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http://www.kotaksecurities.com/pdf/indiadaily/indiadaily27022012.pdf
Metals & Mining
India
Unsustainable rally. Steel equities rallied 23-45% over the past three months, against
1-20% in other markets, led by factors such as (1) the likelihood of resumption of ironore supplies from Karnataka; (2) a smart recovery in European steel prices and (3) signs
of domestic recovery. It helps that soft raw material prices and a rebound in steel prices
are likely to result in a strong March 2012 quarter. We recommend a cautious view of
the sector due to (1) expensive valuations, with stocks trading at 6-8X FY2013E EBITDA;
(2) a soft steel market in Asia and (3) overcapacity in the domestic market.
A rebound, helped by various factors
Steel equities rebounded by23-45% over the past three months, led by factors such as (1) the
likelihood of restart of mining operations in Karnataka, which would ease iron-ore sourcing
constraints for JSW. The CEC report recommended the restart of 45 mining leases with 11 mn
tonnes of production in the A category to restart operations; (2) increase in finished steel prices,
especially in Europe, beneficial to Tata Steel; (3) flow through of lower raw material prices in the
near term, which will benefit all players including SAIL; and (4) rebound in domestic steel
consumption with growth numbers of 11.7%, 8.8% and 7.3% in November, December and
January, respectively, are encouraging in our view
A weak year likely for Asian steel
Steel demand is likely to slow in China, in our view. Prolonged monetary tightening and
consequent impact on the property sector is likely moderate growth to 5% in 2012 from 10%
over the past two years (monetary policy is being loosened though the quantum is unlikely to
match stimulus post GFC). More important, with capacity utilization of only 76% and 30 mn
tonnes of new capacity likely to come on stream, profitability may remain under pressure. To fill
out capacity, production may make its way to export markets. Production in January was muted
qoq at 52.1 mn tonnes (seasonality and slowdown). The pick-up in steel demand has been modest,
at best, post the holiday season with steel production run rate at 1.7mn tonnes in the first 10 days
of February. Long prices are at a yearly low and the rebound in flat prices has been modest.
A brighter domestic situation but overcapacity persists
Closer home, domestic steel data show signs of recovery in demand with January apparent steel
consumption up 7.3% yoy; this comes on the back of an 11.7% yoy growth in November and
8.8% in December 2011. Demand recovery was led mainly by time-bound projects in
infrastructure and real estate, which have started to push hard to procure material to use their
annual budgets before the close of the fiscal year in March. However basic issues of overcapacity,
especially in the flats segment, remain unaddressed and may be a headwind on pricing, especially
in the flats segment. The industry will add 14-16 mn tonnes of capacity in the flats segment over
the next two years, an increase of 65% from FY2011 levels.
Valuations getting into the expensive zone
Steel stocks have traded at a historical P/B band of 0.5-2X and EV/ EBTIDA range of 5-7X. Stocks
are trading at 6-8X FY2013E EBITDA, in the expensive zone. We retain our SELL rating on JSW
Steel (6.4X FY2013E EBITDA): the stock implies EBITDA/tonne of US$146, which is unlikely, in our
view. SAIL trades at consensus FY2013E EBITDA of 8.2X. Tata Steel delivered a strong performance
of 41.8% YTD. The recent rally captures some of the upside of a turnaround in TSE and
commissioning of brown-field expansion at Jamshedpur. Tata Steel can deliver upsides, but only
with a focus on FY2014E financials. We retain our ADD rating on the stock.
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