Tata Steel, NMDC top picks in metal space: Angel Broking

Angel Broking has come out with its report on metal sector. The research firm says in 1QFY2013, among the steel companies, Tata Steel reported a 23.1% fall in operating profits due to higher labor and power costs. SAIL reported a healthy 15.1% increase in operating performance due to lower raw material costs.

Mixed top-line performance: For 1QFY2013 the metal companies in our coverage showed a mixed top-line performance. Steel players like Tata Steel and JSW Steel reported a growth in net sales of 33.2% and 2.5% respectively, whereas all the non-ferrous players except Sterlite Industries (Sterlite) saw their top-line cripple due to lower prices of aluminium and zinc coupled with lower volumes. Among the miners, except for Sesa Goa, all the other companies showed a moderate increase in their top-lines aided by higher volumes.

Margins remain under pressure: The operating profits declined for all of the nonferrous players due to lower realizations and higher input costs. Among the steel players only Tata Steel reported a fall in operating profits and margins due to higher labor costs at its European operations. Mining companies also faced severe margin pressures during the quarter due to lower ore prices and higher input and staff costs. Further, some companies like SAIL, Sesa Goa and Sterlite reported forex losses for the quarter due to a 21.0% yoy depreciation of the INR against the USD.

Mixed top-line performance: Steel companies reported a mixed top-line performance during 1QFY2013. JSW Steel and Tata Steel saw a net sales growth of 33.2% and 2.5% yoy respectively whereas SAIL reported a 1.6% yoy decline in net sales mainly due to lower volumes during the quarter. Among the non-ferrous players only Sterlite reported a 7.8% yoy increase in net sales on the back of higher volumes; however, the top-line of the rest of the players fell on an average by 1.7% due to lower prices of aluminium and zinc. Among the miners, except for Sesa Goa, all other companies showed a moderate increase in top-line aided by higher volumes.

Higher input costs dent operating profits: Among the steel companies, Tata Steel reported a 23.1% fall in operating profits due to higher labor and power costs. SAIL reported a healthy 15.1% increase in operating performance due to lower raw material costs. JSW Steel’s EBITDA grew 33.0% yoy which was in line with increase in sales. In the non-ferrous sector all the four companies in our coverage reported 21.6% fall in operating profits on an average, mainly due to lower prices, higher power costs and lower by-product sales. Among mining companies, Sesa Goa and MOIL also faced severe margin pressures during the quarter; MOIL was hit by lower prices while Coal India’s margins were hit by higher staff costs.

Other income boosts adjusted PAT growth for some companies: Among the steel players, both JSW Steel and SAIL reported a healthy growth in other income by 83.2% and 435.0% yoy respectively which boosted their bottom lines. However, Tata Steel was an exception where other income fell by 92.5% yoy due to a higher base on account of a one-time other income realized by the company in 1QFY2012. All the non-ferrous players reported an average increase of 30.8% yoy in other income due to higher cash balance and increased yields; however except for Hindustan Zinc, the increase in other income failed to boost their bottom-lines because of higher interest costs for the quarter.

Due to a 21.0% yoy depreciation of INR against the USD, some companies (SAIL, Sesa Goa, JSW Steel and Sterlite) reported forex losses.

Steel companies– Outlook

Globally, sea-borne iron ore prices have declined sharply over the past five months in line with a decline in other metal prices. However, the current iron ore prices around US$100-110/tonne are near marginal cost of production for Chinese iron ore miners. Hence, we do not expect any further meaningful downside from the current price levels. Ironically, however, domestic iron ore prices have remained firm on account of mining ban in Karnataka and government’s stricter stance on illegal mining in the mineral-rich states of Odisha and Goa.

Contracted coking coal prices have declined gradually over the past one year. Moreover, spot coking coal prices have declined sharply over the past two months (down 20% to US$175/tonne) – to the lowest level in two years. A decline in coking coal prices is expected to benefit Indian steelmakers during 2HFY2013, although INR depreciation would partially offset the decline in price of coking coal.

Subdued demand, escalating Euro zone debt crisis and falling iron ore and coking coal prices have resulted in a decline in steel prices globally over the past five-six months. However, domestic steel prices have remained flat on account of INR depreciation against the USD. Hence, we expect steel companies’ margins to improve yoy during FY2013.

Steel imports on a rise

Steel imports have continued to rise over the past one year. Indian steel players continue to face threat of higher steel imports from FTA countries (which attract lower import duty). During January- August 2012, steel imports by India have increased by 48.4% yoy to 4.6mn tonne.

Non-ferrous companies–Outlook:

Margins to remain under pressure-

Non-ferrous companies are expected to face a double whammy of declining product prices coupled with higher input costs during FY2013. Base metal prices have declined steeply over the past six months and hence realizations for companies are expected to decline during FY2013 (partially offset by INR depreciation against the USD). Further, although several aluminium companies (globally) have announced production cuts, we are yet to see any meaningful decline in production. Thus, lower realizations coupled with higher prices of key inputs such as imported coal, caustic soda, CP pitch and petroleum coke are expected to hit margins of non-ferrous companies during FY2013 in our view. Nevertheless, we expect prices to improve in FY2014 as announced production cuts restore demand-supply mismatch during FY2014.

Valuations inexpensive, but we remain selective: Metal stocks have been battered over the past six months on account of escalating eurozone debt crisis, subdued domestic demand, decreasing prices, rising input costs and delays in obtaining procedural clearances for mines. Nevertheless, we believe that the recent fall has left some stocks undervalued. We like companies with captive assets, strong visibility over its expansion plans, low leverage levels and inexpensive valuations. Hence, our top picks are Tata Steel, NMDC and Hindustan Zinc.

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