Metals stocks results preview for Q3FY12: Angel Broking

In our view, the steel space will continue to face challenges (as witnessed in 2QFY2012) amid high raw-material costs, low demand and ongoing European debt crisis. Although global steel prices have come off by 12-20% in the past three months, domestic steel prices have remained flat due to the impact of INR depreciation against the USD. For 3QFY2012, coking coal prices have settled at lower levels of US$235/tonne (down 16.1% qoq). Even iron ore contract prices for 4QFY2012 are expected to decline qoq, as spot iron ore prices have declined steeply during the past three months. Steel consumption in India grew by only 1.8% yoy in 1HFY2012 on account of subdued demand. Looking ahead, although we expect steel consumption to pick up, there are some concerns owing to slowdown in the capex cycle, higher interest rates and slowdown in construction and auto demand, among others.

Base metal prices declined steeply in 3QFY2012 on account of escalating Eurozone debt crisis. Going forward, we do not expect base metal prices to spike meaningfully due to slowdown in global growth and slowdown in China. Nevertheless, INR depreciation against the USD would partially offset the impact of lower LME prices for domestic players.

Outlook

Margin improvement to remain muted: Slowdown in the capex cycle and high interest rates are expected to hurt steel demand in the next two quarters. Steel prices in India are expected to remain flat in the near term. Despite the steep decline in international iron ore prices, domestic iron ore prices declined modestly on account of mining issues in Karnataka. Although coking coal prices have declined, INR depreciation against the USD has neutralized its impact.

According to World Steel, global crude steel production for September and October was higher by 9.7% and 6.2% yoy to 124mn tonnes and 124mn tonnes, respectively. Global capacity utilization levels during September and October stood at 79% and 77%, respectively. Given the high production levels coupled with subdued demand in developed countries, we do not expect any significant rise in steel prices in the near term. Nevertheless, INR depreciation against the USD should increase landed cost of steel in India, thereby supporting domestic steel prices.

3QFY2012 expectations: For 3QFY2012, on a yoy basis, we expect net sales to increase, aided by higher realization. Thus, we expect steel companies' top line under our coverage to grow by 10-48% yoy. However, due to relatively higher raw-material costs, margins of steel companies are likely to contract. For Sesa Goa, net sales are expected to decline on account of no production from Karnataka mines and decline in iron ore prices. Further, higher iron ore royalty is expected to result in net profit declining by 47.5% yoy. For Coal India, we expect 39.% yoy growth in net profit on account of price increase taken during February 2011. We remain positive on Tata Steel and Sesa Goa.

Outlook

Although base metal prices are likely to remain under pressure in the near term due to growth concerns, high cost of production should lend support to prices. While the copper market is struggling with supply constraints, downside for aluminium prices is capped due to high energy cost. Zinc and lead prices are unlikely to see any major upside as the market remains in surplus.

We expect non-ferrous companies to register flat top line yoy, owing to a decline in LME prices. Further, we expect an 85-583bp yoy dip in margins on account of lower LME prices and higher costs of coal. We remain positive on Sterlite, HZL and Hindalco.

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