India metals and mining- Cyclical dip, add quality to portfolio .:Macquarie Research

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India metals and mining
Cyclical dip, add quality to portfolio
Cyclical slowdown in demand, supply still constrained
The developed world seems to be heading for a seasonal slowdown, and China
may take a while to come out of the tightening cycle, but downside seems limited
as supply remains constrained. Rising costs also lend support on the downside.
We expect China to reverse in 2nd half of the year, which should push commodity
prices higher. Iron ore, coking coal and copper remain our preferred exposure.
Best growth stocks at bargain: We believe this correction presents a good
opportunity to accumulate some of the best growth stocks at great bargains. JSP
remains our top pick for its strong growth profile at the lowest end of the cost
curve. Among pure steel companies, we prefer JSW Steel, having deleveraged,
focus is back on growth. Sterlite is our preferred pick among base metals.
Steel – high iron ore prices adds to competitive advantage
Indian steel prices have stabilised post a decline in April and are now at a
discount to import parity price. Demand was hit by liquidity tightening, but now
seems to be stabilising, albeit at a slower pace. However, the Indian steel
industry is likely to witness almost 10mnt of capacity addition and slower
demand this year, but still should be able to operate at full capacity as gross
imports stand at 7–8mnt which can be substituted. Our team has increased steel
prices to compensate for rising raw material forecasts, hence only minor change
in steel margins. We like JSP and JSW Steel, where our earnings estimates are
well above consensus. Tata Steel is a leveraged play on the steel cycle, while
SAIL lacks a positive catalyst in the near term and can be avoided currently.
Base metals – zinc has cost support, avoid aluminium
We think zinc prices have corrected quite a bit and are near the marginal cost of
production. We upgrade HZ to Neutral, as stock has corrected almost 25% from
its peak. However, our preferred play on zinc is Sterlite, which has other
catalysts too. Aluminium seems to be peaking out and we remain cautious to the
possibility of unwinding of inventory as interest rate cycle reverses. Hindalco,
with 65% of earnings coming from the rolling business, remains our hedged play
on aluminium.
Bulks – Prefer coking coal and iron ore
Our team has upgraded its outlook for both iron ore and coking coal given the
supply disruptions. We have upgraded NMDC to Outperform to reflect increase
in our long-term iron ore price assumption from US$55 to US$65 and reasonable
valuations. JSP represent a good proxy to play both iron ore and coking coal.
GNC remains our preferred pick to play the coking coal up cycle, given its strong
volume growth and attractive valuations.
Top Picks
 India Metals and Mining – Jindal Steel and Power (JSP IN)
 Steel – JSW Steel (JSTL IN)
 Base Metals – Sterlite Industries (STLT IN)
 Bulks – NMDC (NMDC IN) and Gujarat NRE Coke (GNC IN)