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METALS AND MINING
Fair quarter; improved outlook: Q3FY11 Result Preview: Edelweiss
Key highlights of the sector during the quarter
Ferrous: Q3FY11 saw a sequential increase in average flat and long product
prices of 1.4% and 3.6%, respectively (Source: Steel prices - India, CRISIL).
Companies have increased prices of long products by INR 1,000/t and flat by INR
500-700/t in December. Global HRC prices also remained firm during the quarter
and towards the end rose between USD 25/t and 125/t across regions. Moreover,
coking coal contract prices for Q3FY11 were down ~7% at USD 210/t. The above
factors combined together should result in increased profitability for most steel
companies. However, Tata Steel Europe would see lower EBITDA/t of only USD 29
due to the seasonally lower volumes and marginal decline in prices.
Non-ferrous: LME prices of base metals are up both Y-o-Y and Q-o-Q, with
copper and aluminium up 30% and 17%, respectively, Y-o-Y. Base metal
companies are likely to witness improved margins Q-o-Q as costs are expected to
remain constant, while prices are up Q-o-Q. However, rupee appreciation of 4%
Q-o-Q will adversely impact earnings to an extent.
Result expectations for the sector and stocks under coverage
For ferrous companies, we expect EBITDA/t to increase Q-o-Q due to lower coking
coal costs and increased product prices, though volumes are expected be flat Q-o-Q.
SAIL is likely to benefit from reduced volumes of carryover coking coal (@FOB USD
300/t), while JSPL’s 135 MW power plant could add to earnings. Bhushan Steel is
expected to benefit from its backward integration and lower proportion of coking
coal.
In the non-ferrous space, production volumes for most companies are likely to be
flat Q-o-Q. With prices increasing across base metals and costs likely to be stable,
margins are expected to improve Q-o-Q. Nalco could witness significant margin
improvement in Q3FY11 as its power costs are likely to decline with linkage coal
supply proportion increasing Q-o-Q. Sterlite’s power plant has commenced
generation, but earnings are unlikely to be affected since commercial operation
hasn’t begun. Hindalco‘s aluminium volume is up sequentially but copper is down
due to breakdown of cooling tower of sulphuric acid plant during the quarter.
Outlook over the next 12 months
Ferrous: As anticipated, steel companies have announced price hikes of INR 1,000-
1,500/t in January, factoring in both demand pull and cost push. We maintain our
view that iron ore prices have peaked and have a downside risk. Moreover, with
demand picking up both in developed world and emerging economies (particularly
India and China), steel fundamentals have improved. We expect steel prices to
increase by USD 75 to 100/t over November levels and margins to expand by USD
40-50/t in FY12.
Non-ferrous: Base metal prices have rebounded sharply with prices increasing 12-
19% sequentially. We believe that underlying demand continues to remain strong.
We do see tightness developing in aluminium, leading prices to rally to USD 2,550/t
in FY12.
Recommendations
Top picks: Ferrous: Tata Steel, JSW Steel, Bhushan Steel.
Non-ferrous: Hindalco.
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