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Metals & Mining
India
3QFY11E preview—a strong quarter likely for non-ferrous companies. We expect
a strong quarter for non-ferrous companies led by sharp sequential and yoy increase in
commodity prices. Domestic operations of steel companies may have a better quarter
on a sequential basis led by a marginal uptick in steel realization and deliveries, while
international operations may suffer from reduced profitability. Our outlook remains
bright and we continue to prefer integrated players. Hindalco, Sterlite and Tata Steel
are our top picks in the sector
Sequential improvement in earnings for non-ferrous companies
We expect the performance of non-ferrous companies to improve sequentially, aided primarily by
higher commodity prices during the quarter. Prices of all non-ferrous metals have increased on a
sequential as well as yoy comparison; the average aluminium price was US$2330 for 3QFY11 (up
12% qoq, 27% yoy) and zinc was US$2341 (16% qoq and 5% yoy). Exhibit 1 gives details of the
average LME prices over the previous few quarters. The cost of production is likely to be at similar
levels compared to the last quarter. This will translate into 16 to 75% growth in earnings on a qoq
basis.
We expect solid EBITDA growth on yoy comparison for Hindalco and Nalco. Hindustan Zinc may
report solid sequential performance, though earnings on a yoy comparison may decline on
significant increase in cost of production. Sterlite will likely report modest yoy growth in EBITDA
led by improvement in aluminium and copper smelting business performance
Steel companies’ performance may be a mixed bag
We expect steel companies’ performance to be a mixed bag—while domestic operations may
improve sequentially, international operations may be a drag. A marginal increase in steel prices on
a sequential basis (US$15/ ton) may help domestic business performance. However, a rise in input
costs (iron ore and coking coal) may hurt profitability on a yoy comparison except for integrated
players. We expect modest performance from JSW Steel.
Key focus areas
Expect investor focus on (1) indications of demand strength; (2) profitability guidance for the Mar’
2011 quarter by steel companies; (3) impact on profitability from the recent spike in coking coal
led by floods in Queensland forced miners to invoke force majeure clause. This may force buyers to
procure coking coal in the spot market at higher prices.; (3) progress on greenfield and brownfield
expansion plans; (4) preliminary assessment of the impact of proposed mining tax in India and
(5) status of approvals for various mine allocation applications.
Strong play on volume growth; reiterate Attractive coverage view
Indian metal stocks are a strong play on volumes; we forecast volume growth of 20-30% from
FY2012-13E for the India business of the metals sector. More important, volume growth will be
profitable since most of the capacity expansion has raw material integration. Most of the stocks
are approaching our fair valuation and we highlight that (1) our estimates are based on
conservative commodity price assumptions. Exhibit 2 compares spot commodity prices with our
forecast, and (2) our valuations do not include value accretion from projects that may commence
production in late FY2012E and early FY2013E. Tata Steel, Hindalco and Sterlite are our top picks
in the sector.
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