Metals and Mining - Recovery not in sight; Edelweiss PDF link

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Global economic activity still in weak terrain

A few global lead indicators have improved, but the improvement is not pervasive, persistent and pronounced enough to indicate a reversal of the ongoing slowdown. Global money supply growth is a key concern, having slipped sharply from a peak of 16% to 9% currently. Europe indicators point to recession. In a relative sense, emerging markets will post better growth, but with volatility.

Chinese lead indicators up, but pick up to be modest, back-ended

PMI, OECD LEI and bank lending are up in China; lending in March has been the strongest surprise. However, the extent and pace suggests a weak H1CY12 with pick up only in H2CY12, which too will be modest compared to historical standards. Stimulus possibilities are modest compared to those adopted in 2009.

Indian steel stocks to outperform non-ferrous stocks

We expect Chinese steel demand growth to slow sharply to 3% in CY12 (long term average: 12%). Led by this and also weak ROW steel demand, raw material prices will be sharply lower this year. Indian steel prices/margins to outperform led by better demand (6.5% growth), forex volatility, import duty of 7.5% and capacity delays. Non-ferrous costs to remain elevated led by structurally rising India coal prices, putting pressure on margins.

Stocks not expensive, factor weak scenario but lack sector triggers

Most of our coverage stocks are not expensive, trading between 4.0x and 6.0x FY14E EV/EBITDA having corrected 25-40% from their 52-week highs. We have cut earnings by up to 40% in the past nine months and further downside risk to earnings has eased. However, lack of sector triggers will continue to keep investors underweight on metals & mining stocks in the near term.

Outlook & valuations: Be selective; Top picks: Tata Steel, JSW Steel

Considering the sector challenges, we would advocate a selective, bottom-up approach. Our top picks are Tata Steel and JSW Steel. Tata Steel (TP: INR563, CMP: INR465) to benefit from: (i) visible, high margin 2.9mtpa India expansion; and (ii) margin expansion in European business, in spite of weak demand, led by lower raw material prices and high-end product mix. JSW Steel (TP: INR997, CMP: INR758) will benefit from the restart of iron ore mining in Karnataka and subdued coking coal prices. We rollover our valuation to FY14 basis, but retain our absolute recommendations on our coverage universe with marginal change in target prices.

Metals and Mining - Recovery not in sight; sector update

Regards,