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Metal & Mining: Steel to remain volatile;
non-ferrous a function of fund flows
Key themes for 2011
For base metals the key theme, in our view, would be the
behavior of the financial investor and the US$ weakness.
For aluminum, while inventory levels continue to move
up, near-term tightness in physical availability means
LME prices are likely to remain supported at elevated
levels in the near term. The key themes for steel over the
next year are increasing raw material prices and
overcapacity in the domestic flat steel market. We
believe that the large addition in flat steel capacity (JSW,
Essar, Bhushan, Tata Steel) over the next two years will
squeeze the domestic price premium on steel and could
make cost-push-driven price rises difficult.
How the business is expected to evolve through the
year
Steel: We expect FY12E/CY11E to be similar to last
year with both steel prices and equities moving up in 1H
and likely correcting in 2H. Over the next few months a
combination of demand recovery, severe cost push in raw
materials, particularly coking coal and scrap should drive
up steel prices. Domestically, increasing flat steel
capacity combined with sluggish demand should result in
domestic prices lagging global prices in our view. We are
also likely to see a repeat of the mismatch of steel prices
and costs with margins likely expanding in the March-11
quarter and moving down from there. We would focus on
coking coal prices and availability post the seasonal rains
in Australia.
Coal: Production and offtakes continue to lag targets due
to law & order issues, MoEF directives impacting
production and logistic bottlenecks. We wait for more
clarity on MOEF directives as the same would be a key
driver for Coal India’s volumes.
Base Metals: Coal is likely to be a key cost driver for
Indian aluminum companies given coal cost escalation
seen recently. Aluminum production could spike up
sharply as China’s NDRC energy saving drive comes to
an end.
Indian metal companies have seen significant equityraising
in 2010 and there are still a few large one in the
pipeline for the 1H CY11. We believe 2011E is likely to
see further equity issuance in the Indian steel space.
Sector view
We expect a volatile year across metal equities in
CY11E. Steel is likely to be volatile and given the
inherent over capacity sustainability of any steel price
rally looks difficult over the course of the year.
Stock recommendations
Our top pick in the sector remains Sterlite Industries
given the strong volume growth from zinc and earnings
growth from power sale (2400MW+the power from
aluminum segment). In steel, we expect Tata Steel to
outperform as any cost-push based price increase will
flow through to the bottom line given its integrated
domestic operations. We remain UW on Nalco given the
unattractive valuations, and JSW Steel as we believe the
volume growth and improved balance sheet are built into
the stock price.
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