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Metals & Mining
Positive on aluminium/steel/coking coal; negative on copper/iron ore
INR appreciation, regulatory risks are an overhang on the sector
Tata Steel is our top pick for 2011, followed by Hindalco
2011 sector outlook
We prefer aluminium to copper, and steel to
iron ore. We believe the 20-year high in the
copper-to-aluminium ratio will trigger substitution
from copper into aluminium over the next few
years, and high off-exchange inventories will push
down copper prices which do not have cost
support. Aluminium, on the other hand, will
benefit from the substitution and is well supported
on the cost curve despite idle capacity in China.
We also believe steel profit margins will bottom
over the next couple of quarters as global
utilization rates rise to over 80% due to continued
lower production growth in China and decent
demand growth across the globe. We are negative
on iron ore as we believe restarts in Indian ore
exports next year will pressurize iron ore prices
which are not well supported by the cost curve.
For Indian Metals stocks, we expect 2011
(FY12e) to register a strong 14% y-o-y growth in
revenues and 18% growth in EBITDA led by
stronger commodity prices and supported by
decent volume growth (c9% in non-ferrous and
steels; c17% in bulks).
Commodity prices (positive for aluminium/steel):
Commodity prices have seen strong upswings in the
last quarter of CY10 due to issues ranging from
supply shocks stemming from regulatory issues (iron
ore) and US dollar weakness. In 2011, we expect
aluminium prices to increase 7% over CY2010 led
by Chinese output cuts and higher power costs. ETF
launches could be wildcards providing further
upside. We expect the ban on iron ore exports in
Karnataka to be lifted in Jan-11 and a declining trend
in global iron ore prices throughout 2011. While
steel demand has recently been in a lull after a slump
in construction-related demand owing to an extended
monsoon, we believe underlying demand remains
strong and, together with high input costs, will
warrant an increase in domestic steel prices going
forward. Also with the removal of export rebates, a
clampdown on capacity and our house expectation
of strong demand, we see Chinese imports into India
being a smaller threat in 2011.
INR appreciation (mostly negative): However,
an appreciating rupee remains a major negative
risk in terms of steel imports into India, which in
turn might prevent significant steel price
appreciation. On the flip side, for the less
integrated players, such as JSW Steel, it would
mean lower raw material costs. Base metal
players may lose out on conversion into INR. The
effect may be pronounced for Hindalco, wherein
benefits from a stronger Novelis may be partly
offset by a stronger INR. HSBC forecasts the INR
to appreciate c6% vs the USD in 2011.
Regulatory issues (negative): The Mineral
Development and Regulation (MMDR) bill, when
passed in parliament, could have a negative
impact on miners’ earnings in 2011. The bill
would require companies to share 26% of their
profits with tribal groups displaced by mining
activities. Also, with the issue of mining leases
without “value add” in mineral-rich states like
Orissa becoming increasingly difficult and global
steelmakers vying for a share of the growth in
domestic steel consumption, 2011 could see more
M&As and JVs between steelmakers and iron
miners or between international and smaller
domestic steelmakers. Key tie-ups between
steelmakers and miners announced in 2010 were
Severstal-NMDC for a 5mtpa plant in Karnataka
and POSCO-SAIL JV for a 3mtpa FINEX
technology plant that utilizes iron ore fines (SAIL
is India’s second largest iron ore miner).
Overall going into 2011, we prefer steelmakers to
iron ore miners and in non-ferrous we prefer
aluminium to copper and zinc.
2011 top picks
Tata Steel, OW(V), TP INR730
Tata Steel is our top pick in the steel space due to
its high operating and financial leverage which
helps it benefit most from steel price increases.
The 2.9mtpa expansion at Jamshedpur should
complete by 2HFY12. While we have not
accounted for upside from raw material projects in
our model, projects such as Mozambique coal and
Canada DSO projects which start flowing in in
2HCY12, could provide USD300m of potential
EBITDA increase after full commissioning.
