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Metals & Mining
India
2QFY12E to be a weak quarter. We expect a weak quarter for all steel companies as
the lag impact of increase in raw material costs will eat into profitability. Performance of
non-ferrous companies will also be impacted sequentially by softening of commodity
prices. Besides sharp depreciation of the Re against the US$ will result in losses for
companies with unhedged forex loans. We expect 8-75% qoq decline in earnings for
various companies in our coverage. We are still cautious on the space though nonferrous
stocks appear to have reached distressed levels. Sterlite and Tata Steel are our
top BUY ideas.
EBITDA/tonne sequential decline for all steel names
We expect a weak quarter for all steel companies as the lag impact of increase in raw material
costs will eat into profitability. Note that contract coking coal prices increased to US$330/tonne for
the June quarter (from US$225 in the March quarter); full impact of this increase will be felt in the
September quarter. Steel prices have increased marginally in 2QFY12. As a result, we expect
sequential contraction in EBITDA margin. Steel deliveries volumes will show a modest growth on a
yoy basis and will be flattish on a quarterly basis.
We expect Tata Steel’s domestic operations to continue to be robust and factor in an EBITDA of
US$382/tonne while European operations will continue to disappoint as weak demand and global
uncertainty plays spoilsport. We expect JSW to report EBITDA of US$130 (down 28.7%
sequentially) as the impact of the mining ban in Karnataka led to a spike in input costs.
Softening of commodity prices to impact profitability of non-ferrous companies
We expect the performance of non-ferrous companies to be impacted by sequential decline in
commodity prices. LME zinc, lead and aluminium prices have each declined by around 2-8%
sequentially. Hindalco’s operating profit will likely decline qoq owing to decline in commodity
prices, input cost escalation and bi-annual shutdown of the copper plant towards the start of the
quarter. Sterlite’s earnings will also decline sequentially on weakness in zinc and aluminium prices.
Losses on unhedged forex exposure to hurt net income of all but HZ and Nalco
The sharp depreciation of the Rupee versus the US Dollar will result in forex losses for most of the
companies in the sector. Rupee has depreciated by 9% from the previous quarter end rate of
Rs44.6. While most companies hedge overseas borrowings, FCCBs and other convertibles are
unhedged. Accordingly, we forecast forex losses of Rs0.9-4.4 bn with Tata Steel and Sterlite likely
to report the highest forex losses.
Lots of more pain left in steel stocks; value in non-ferrous names
Steel stocks have corrected by 19-25% in the past one month and 37-55% CYTD. Steel stocks
currently trade at a 12-month rolling forward P/B band of 0.6-1.3X, lower than their historical
band. However, in the face of apparent negatives on overcapacity, further decline in steel prices
and slowdown in the domestic markets, stocks have not reached distressed levels with the
exception of Tata Steel. We maintain our negative view on the rest of the steel names.
Non-ferrous names have corrected significantly with Sterlite reaching distressed levels. Aluminium
prices have already corrected below the 90th percentile of cash cost of production and does not
have a further scope for downside. Zinc prices have also corrected materially with low probability
of further correction. We recommend buying Sterlite at the current levels—a relatively strong
balance sheet and distressed valuations are the positives
METALS & MINING
Steel
n Indian domestic demand growth has faltered to levels not seen for long. As per
industry reports, domestic steel demand growth has been <2%Y/Y for April-August
2011 which is quite shocking. This might be attributed broadly to three domestic
reasons: (a) Slowdown of government expenditure driven by its planned
pullout as Indian economy had recovered from financial crisis of 2008 (b) Slowdown
in decision making and awards of infrastructure projects given the initiation
of cleanup of corruption at various levels within India (c) Rising inflation and interest
rates hampering consumer demand and industrial growth expectations
leading to slowing in both for both consumer durable goods and capital expenditure
projects.
n Domestic steel price realizations for Q2 is expected to remain flattish (marginally
up for long products and down for flat products) on Q/Q basis while the substantial
increase in coking coal costs would flow into P&L in this quarter which would
lead to contraction in EBITDA margins for Q2. Lower steel demand and monsoons
would keep sales volume subdued in Q2 and there is likely to be some
inventory pileup.
n European steelmakers are suffering from weaker demand, prices and destocking
by their customers, which may force them to cut crude steel capacity utilisation
and idle some furnaces in the next few months. Lower steel prices and higher
raw material prices would see sharp margin contraction in Q2FY12e.
