Key Sectoral Tailwinds: - Decarbonization / Hydrogen Tech Costs Exorbitantly High - European Carbon Border Tax - Could this Disrupt Global Trade? - Policy Changes in China Result in Global Steel Prices Spike - Domestic steel demand expected to remain robust Key Highlights: Hydrogen & Carbon Capture are currently the known technologies to greening steel. Any technology involving the mix of the two would increase the steel-making cost by 25%-60%. With R&D/capex costs being steep, the ongoing projects (mostly European) are likely to add only 1% of steel capacity by CY30. The concept of "carbon pricing" -- levying a charge for each metric ton of carbon dioxide emitted by industry - is well embedded in many countries' climate and sustainability policies. But the EU's carbon border adjustment mechanism, better known as a carbon border tax, is the first time pricing and will apply equally to imports. Thus, the impact will reverberate through global value chains and could redefine the competitive balance between nations in many industries. It will also provide a renewed impetus for producers around the world to accelerate efforts to slash their carbon footprints. China's top steel producers have fixed peak CO2 emission for CY22-CY25, which is expected to peak by CY30. Baowu, HBIS and Ansteel (largest steel producers in China) have set peak CO2 emissions during CY22-CY25. While the modalities of achieving these must be seen, any meaningful reduction in CO2 emissions would involve costlier capex/raw material and process cost. We expect India's steel utilization to remain high over FY21-FY24E, notwithstanding the capacity addition announcements in recent times. Indian producers have planned 32mtpa capacity addition over FY21-FY25, which is largely back-ended, and we note that it will just manage to keep up with the expected demand. Given the spike in leverage between FY19 to 1HFY21, most steel majors deferred their expansion projects and focused on deleveraging. In the long term, with challenges around greenfield additions, we believe India is unlikely to see a supply surge despite an improvement in balance sheets. ESG Analysis: Analyzing JSW Steel (JSTL), Godawari Power & Ispat (GPIL), Steel Authority of India (SAIL) and Manganese Ore India Ltd. (MOIL) on 20 key criteria under ESG Matrix, we have assigned an overall score of 59% to JSTL, 62% to GPIL, 60% to SAIL and 62% to MOIL respectively. Under "Environmental Head", we have assigned 47%/50%/41%/53% score to JSTL/GPIL/SAIL/MOIL, as BOF technology of Steel making is the most polluting route along with mining, which pose a great danger to the environment. Under "Social Head", we have assigned 64%/70%/66%/63% score to JSTL/GPIL/SAIL/MOIL. Under "Governance Head", we have assigned 65%/65%/75%/72% score to JSTL/GPIL/SAIL/MOIL (please refer to page no.4 for detailed ESG analysis). Initiate Coverage with a POSITIVE View We initiate coverage on the Indian ferrous sector with a positive outlook. We believe that domestic steel companies are well-positioned to benefit from the multi-year high spreads due to structural advantages. In our view, China is serious on its path to control production, lower exports and decarbonize, whereby there will be higher capex/opex. Hence, structurally we see better spreads compared to the past cycles. Further, the Indian steel industry's demand is poised to grow with considerable investments expected in the construction, infrastructure, and manufacturing sectors in view of the expected economic revival over the next few years. We initiate coverage on 4 companies and rate JSW Steel (BUY, Target Price Rs808), GPIL (BUY, Target Price Rs551) as our top picks in the sector, while remaining positive on SAIL (BUY, Target Price Rs131) and MOIL (BUY, Target Price Rs233). Link to the report

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