Margin pressure to continue for metal sector: Experts

Bhavesh Chauhan, metal analyst at Angel Broking and Ankit Miglani, deputy managing director of Uttam Galva, in an interview to CNBC-TV18, share their views on how the metal sector is going to perform going forward.

Below is the edited transcript of the interview. Also watch the accompanying videos.

Q: We had some steel companies raising prices on September 1 by about Rs 1,000 a tonne. On the other hand, we are hearing auto sales have dipped, which means that demand should be an issue. What is the sense you are getting, are steel margins going to get compressed or do you think they will remain steady with steelmakers pushing up the product prices?

Miglani: Margins are under pressure and will remain under pressure for the next few quarters. The price hikes you have seen are more of an adjustment for severe depreciation of the rupee. There is no real increase in fundamental price, fundamental demand is quite slow and we don’t expect that to significantly increase over the next couple of quarters.

In fact the Organisation of Economic Cooperation and Development in Paris came out with the consolidated leading indicators yesterday. It points to a global slowdown and that includes India as well, hence, it is going to put a lot of pressure on demand side. The high interest rates in India are not helping the matter much and that would put pressure on margins. So overall, we don’t see a very great situation for the next two quarters. It’s going to be a struggle and the industry players will have to be on their toes to work on value added products.

Q: Have the steel companies been able to push up at least the rupee depreciation impact? Are they selling because of the growth problems or are you differentiating?

Chauhan: The steel prices have risen by Rs 1,000 and going forward, we do not expect a significant rise at least in steel prices. However, coking coal prices have come down 9.5% to USD 285 a tonne for the next quarter and that should help improve margins for steel companies in second half of FY12. However, for the quarter ending September, the margins could remain under pressure.

Q: How much lower can your EBITDA margins go from 7% and what will be your volume forecast for the fiscal year?

Miglani: Our volumes will be consistent with the volumes last year; in fact, they are likely to be marginally better. The effect of the higher interest rates will filter down to the bottomline. We are trying to compensate for that by improving our EBITDA to some extent by working on value-added products, improving product mix and we are working out alternates for cost reduction. The fact that our power plant starts this year, we have already started production, which will cut down our power bill significantly. All this will help improving our EBITDA margins, which should compensate for the other pressures for this year.

Q: How much lower can your EBITDA margins go from 7% and what will be your volume forecast for the fiscal year?

Miglani: Our volumes will be consistent with the volumes last year; in fact, they are likely to be marginally better. The effect of the higher interest rates will filter down to the bottomline. We are trying to compensate for that by improving our EBITDA to some extent by working on value-added products, improving product mix and we are working out alternates for cost reduction.

The fact that our power plant starts this year, we have already started production, which will cut down our power bill significantly. All this will help improving our EBITDA margins, which should compensate for the other pressures for this year.

Q: While you are positive on most of the metal companies, given the concerns that perhaps it’s not a good time to go and accumulate in the near-term, is there a lower opportunity for an investor to enter into these metal companies?

Chauhan: It is difficult to take a call on how much decline we can expect from hereon because if you look at the stocks they have battered close to 50% from their peaks. So going forward, I would advice investors to buy on declines or even at current levels. If you look at valuations, SAIL is trading at 5.4 times FY13 EV/EBITDA and Tata Steel at 4.8 times FY13 EV/EBITDA. So, we see value in the stocks and we would recommend investors to start accumulating the stocks.

Q: Both SAIL and Tata Steel ?

Chauhan: Yes.

Q: We are seeing some pressure on the costs side for metal stocks like Hindalco and Nalco because of higher power and coal cost and that is a major input for an aluminum maker, so any new views on Hindalco?

Chauhan: Project delays are a major concern for Hindalco. In the last three quarters, it reported project delays except for the first quarter of the fiscal. Coal prices have risen significantly. We also heard that Nalco had to cut production on account of shortage of coal supply.

So, coal prices are hitting the sector. Around 30% of costs of aluminum are power cost, which come from coal. However, even at current levels, everything is discounted. Hence, we like Hindalco although we are neutral on Nalco.

Q: Arcelor Mittal has been increasing its stake in the company. It already stands at about 34%. Will they further increase their stake going forward?

Galva: Currently, there is no intention to modify our equity holdings structure. As far as board seat is concerned, they will appoint two board members at some point. But we don’t know when and who that would be. However, our agreement is that they are entitled to board seats.

Q: Are you sensing that there is going to be overall dip in volumes? How are you looking at the sector itself in terms of volume growth?

Galva: It is not as lucid as it is right now and we don’t have a number on how much real demand has dropped or how much it is expected to drop.  However, we are seeing a slowdown in auto. We are seeing pressure on white goods appliances and capital goods and that all is reflecting on the demand side. Construction is under a lot of pressure and that can be actually correlated with the drop in cement prices over the past couple of months. 

The steel prices have not corrected domestically because of the ban of iron ore supplies from Karnataka; the ban is creating a lot of disequilibrium in India. Fundamentally, we are seeing real demand going slow. The fact that inventories in the pipeline are not very heavy, it is a clear indicator that it’s not apparent demand but real demand that has actually slowed down. A slight recovery in demand will have a drastic effect on prices because there is no inventory on the ground.

Q: Would you factor in a price cut anytime in case real demand doesn’t improve? Steel companies have managed a very minor hike, but is that the way forward since coking coal prices appear to have peaked off?

Galva: The rupee has depreciated further and a price cut seems really unrealistic. Prices are very close to cost levels on an average basis. So, I don’t think any price cuts are due.

Q: Any opinion on any of the other steel stocks? Are only Tata Steel and Sail in your coverage?

Chauhan: There are many companies in our coverage but we see most of the value in the large caps. We have a neutral rating on JSW Steel , while in the midcap space, we like Godawari Power and Sadhana Energy .