Raw materials
n From US$ 330/t in Q1, contract prices of hard coking coal eased off marginally to
US$ 315/t FOB (down (4.5% Q/Q) for Q2FY12 and further down to US$ 285/t
FOB (down 9.5% Q/Q) for Q3. However, due to one quarter lag flow?through
into the P&L, lower cost benefit would flow through in Q3 and Q4 and not in
Q2FY12.
n Iron ore spot/contract prices have been remarkably stable with variation of <1%
Q/Q. Prices are holding on at higher levels due to record steel production levels
in China and regulatory hurdles for exports of iron ore from India. This is positive
for iron ore mining companies and steel players with captive iron ore mines while
negative for non-integrated steel smelters.
Base metals
n (i) Average LME aluminium prices for Q2 were down 7.3%Q/Q but up 14.5%Y/
Y. Average aluminium inventory at LME was up 3%Y/Y but down 1.4% Q/Q. (ii)
Average LME copper prices for Q2 were down 2.8%Q/Q but up 22.7%Y/Y. Average
copper inventory at LME was up 14.5%Y/Y but was flattish i.e. up 0.5%
Q/Q. (iii) Average LME zinc prices for Q2 were down 1.5%Q/Q but up 9.6%Y/Y.
Average zinc inventory at LME was sharply up 39.6%Y/Y but was moderately up
4.8% Q/Q.
n For non ferrous metals, production cost is expected to be flattish on Q/Q basis but
correction in product prices would result in lower profitability on Q/Q basis. As
base metal price correction has been severe only towards end of Q2, earning
impact would be felt mainly in Q3 results.
Regulatory
n Supreme Court had banned iron ore mining in Karnataka's Bellary,Chitradurga
and Tumkur district during the quarter. Central Empowered Committee (CEC)
had found that illegal mining was widespread which resulted in environmental
damage and loss of forest cover. Thus, based on CEC's suggestions, the SC imposed
a ban on iron ore mining. Subsequently, the SC had permitted NMDC to
operate its Kurumaswamy mine (@1mn tonnes per month) in the Bellary region
and permitted e-auction of iron ore inventory (approximately 25.0mn tonnes) at
the rate of 1.5mn tonnes per month. All this has escalated cost of production for
steel producers in the belt and they also had to significantly curtail production
capacity due to shortage of iron ore. With the region contributing about 20-25%
of Indian steel production, impact on domestic steel supply has been significant.
This is likely to benefit steel producers in other region in Q3.
n New mining bill has been approved by Union Cabinet on September 30, 2011 in
the same format which was approved by the Group of Ministers during July
2011. The bill makes it mandatory for coal miners to share 26% of their profits
with project-affected people. The draft bill also proposes that companies mining
other minerals (such as limestone, iron ore, copper and bauxite) should pay an
amount equivalent to 100% of the royalty on their production to the local population
of the project site.Furthermore, the new bill obligates mining firms to pay
a 10.0% cess to state governments and 2.5% to the centre on the total royalty
paid. So, effectively royalty payments for non-coal mining (both merchant and
captive) would potentially rise by 135% if the bill becomes a law in the present
format. This might take another 2-3 quarters and final law might differ from
present draft.
Sesa Goa
n Sesa Goa's iron ore mining operations have been hit in Karnataka post ban imposed
by Supreme Court in August 2011, It had about 0.8mt of iron ore inventory
at Karnataka at the time of imposition of ban which it would be tendering
for sale through e-auction process directed by Supreme Court. This should get
cleared in Q3.
n Sesa Goa iron ore sales volume for Q2 is likely to fall 13.5% Y/Y to 1.75mt due
to good monsoon this year and ban of mining imposed in Karnataka during Q2.
We expect realizations to have improved 3.5% Q/Q as there is more sales of
lumps from Goa in monsoons and domestic iron ore sales realizations in
Karnataka had improved in July due to mining ban imposed in bellary region.
n Sesa Goa is expected to report Q2 revenue of Rs.10bn up 9.4% Y/Y and EBITDA
of Rs.5.2bn up 72.1% Y/Y. Q2 PAT is however expected to fall 9.3% Y/Y to
Rs.3.51bn due to sharp fall in other income and quantum jump in tax rate. We
expect Q2 EPS of Rs. 4.02 vs. Rs.4.48 Y/Y.
