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Metals
In our view, the steel space will continue to face challenges
amid near-term negatives like seasonal fall in demand and
high raw-material costs. Globally, steel prices are expected to
remain under pressure. For 2QFY2012, coking coal and iron
ore contracts are expected to settle close to their peak levels of
1QFY2012 levels. Base metal prices are also likely to remain
under pressure in the near term on demand concerns due to
slowdown in growth, led by monetary tightening in China and
escalating debt crisis in Europe.
In 1QFY2012, the BSE Metal index underperformed the Sensex
by 3.7% and fell by 6.8% in absolute terms. SAIL underperformed
by 15.9% on reports of the FPO being delayed, while JSW Steel
remained flat relative to the Sensex. However, Tata Steel
outperformed by 1.2%. Relative to the Sensex, Nalco fell by
10.4%, led by concerns on coal supplies. Hindalco
underperformed by 10.2% due to delay in expansion projects.
However, Sterlite remained flat, while HZL outperformed by
2.1%. Coal India continued to outperform, gaining 16.1%,
while Sesa Goa was flat. However, NMDC and MOIL
underperformed by 7.0% and 12.2%, respectively.
Key events
Tata Steel closes Scunthrope plant in Europe: During the quarter,
Tata Steel announced to close its Scunthrope plant (long products
business) in Europe as the unit has been incurring losses for the
last two years due to weak demand from the construction
segment. As per Tata Steel, demand for structural steel in UK is
only two-third of 2007 level and is not expected to fully recover
within the next few years. The proposal is expected to cut 1,200
jobs at Scunthrope and 300 jobs at Teesside sites. We believe
the closure will help the company in reducing its operating costs
Tata Steel sells its stake in Riversdale Mining: During the quarter,
Tata Steel sold its 26.3% stake in Riversdale Mining to Rio Tinto
for A$1,060mn. However, the company will retain its current
holding of 35.0% in Mozambique coking coal project, which
will partially integrate its European operations. We believe the
sale should aid in part-funding the company's ongoing
expansion plans.
MoEF clears allegation on Vedanta Aluminium: After putting a
ban on expansion plans at Vedanta Aluminium at Lanjigarh,
Orissa, in 2010, the Ministry of Environment and Forests (MoEF)
has cleared anti-pollution measures taken by the company
following allegations of a crack in red mud pond, which resulted
in leakage of red mud.
Posco starts land acquisition process: After a long delay of five
years, MoEF finally gave environment and forest clearance to
Posco in May 2011 to build the US$12bn steel plant in Orissa
with a series of conditions. Posco has started the land acquisition
process but is facing stiff resistance from villagers.
Power cuts in China: China is facing severe power crisis since
2004 due to low hydropower production, poor coal
transportation and inadequate power transmission systems.
While the government has raised power tariffs in a bid to
improve the situation, we believe the situation could worsen if
coal prices continue to rise. In the near term, the increase in
power cost has supported aluminium prices at higher levels.
Ferrous sector
During the quarter, steel prices in India remained flat sequentially
with a negative bias due to moderating growth, led by interest
rate hikes. In 1QFY2012, average HRC prices in India were
flat qoq at ~`39,000/tonne, though up by 6.1% yoy. World
average HRC prices increased by 1.9% qoq to US$809/tonne
(up 11.7% yoy), while average Chinese export prices were flat
qoq at US$714/tonne, though up by 11.5% yoy.
JSW Steel and Essar Steel hiked flat product prices by
`600-1000/tonne in June (first time in FY2012), citing higher
raw-material prices, whereas SAIL kept its prices unchanged at
May levels.
Raw-material prices trading near peak levels: Following the
floods in Australia in January 2011, which led to significant
supply shortages resulting in substantially higher coking coal
prices, 2QFY2012 benchmark coking coal contracts are also
settled at higher levels of US$315/tonne (US$330/tonne for
1QFY2012). Additionally, if the workers' strike at BHP Billiton
continues, significant supply pressures in the near term may be
witnessed. However, coking coal prices are expected to moderate
in 2HFY2012, but the pace would depend on how operations
in Australia normalise and normalcy in supply is restored.
