All you want to know about Indian metal space

Motilal Oswal has come out with a report on metal sector. The top picks in metal sector are Tata Steel and JSW Steel.

Indian Metal space:

In the Indian Metals space, we like steel and zinc. Primary steel producers will deliver stronger volume growth over 12-15 months. The zinc business is also attractive due to stronger growth in by-products like silver and lead, and bullish outlook on zinc prices. The aluminum segment is facing challenges due to shortage of coal, rising input costs, and project delays. The copper business in India is limited to custom smelting and is, therefore, less significant.

Expect temporary oversupply of finished steel in India: With 20mtpa capacity likely to commission over the next 12-15 months, we expect temporary oversupply of steel in India. Given a tough export market, primary producers will try to substitute imports and crowd out secondary producers to sustain production at new capacities. Margins will come under pressure.

Tougher times for secondary producers: Secondary producers have to face the additional challenge of sourcing coal and the requisite grade of iron ore for sponge iron production due to dwindling supplies. Export of Indian iron ore fines is expected to decline due to discouraging government policies. As the market for fines dries, the supply of sponge iron grade iron ore, which requires additional crushing to achieve smaller size of iron ore lumps, will decline.

Iron ore supply to ease in two years, coking coal market to remain tight for four years: Global finished steel consumption is likely to grow by 68m tons in 2011 and by 55m tons in 2012. This will drive demand for seaborne trade by 95m tons in 2011 and 77m tons in 2012 and demand for coking coal by 47m tons in 2011 and 38m tons in 2012. Investment spurred by high margins will bring 730m tons of new iron ore supplies over five years (v/s 1b tons of seaborne iron ore trade currently) and ease the market.

Tata Steel and JSW Steel are our top picks: Tata Steel's cash flows will grow on the back of both volume growth and margin expansion. Sale of Teesside plant and start of coking coal production in Mozambique and iron ore production in Canada are other positives. JSW Steel will achieve the highest volume growth and is the most efficient producer. We are downgrading SAIL to Sell due to widening competitive disadvantage on labor cost, operating inefficiencies, and disappointing project execution. As iron ore prices soften, SAIL will have nowhere to hide.

Buy Sterlite and Hindalco in the non-ferrous space: Sterlite Industries is our top pick in the non-ferrous space due to strong earnings growth in zinc, lead, silver and energy businesses, though uncertainties over power sale, sourcing of coal and bauxite, and minority stake buyouts continue to haunt. The outlook on zinc prices is bullish primarily from the supply side, as a couple of large mines are expected to get depleted over the next 2-3 years. We also like Hindalco due to the group's strong operating cash flows. Utkal Alumina, though delayed a bit, will boost Hindalco's earnings.

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