India Equity Research: J.P. Morgan - India Metal & Mining

Indian MM equities have been the best performing sector post elections, up ~22% v/s the broader MSCI India which was up 6%. Large cap stocks in the sector have rallied ~30-50%. While the election results are cited as the key catalyst for the sharp move, in our view, massively under-weight investor positioning, especially among Foreign Investors (please see chart below from our strategist team on weights) has driven the sharp rerating as positioning shifts from one extreme pre elections, to another extreme post elections. How much the actual holding has changed will only be known post the June quarter, when the company wise holding data is available. Our conversations with investors highlight a rush to buy these names, irrespective of valuations, fundamentals and earnings momentum, with some investors asking us to look at these names in a FY17/18E basis.

Given the sharp run up in the Indian MM universe, and U turn in investor positioning, we would NOT be surprised to see profit booking in these names over the next few weeks, though it could likely require a market cool off.

On a pure operating framework we highlight the following trends:

a) Steel- Spreads remain elevated, domestic prices steady, while demand weak: Raw Material (Iron ore + coking coal) have fallen at a faster rate than steel prices, implying spread expansion. This is particularly visible in Europe, and we expect this to flow through to TATA’s Q1/Q2 FY15 numbers. Domestic demand in India remains weak, while prices are steady.

b) Aluminum and Zinc- Prices remain elevated v/s March quarter: LME prices remain elevated, with premiums for aluminum increasing.

c) COAL India continues to miss targets (April and May): While the stock remains bid up on ‘reform expectations’ the company missed production and off take targets for April and May. Arguably investors are looking at FY17/18/19 estimates (as some told us on our downgrade), however continuous disappointment on operating numbers would be challenge to the ‘Bulls’.

What would you buy NOW?: This is the one common question we are getting from investors. While investors are now willing to look at stocks on FY17 and FY18, we are comfortable with a valuation framework on FY16 as of now, given the visibility. On this parameter, there is still potential upside v/s our PT on TATA, Hindalco and JSW Steel; the latter two have relatively underperformed in the last 1-2 weeks.

Change in FII portfolio weights (March 2010 – March 2014)