In case of iron ore negotiations, media reports suggest that
2QFY2012 contracts are likely to settle at 1QFY2012 levels.
During the quarter, average spot iron ore prices for 63% Fe
grade (CFR, China) were flat qoq at US$181/tonne (up 9.2% yoy).
Iron ore exports from Karnataka yet to resume: Following an
order of the Supreme Court on April 5, 2011, to lift the export
ban on iron ore, the Karnataka government is likely to resume
iron ore exports by July 2011, as the government is working on
a mechanism (infrastructure such as checkpoints and satellite
tracking systems) to check illegal mining.
As per Federation of Indian Mineral Industries, iron ore exports
from India have declined by ~18% to 85.4mn tonnes during
April 2010-February 2011 on account of export ban in
Karnataka and increased export duty. In May 2011, Indian iron
ore exports to China fell by 35% yoy to 6.8mn tonnes. Total
iron ore exports to China for April-May 2011 fell by 32.4% yoy
to 15.8mn tonnes.
Outlook
Raw-material cost pressure to persist: We expect raw-material
prices to remain volatile as a result of floods in Australia and
low supplies of iron ore from India. However, softer demand
from China is expected to keep further increases in iron ore
price muted. Moreover, coking coal prices may decline as the
flood situation in Australia normalises and normalcy in supply
is restored.
According to World Steel, global crude steel production for April
and May was higher by 5.0% and 4.2% yoy to 127mn tonnes
and 130mn tonnes, respectively. Global capacity utilisation levels
are estimated to have remained flat at 81% in 1QFY2012. Given
that steel production and raw-material prices are at elevated
levels, we expect steel prices to remain under pressure, thereby
leading to margin pressure in the near term.
1QFY2012 expectations: For 1QFY2012, on a yoy basis,
we expect sales volume to increase, aided by higher realisations.
Thus, we expect the top line of all the companies under our
coverage to grow by 4-35% yoy. However, due to relatively
higher raw-material costs, margins of steel companies are likely
to contract by 300-370bp yoy. For Sesa Goa, iron ore sales
volume is likely to be negatively affected and, thus, we expect
flat top-line growth on a yoy basis. We remain positive on
Tata Steel and JSW Steel.
Non-ferrous sector
During the quarter, base metal prices witnessed a mixed trend
sequentially as concerns over the slowdown in economic growth
and Greek default intensified. The sector also suffered due to
hike in interest rates and bank reserve requirements by China.
On a sequential basis, average aluminium and alumina prices
on LME increased by 4-5%, while copper, zinc and lead prices
declined by 2-6%. On a yoy basis, copper, aluminium, alumina,
zinc and lead increased by 11-31% with copper and lead
gaining 30.5% and 31.0%, respectively.
On a yoy basis, inventory levels at LME warehouse for copper
and aluminium increased by 3.1% and 1.6%, respectively.
Inventory levels for zinc and lead were higher by 40.7% and
69.8%, respectively. However, on YTD basis, copper, aluminium,
zinc and lead inventory increased by 23.2%, 5.2%, 23.1% and
53.8%, respectively.
Outlook
Though base metal prices are likely to remain under pressure
in the near term due to concerns on growth, long-term
demand-supply fundamentals remain intact for some metals.
The copper market is struggling with supply constraints, while
the downside for aluminium prices is capped due to high energy
cost. However, zinc and lead prices are unlikely to see any major
upside as the market remains in surplus.
For 1QFY2012, we expect non-ferrous companies to register
positive top-line growth of 18-72%, owing to a surge in LME
prices. HZL and Sterlite are expected to report yoy margin
expansion of 599bp and 350bp, respectively. However, Nalco
and Hindalco are expected to witness a yoy margin contraction
of 488bp and 136bp, respectively, on account of higher
operating cost. We remain positive on Sterlite and Hindalco.
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