Our target price of INR730 is based on FY12e
EV/EBITDA of 6.5x. Our target EV/EBITDA is
based on the historical trading average of the past
five years, which we think is fair considering the
business dynamics of TATA are not likely to
change materially over the next couple of years.
TATA has historically traded in a one-year
forward EV/EBITDA range of 5-7x, which forms
the basis of our primary valuation of TATA’s
businesses at FY12e EV/EBITDA of 6.5x.
Since a large amount of incremental growth in
diluted EPS is driven by increase in volumes,
timely expansion is critical. In addition, lowerthan-
estimated steel prices and higher-thanestimated
coking coal costs pose negative risks to
our estimates of TATA’s earnings.
Hindalco, OW(V), TP INR260
We expect Hindalco to benefit from 7% higher
aluminium prices y-o-y in FY12. In addition, we
expect Novelis (wholly-owned subsidiary
acquired in 2007) to post 16% y-o-y growth in
EBITDA (USD1.1bn). Hindalco currently trades
at FY12e EV/EBITDA of 6.6x against a global
aluminium players market weighted average of
7.9x. The stock trades at 1.2x PB with an FY12e
ROE of 13% against a global average of 1.4x and
an average ROE of 10%. With the bulk of
capacity expected in the latter half of FY12e, we
expect FY13e ROE to jump to 18%.
Our primary valuation of HNDL is based on
2012e EV/EBITDA of 7.0x for the standalone
business and other businesses and 8.0x
EV/EBITDA for Novelis. Our valuation
comprises enterprise values of INR156 per share
for HNDL’s standalone business, INR207 for
Novelis and INR25 for other businesses; it
deducts INR123 per share in net debt.
Lower-than-estimated aluminium prices pose
negative risks to HNDL’s standalone earnings.
High financial leverage creates high earnings
sensitivity and is negative in downcycles. In
addition, increasing competition may pose a risk
to incremental volume offtake for Novelis.
India Equity Research Reports, IPO and Stock News Visit http://indiaer.blogspot.com/ for complete details �� ��
Metals & Mining
Positive on aluminium/steel/coking coal; negative on copper/iron ore
INR appreciation, regulatory risks are an overhang on the sector
Tata Steel is our top pick for 2011, followed by Hindalco
2011 sector outlook
We prefer aluminium to copper, and steel to
iron ore. We believe the 20-year high in the
copper-to-aluminium ratio will trigger substitution
from copper into aluminium over the next few
years, and high off-exchange inventories will push
down copper prices which do not have cost
support. Aluminium, on the other hand, will
benefit from the substitution and is well supported
on the cost curve despite idle capacity in China.
We also believe steel profit margins will bottom
over the next couple of quarters as global
utilization rates rise to over 80% due to continued
lower production growth in China and decent
demand growth across the globe. We are negative
on iron ore as we believe restarts in Indian ore
exports next year will pressurize iron ore prices
which are not well supported by the cost curve.
For Indian Metals stocks, we expect 2011
(FY12e) to register a strong 14% y-o-y growth in
revenues and 18% growth in EBITDA led by
stronger commodity prices and supported by
decent volume growth (c9% in non-ferrous and
steels; c17% in bulks).
Commodity prices (positive for aluminium/steel):
Commodity prices have seen strong upswings in the
last quarter of CY10 due to issues ranging from
supply shocks stemming from regulatory issues (iron
ore) and US dollar weakness. In 2011, we expect
aluminium prices to increase 7% over CY2010 led
by Chinese output cuts and higher power costs. ETF
launches could be wildcards providing further
upside. We expect the ban on iron ore exports in
Karnataka to be lifted in Jan-11 and a declining trend
in global iron ore prices throughout 2011. While
steel demand has recently been in a lull after a slump
in construction-related demand owing to an extended
monsoon, we believe underlying demand remains
strong and, together with high input costs, will
warrant an increase in domestic steel prices going
forward. Also with the removal of export rebates, a
clampdown on capacity and our house expectation
of strong demand, we see Chinese imports into India
being a smaller threat in 2011.