India Equity Research Reports, IPO and Stock News
Visit http://indiaer.blogspot.com/ for complete details �� ��
Metals & Mining
India
2QFY12E to be a weak quarter. We expect a weak quarter for all steel companies as
the lag impact of increase in raw material costs will eat into profitability. Performance of
non-ferrous companies will also be impacted sequentially by softening of commodity
prices. Besides sharp depreciation of the Re against the US$ will result in losses for
companies with unhedged forex loans. We expect 8-75% qoq decline in earnings for
various companies in our coverage. We are still cautious on the space though nonferrous
stocks appear to have reached distressed levels. Sterlite and Tata Steel are our
top BUY ideas.
EBITDA/tonne sequential decline for all steel names
We expect a weak quarter for all steel companies as the lag impact of increase in raw material
costs will eat into profitability. Note that contract coking coal prices increased to US$330/tonne for
the June quarter (from US$225 in the March quarter); full impact of this increase will be felt in the
September quarter. Steel prices have increased marginally in 2QFY12. As a result, we expect
sequential contraction in EBITDA margin. Steel deliveries volumes will show a modest growth on a
yoy basis and will be flattish on a quarterly basis.
We expect Tata Steel’s domestic operations to continue to be robust and factor in an EBITDA of
US$382/tonne while European operations will continue to disappoint as weak demand and global
uncertainty plays spoilsport. We expect JSW to report EBITDA of US$130 (down 28.7%
sequentially) as the impact of the mining ban in Karnataka led to a spike in input costs.
Softening of commodity prices to impact profitability of non-ferrous companies
We expect the performance of non-ferrous companies to be impacted by sequential decline in
commodity prices. LME zinc, lead and aluminium prices have each declined by around 2-8%
sequentially. Hindalco’s operating profit will likely decline qoq owing to decline in commodity
prices, input cost escalation and bi-annual shutdown of the copper plant towards the start of the
quarter. Sterlite’s earnings will also decline sequentially on weakness in zinc and aluminium prices.
Losses on unhedged forex exposure to hurt net income of all but HZ and Nalco
The sharp depreciation of the Rupee versus the US Dollar will result in forex losses for most of the
companies in the sector. Rupee has depreciated by 9% from the previous quarter end rate of
Rs44.6. While most companies hedge overseas borrowings, FCCBs and other convertibles are
unhedged. Accordingly, we forecast forex losses of Rs0.9-4.4 bn with Tata Steel and Sterlite likely
to report the highest forex losses.
Lots of more pain left in steel stocks; value in non-ferrous names
Steel stocks have corrected by 19-25% in the past one month and 37-55% CYTD. Steel stocks
currently trade at a 12-month rolling forward P/B band of 0.6-1.3X, lower than their historical
band. However, in the face of apparent negatives on overcapacity, further decline in steel prices
and slowdown in the domestic markets, stocks have not reached distressed levels with the
exception of Tata Steel. We maintain our negative view on the rest of the steel names.
Non-ferrous names have corrected significantly with Sterlite reaching distressed levels. Aluminium
prices have already corrected below the 90th percentile of cash cost of production and does not
have a further scope for downside. Zinc prices have also corrected materially with low probability
of further correction. We recommend buying Sterlite at the current levels—a relatively strong
balance sheet and distressed valuations are the positives
METALS & MINING
Steel
n Indian domestic demand growth has faltered to levels not seen for long. As per
industry reports, domestic steel demand growth has been <2%Y/Y for April-August
2011 which is quite shocking. This might be attributed broadly to three domestic
reasons: (a) Slowdown of government expenditure driven by its planned
pullout as Indian economy had recovered from financial crisis of 2008 (b) Slowdown
in decision making and awards of infrastructure projects given the initiation
of cleanup of corruption at various levels within India (c) Rising inflation and interest
rates hampering consumer demand and industrial growth expectations
leading to slowing in both for both consumer durable goods and capital expenditure
projects.
n Domestic steel price realizations for Q2 is expected to remain flattish (marginally
up for long products and down for flat products) on Q/Q basis while the substantial
increase in coking coal costs would flow into P&L in this quarter which would
lead to contraction in EBITDA margins for Q2. Lower steel demand and monsoons
would keep sales volume subdued in Q2 and there is likely to be some
inventory pileup.
n European steelmakers are suffering from weaker demand, prices and destocking
by their customers, which may force them to cut crude steel capacity utilisation
and idle some furnaces in the next few months. Lower steel prices and higher
raw material prices would see sharp margin contraction in Q2FY12e.
