the basis of a benchmark price set by the state-run Indian Bureau of Mines.
Steel Authority rose as much as 2.3 percent to 51 rupees and traded at 50.30 rupees as of 9:29 a.m. in Mumbai. Tata Steel advanced 1.6 percent to 268.85 rupees, while JSW Steel rose 1.1 percent to 652.70 rupees. Steel Authority, with a 45 percent drop, has been the biggest loser among India’s three largest steelmakers this year.
Its profitability is also the lowest of the three. The company reported earnings before interest, tax, depreciation and amortization of 5,064 rupees ($83) a ton, less than a third of bigger rival Tata Steel’s Indian operations and about 20 percent lower than JSW Steel, the third-biggest producer.
Profit for the year ended March 31 at Steel Authority fell to the lowest in a decade, dragged by an increase in finance costs to fund a 721.3 billion rupee expansion plan that seeks to raise annual crude steel output by 60 percent.
The slowest economic growth in a decade in the last fiscal year halted construction, while sales of automobiles, a key consumer of steel, declined. Car sales in the year ended March 31 fell for the first time since 2001 as high interest rates kept buyers away.
“If the panel’s recommendations are accepted, it would adversely impact the profitability of domestic steel companies,” ICICI Securities Ltd. analysts Dewang Sanghavi and Shashank Kanodia said today in a report. “Taking into account the current weak state of the industry, we believe the recommendations may not be accepted by the mines ministry.”
Steel Authority’s average selling price fell 11 percent from a year ago to 34,489 rupees a ton in the three months ended March 31, Chairman C.S. Verma said in May. The company expects prices to fall from that level in the present quarter, Ram Modi, an analyst at Dolat Capital in Mumbai wrote in a June 21 report.
While large iron ore producers may be able to pass on costs, smaller miners would find it a challenge, said R.K. Sharma, secretary general at Federation of Indian Mineral Industries, a lobby group. Higher taxes would also hurt India’s export competitiveness, he said.
“Increase in royalties will mean the demise of many small miners and will have a cascading effect on prices,” Sharma said in a phone interview. “Increase in costs can wipe out India’s participation in the iron ore export market as prices are falling.”
Global iron ore prices have declined 21 percent this year. Ore at China’s Tianjin port fell to $114.20 a ton as of June 26, according to data compiled by Bloomberg.
Prasun Kumar Mukherjee, managing director at Sesa Goa declined to comment on the impact of higher royalties. NMDC Finance Director Swaminathan Thiagarajan couldn’t be reached on his mobile phone.
The planned increase in taxes will precede the country’s new mining law, which will require miners to set aside an amount equal to royalty payments for social welfare programs. The law is awaiting parliament’s approval.
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