INR appreciation (mostly negative): However,
an appreciating rupee remains a major negative
risk in terms of steel imports into India, which in
turn might prevent significant steel price
appreciation. On the flip side, for the less
integrated players, such as JSW Steel, it would
mean lower raw material costs. Base metal
players may lose out on conversion into INR. The
effect may be pronounced for Hindalco, wherein
benefits from a stronger Novelis may be partly
offset by a stronger INR. HSBC forecasts the INR
to appreciate c6% vs the USD in 2011.
Regulatory issues (negative): The Mineral
Development and Regulation (MMDR) bill, when
passed in parliament, could have a negative
impact on miners’ earnings in 2011. The bill
would require companies to share 26% of their
profits with tribal groups displaced by mining
activities. Also, with the issue of mining leases
without “value add” in mineral-rich states like
Orissa becoming increasingly difficult and global
steelmakers vying for a share of the growth in
domestic steel consumption, 2011 could see more
M&As and JVs between steelmakers and iron
miners or between international and smaller
domestic steelmakers. Key tie-ups between
steelmakers and miners announced in 2010 were
Severstal-NMDC for a 5mtpa plant in Karnataka
and POSCO-SAIL JV for a 3mtpa FINEX
technology plant that utilizes iron ore fines (SAIL
is India’s second largest iron ore miner).
Overall going into 2011, we prefer steelmakers to
iron ore miners and in non-ferrous we prefer
aluminium to copper and zinc.
2011 top picks
Tata Steel, OW(V), TP INR730
Tata Steel is our top pick in the steel space due to
its high operating and financial leverage which
helps it benefit most from steel price increases.
The 2.9mtpa expansion at Jamshedpur should
complete by 2HFY12. While we have not
accounted for upside from raw material projects in
our model, projects such as Mozambique coal and
Canada DSO projects which start flowing in in
2HCY12, could provide USD300m of potential
EBITDA increase after full commissioning.
Our target price of INR730 is based on FY12e
EV/EBITDA of 6.5x. Our target EV/EBITDA is
based on the historical trading average of the past
five years, which we think is fair considering the
business dynamics of TATA are not likely to
change materially over the next couple of years.
TATA has historically traded in a one-year
forward EV/EBITDA range of 5-7x, which forms
the basis of our primary valuation of TATA’s
businesses at FY12e EV/EBITDA of 6.5x.
Since a large amount of incremental growth in
diluted EPS is driven by increase in volumes,
timely expansion is critical. In addition, lowerthan-
estimated steel prices and higher-thanestimated
coking coal costs pose negative risks to
our estimates of TATA’s earnings.
Hindalco, OW(V), TP INR260
We expect Hindalco to benefit from 7% higher
aluminium prices y-o-y in FY12. In addition, we
expect Novelis (wholly-owned subsidiary
acquired in 2007) to post 16% y-o-y growth in
EBITDA (USD1.1bn). Hindalco currently trades
at FY12e EV/EBITDA of 6.6x against a global
aluminium players market weighted average of
7.9x. The stock trades at 1.2x PB with an FY12e
ROE of 13% against a global average of 1.4x and
an average ROE of 10%. With the bulk of
capacity expected in the latter half of FY12e, we
expect FY13e ROE to jump to 18%.
Our primary valuation of HNDL is based on
2012e EV/EBITDA of 7.0x for the standalone
business and other businesses and 8.0x
EV/EBITDA for Novelis. Our valuation
comprises enterprise values of INR156 per share
for HNDL’s standalone business, INR207 for
Novelis and INR25 for other businesses; it
deducts INR123 per share in net debt.
Lower-than-estimated aluminium prices pose
negative risks to HNDL’s standalone earnings.
High financial leverage creates high earnings
sensitivity and is negative in downcycles. In
addition, increasing competition may pose a risk
to incremental volume offtake for Novelis.
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