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Metals
During 3QFY2011, steel prices remained muted on a qoq basis,
as appreciating INR led to price cuts in November, reversing
October gains; but later in December, companies hiked steel
prices by `500/tonne. Base metal prices also witnessed huge
volatility during the quarter; however, prices increased by
11-19% qoq due to Chinese production cuts and US Treasury
commitment to buy US $600bn treasury securities.
During 3QFY2011, the BSE metals index outperformed the
Sensex by 2.1% and gained 4.3% in absolute terms. A series of
industry and corporate events took place during the quarter,
which dictated the direction of few stocks. In the ferrous space,
Tata Steel topped the charts, outperforming the Sensex by 2.2%,
on account of Rio bidding for Riversdale, in which Tata Steel
holds a 24% stake. SAIL underperformed the Sensex by 13.2%
on reports that its FPO price would be at lower levels. Sesa
Goa underperformed the Sensex by 1.9%, while NMDC
outperformed by 4.3%. On the non-ferrous front, Hindustan
Zinc, Hindalco and Sterlite outperformed the Sensex by 24.1%,
22.8% and 9.6%, respectively, on account of higher LME prices.
Ferrous sector
Steel companies hiked steel prices by `1000/tonne in October,
which was reversed in November to counter cheaper imports
as the INR appreciated against the USD. However, in December,
companies increased prices by `500/tonne on the back of
improvement in demand and rising raw-material prices.
In 3QFY2011, average world HRC prices marginally increased
by 1.2% qoq to US $675/tonne (up 20.3% yoy). Average
Chinese export prices showed a flattish trend qoq and were
higher by 24.2% yoy to US $615/tonne. Average domestic HRC
prices increased by 1.0% qoq to `35,000/tonne and 6.6% yoy.
Domestic steel demand remains strong: As per the steel ministry,
Indian steel consumption for FY2011 is expected to grow at
10%. In the eight months of FY2011, steel consumption rose by
7.2% to 43.5mn tonnes, while steel production grew by 5.0%.
For 3QFY2011, we expect steel companies to register higher
sales volume growth of 4-14% yoy.
Major events
Coal India (CIL) and MOIL debut: While CIL's issue, which
mopped up `15,200cr in October, was the biggest IPO in the
history of the Indian capital market, MOIL was subscribed 55x,
the highest total subscription multiple witnessed this year. On
the listing day, CIL and MOIL closed higher at 40% and 24%,
respectively.
JSW Ispat Steel: JSW Steel will buy a 41.3% controlling stake in
Ispat through fresh equity issuance of 108.6cr for `2,157cr
(acquisition price: `19.85/share). We believe the acquisition is
positive for JSW Steel in the long term, as it will become India's
largest steel company with a total capacity of 14.3mn tonnes.
With operational synergies expected to accrue in FY2012, Ispat
is likely to post positive EBITDA/tonne of US $50. Moreover, as
and when Ispat's capex projects (coke over, pellet and power
plant) are completed, EBITDA/tonne is likely to increase to
US $100-125.
Rio bidding for Riversdale: Rio Tinto made a bid of AUD3.5bn
(AUD15/share) to take over Riversdale Mining, in which Tata
Steel has a 24.2% stake, and later revised it to AUD3.9bn
(AUD16/share). International Coal Ventures Ltd., comprising
SAIL, CIL, NTPC, RINL and NMDC, is also reportedly in the
race for Riversdale and has appointed Citigroup to conduct a
due diligence on Riversdale. While a counter bid from Tata Steel
seems unlikely, given its high leverage, we believe Tata Steel
will continue to hold on to its existing stake and may not sell out
as its investment in Riversdale is of strategic importance and
will help in increasing the raw-material integration level at Tata
Steel Europe.
Karnataka High Court upholds ban on iron ore, iron ore exports
decrease: On November 19, 2010, the Karnataka High Court
upheld the government's decision to halt iron ore exports. Iron
ore exporters have contested the ban and the matter is now
being heard by the Supreme Court. Next hearing by the Supreme
Court is expected in the third week of January 2011.
According to the FIMI, Indian iron ore exports for November
were down 30.6% yoy to 8.1mn tonnes. Total iron ore exports
for April-November were down 16% yoy to 54.6mn tonnes.
