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Indian metal stocks have sharply underperformed their regional and global peers with India
losing its inherent profitability on account of iron ore issues, increasing power / employee
costs and steep interest cost cycle. The extent of underperformance is relatively lower in
the non-ferrous segment in spite of our assessment that loss in relative profitability is much
steeper in the non-ferrous space (aluminium) vis-Ã -vis steel. The quarter reiterates our
assessment with Aluminum EBITDA and adjusted PAT going down 23% and 17% YoY visà -
vis 14% and 7% for the ferrous space (excluding Tata Steel Europe [TSE]). The only
commodity where India has retained its profitability is zinc where Hindustan Zinc (HZL)
outperformed its global and regional peers across the value chain. Sterlite (SIL) continues
to reel under investor concern of possible equity reinfusion in Sterlite Energy (SEL) and
Vedanta Aluminium (VAL). Margin pressures will define Q4FY12 earnings as well with
partial relief flowing in not before Q1FY13, and that too for ferrous players.
• Steel – Domestic demand uncertainty, increasing cost base, lower profitability
drive incremental underperformance: Higher raw material costs and stickiness in
pricing will lead to ~400bps YoY margin drop for Tata Steel India, SAIL and JSW Steel
(JSWS). We expect TSE to post an EBITDA loss of US$30/te in the quarter. A
possible increase in pension liabilities post the triennial valuations and asset
impairment with potential increase in goodwill has opened the scope of further
reduction in adjusted book value of the company, leading to further investor concerns.
• Sesa Goa – Goa poses additional risk; NMDC offers balanced risk-reward:
Q3FY12 will reflect the full impact of the Karnataka mining ban. Increase in export duty
to 30%, possible impact of M.B. Shah Commission’s report in Goa and impasse in
Karnataka leave out any meaningful growth opportunities in FY13. Sesa has higher
investment value than core operational value. With meaningful volume accretion
possibilities, scope of consensus upgrades and beaten down valuation, NMDC offers a
much better risk reward. We expect NMDC’s top line and EBITDA to increase 16%
and 21% YoY respectively in Q3FY12.
• Non-ferrous – Aluminium the weak link: Irreversible cost pressures in Aluminium
are leading to underperformance of the domestic players against the regional and the
global peers, and this is set to continue. Further, slip-ups in project implementation will
act as a long-term headwind for the space. SIL continues to fight profit erosion in SEL,
where incremental equity contribution from SIL will be soon required. Investor
concerns exist on further equity contribution from SIL to VAL as well (a risk that might
be temporarily avoided due to benevolent lending by SBI). Lead volumes can again
play a spoilsport for HZL, and chances of negative surprise in Q3FY12 are high.