Raw materials
n From US$ 330/t in Q1, contract prices of hard coking coal eased off marginally to
US$ 315/t FOB (down (4.5% Q/Q) for Q2FY12 and further down to US$ 285/t
FOB (down 9.5% Q/Q) for Q3. However, due to one quarter lag flow?through
into the P&L, lower cost benefit would flow through in Q3 and Q4 and not in
Q2FY12.
n Iron ore spot/contract prices have been remarkably stable with variation of <1%
Q/Q. Prices are holding on at higher levels due to record steel production levels
in China and regulatory hurdles for exports of iron ore from India. This is positive
for iron ore mining companies and steel players with captive iron ore mines while
negative for non-integrated steel smelters.
Base metals
n (i) Average LME aluminium prices for Q2 were down 7.3%Q/Q but up 14.5%Y/
Y. Average aluminium inventory at LME was up 3%Y/Y but down 1.4% Q/Q. (ii)
Average LME copper prices for Q2 were down 2.8%Q/Q but up 22.7%Y/Y. Average
copper inventory at LME was up 14.5%Y/Y but was flattish i.e. up 0.5%
Q/Q. (iii) Average LME zinc prices for Q2 were down 1.5%Q/Q but up 9.6%Y/Y.
Average zinc inventory at LME was sharply up 39.6%Y/Y but was moderately up
4.8% Q/Q.
n For non ferrous metals, production cost is expected to be flattish on Q/Q basis but
correction in product prices would result in lower profitability on Q/Q basis. As
base metal price correction has been severe only towards end of Q2, earning
impact would be felt mainly in Q3 results.
Regulatory
n Supreme Court had banned iron ore mining in Karnataka's Bellary,Chitradurga
and Tumkur district during the quarter. Central Empowered Committee (CEC)
had found that illegal mining was widespread which resulted in environmental
damage and loss of forest cover. Thus, based on CEC's suggestions, the SC imposed
a ban on iron ore mining. Subsequently, the SC had permitted NMDC to
operate its Kurumaswamy mine (@1mn tonnes per month) in the Bellary region
and permitted e-auction of iron ore inventory (approximately 25.0mn tonnes) at
the rate of 1.5mn tonnes per month. All this has escalated cost of production for
steel producers in the belt and they also had to significantly curtail production
capacity due to shortage of iron ore. With the region contributing about 20-25%
of Indian steel production, impact on domestic steel supply has been significant.
This is likely to benefit steel producers in other region in Q3.
n New mining bill has been approved by Union Cabinet on September 30, 2011 in
the same format which was approved by the Group of Ministers during July
2011. The bill makes it mandatory for coal miners to share 26% of their profits
with project-affected people. The draft bill also proposes that companies mining
other minerals (such as limestone, iron ore, copper and bauxite) should pay an
amount equivalent to 100% of the royalty on their production to the local population
of the project site.Furthermore, the new bill obligates mining firms to pay
a 10.0% cess to state governments and 2.5% to the centre on the total royalty
paid. So, effectively royalty payments for non-coal mining (both merchant and
captive) would potentially rise by 135% if the bill becomes a law in the present
format. This might take another 2-3 quarters and final law might differ from
present draft.
Sesa Goa
n Sesa Goa's iron ore mining operations have been hit in Karnataka post ban imposed
by Supreme Court in August 2011, It had about 0.8mt of iron ore inventory
at Karnataka at the time of imposition of ban which it would be tendering
for sale through e-auction process directed by Supreme Court. This should get
cleared in Q3.
n Sesa Goa iron ore sales volume for Q2 is likely to fall 13.5% Y/Y to 1.75mt due
to good monsoon this year and ban of mining imposed in Karnataka during Q2.
We expect realizations to have improved 3.5% Q/Q as there is more sales of
lumps from Goa in monsoons and domestic iron ore sales realizations in
Karnataka had improved in July due to mining ban imposed in bellary region.
n Sesa Goa is expected to report Q2 revenue of Rs.10bn up 9.4% Y/Y and EBITDA
of Rs.5.2bn up 72.1% Y/Y. Q2 PAT is however expected to fall 9.3% Y/Y to
Rs.3.51bn due to sharp fall in other income and quantum jump in tax rate. We
expect Q2 EPS of Rs. 4.02 vs. Rs.4.48 Y/Y.
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