Sesa Goa closes third-party operations in Orissa: Sesa Goa
has closed its mining operations in Thakurani mines in Barbil,
Orissa, from December 1, 2010, as it was unable to renew the
mining contract on viable commercial terms on a long-term
basis. Sesa Goa started operating the Thakurani mines from
1999 under a 10-year contract that expired in June 2009. Since
then, the company has been carrying out its operations on shortterm
renewals. In FY2010, iron ore sales volume from Orissa
mine stood at 1.9mn tonnes. In our view, Sesa Goa's volume
growth is at risk, given the closure at Orissa and ban in
Karnataka.
Sterlite acquires Skorpion Zinc Mine - First phase of the Anglo
Zinc acquisition: During the quarter, Sterlite completed the
acquisition of Skorpion Zinc Mine (Namibia) from Anglo for
US $707mn. The Namibian asset is part of the acquisition of
Anglo American's zinc assets announced in May 2010 for a
consideration of US $1,338mn. As per Sterlite, the acquisition
has been undertaken by its wholly owned subsidiary Sterlite
Infra, as against intended under Hindustan Zinc because the
Indian government's approval was not received within the
contractual completion timeline for Skorpion. The acquisitions
of the other two mines (Lisheen mine and Black Mountain mines)
are expected to be completed by 1QFY2012.
GoM approves new mining policy: The Group of Ministers
(GoM) has approved the draft mining bill, which provides for
sharing 26% of mining profits with locals. The approved draft
will now be placed before the cabinet. As clarifications are
required on the implementation of the bill, we feel mining stocks
will remain under pressure in the near term.
4QFY2011 raw-material prices fixed higher: The settlement of
benchmark coking coal contracts for the January-March 2011
quarter was higher by 7.7% at US $225/tonne (US $209/tonne
for October-December 2010). In case of iron ore negotiations,
media reports suggest a hike of 7-10% over 3QFY2011. During
the quarter, average spot iron ore prices for 63% Fe grade (CFR,
China) were up 63.4% yoy and 14.0% qoq to US $163/tonne.
Outlook
Iron ore prices to remain firm on supply disturbances: We expect
iron ore prices to remain firm because of the continuing ban
on exports by Karnataka. Further, Chinese iron ore imports
increased by 25.5% mom to 57.4mn tonnes in November, thus
providing support to prices.
According to World Steel, global capacity utilisation levels have
marginally increased to ~75% in 3QF20Y11E as compared to
73-74% in 2QFY2011. With increasing raw-material prices and
low inventory levels, companies are expected to raise prices by
`1,000-1,500/tonne in January. We expect steel prices to remain
firm in the coming months.
3QFY2011 expectations: For 3QFY2011, we expect steel
volumes to increase, aided by higher realisations. Thus, the top
line of the steel companies under our coverage is expected to
grow by 7-26% yoy. However, due to relatively higher
raw-material costs, margins of steel companies are likely to
contract by 440-940bp yoy-except for Tata Steel, which is
expected to report a 166bp margin expansion. For Sesa Goa,
the top line is expected to marginally dip on account of lower
iron ore sales volume. We remain positive on Tata Steel and
JSW Steel.
Non-ferrous sector
The quarter witnessed great volatility with 1) temporary tightness
in the Chinese domestic market due to energy conservationrelated
production cuts; and 2) metal prices touching record
high in early November, after the Federal Reserve announced
that it would buy US $600bn of treasury securities. However,
base metals fell the most in mid-November, as China raised
the reserve requirement for the fifth time (the sixth hike came in
December). However, the loan package of 85bn agreed
between Ireland and the EU supported prices thereafter.
During the quarter, average LME prices of copper, aluminium,
alumina, zinc and lead increased by 11-19% qoq and 4-30%
yoy. During the quarter, copper touched new highs of
US $9,405/tonne. Aluminium touched 2010-high of
US $2,453/tonne, while zinc and lead were also close to their
2010 highs.
On a yoy basis, inventory levels of copper and aluminium, at
the LME warehouse, were down 24.8% and 7.6%, respectively,
but were higher by 43.7% and 42.2% for zinc and lead,
respectively.
Outlook
In our view, the key positives for base metal prices are ongoing
economic recovery, tighter market balances and emergence of
restocking activity. Further, the launch of the physically backed
base metals exchange traded funds could be another trigger.
However, developments in China need to be closely watched
as frequent tightening of the monetary policy to contain inflation
can be somewhat discouraging.
We expect non-ferrous companies to register positive top-line
growth of 7-21% yoy, owing to a surge in LME prices. While
Nalco is expected to report margin expansion of 434bp yoy,
Hindustan Zinc's margin is expected to contract by 693bp yoy
on account of higher operating cost. We maintain our
Accumulate rating on Sterlite.
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