METALS & MINING :Q4FY12 RESULTS PREVIEW :Kotak Securities PDF link

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http://www.kotaksecurities.com/pdf/dmb/MorningInsight10042012.pdf

METALS & MINING
Improved Q4 performance likely driven by strong seasonality -
Tough quarters to follow
Steel
 Steel companies' earnings would see a relief rebound in Q4, primarily helped by
strong seasonality. Steel prices have risen by 6-8% Q/Q while iron ore prices
have remained flattish and coking coal spot prices have further corrected. So,
steel companies would report better operating margins during Q4 further helped
by improved sales volume on Q/Q basis.
 But we would highlight that the steel capacity in India is ramping up at a fast
pace while domestic steel demand growth has faltered to mere 5%Y/Y levels
which we believe would pressure steel prices in coming months as seasonality
aided demand fades away in a month from here. We believe that next quarter
onwards operating margins of steel companies would be substantially down. So,
non-sustenance of Q4 margin improvement would not help investor sentiment
even if sequentially much better earnings are reported by steel companies.
Raw materials/ Mining
 Quarterly contract prices for hard coking coal continues its downward trend.
Starting Q1FY12 at US$ 330/t FOB, Q2 was marginally lower (4.5% Q/Q) to US$
315/t FOB, Q3 fall accelerated to 9.5% Q/Q to US$ 285/t FOB. Q4 contracts were
settled at US$235/t FOB down 16.1% Q/Q and now Q1FY13 prices have settled
at $206/t, down ~12% Q/Q. Spot coking coal prices have fallen below $200/t.
The fall in coking coal prices is welcome development for Indian steel companies
as they are mostly dependent on its imports. But it also leads to lower steel price
expectations which is not positive.
 62% Fe grade iron ore export spot prices to China are trading at ~147$/t CIF and
58% Fe grade prices are trading at $135/t CIF. Average iron ore prices have
been remarkably stable during Q4 (up  2 to 5% Q/Q for various grades) despite
flattering steel demand in China, indicating that at lower levels, there is appetite
for imported ore as China's domestic iron ore cost of seems to have shot up.
Base metals
 Average LME aluminium prices for Q4FY12 were modestly up 3.5%Q/Q but
sharply down 13.2%Y/Y. Average aluminium inventory at LME continues to pile,
up 8.8%Q/Q and up 11.3% Y/Y. LME inventory levels are now 5x the levels of
late 2008 financial crisis and indicates aluminium price weakness would continue
for quite some time.
 Average LME copper prices for Q4FY12 bounced back by 10%Q/Q but still down
13.8%Y/Y. Average copper inventory at LME was down by massive 24.5% Q/Q
helping it to be down 23.2% Y/Y. Copper is clearly outperforming other base
metals by miles.
 Average LME zinc prices for Q4FY12 were up by 6.2%Q/Q but down 15.9%Y/Y.
Average zinc inventory at LME have risen further 9.4%Q/Q and is up sharp 19%
Y/Y.
 US$ depreciated by ~4% vs. INR during Q4 which negatively impact base metal
companies realization so the positive Q/Q gain would be minimal for zinc and
aluminium companies. Also, to be noted is that aluminium and zinc prices have
corrected by ~10% over last month or so as reflected by piling up of LME inventory date and that does not auger well for next quarter results.
 Domestic coal prices are likely to move up for base metal companies in coming
quarters as more domestic coal gets diverted to power companies at regulated
prices.