Iron ore royalty to impact SAIL, Hind Zinc most: Edelweiss

The Cabinet Committee on Economic Affairs (CCEA) has hiked the royalty rates on iron ore from 10% to 15%. Experts believe this is a move at an attempt to broker peace with the states to clinch a deal on GST. Prasad Baji, Senior VP, Institutional Equities – Research, Edelweiss Financial Services in an interview to CNBC-TV18’s Ekta Batra and Anuj Singhal spoke about the impact of this move on ferrous and non-ferrous metal stocks. He says the hike would imply a cost push of Rs 300 per tonne for steel, which is not a big price hike. He believes that the ferrous companies would pass on the added costs arising out of higher royalty rates.On the ferrous side the maximum impact would be for SAIL because its EBITDA per tonne is the lowest compared to most companies. On the non-ferrous side Hindustan Zinc could see around 3 percent impact at the EBITDA level but there are other things which could mitigate this impact, says Baji.On the non-ferrous side, their top picks are Sesa Sterlite and Hindalco with price targets of Rs 392 and Rs 240 respectively. And on the ferrous side, they are bullish on stocks like JSW Steel and Tata Steel with a price target of Rs 1856 and Rs 670 respectivelyBelow is the transcript of Prasad Baji’s interview with Anuj Singhal and Ekta Batra of CNBC-TV18.Anuj: You believe the increase in cost would be easily passed on by steel companies? A: The increase in the cost push would be around Rs 300 per tonne which is not a very high number if you look at the realisation. Even the base products rebar and HRC are anywhere between Rs 35,000- 38,000 per tonne. Even at the EBITDA per tonne it is only around 3 percent of the average EBITDA per tonne for the universe. So, it is not a big number. Since it is for the sector as a whole we expect it to be passed on. Rs 300 per tonne is not such a price hike which will attract big imports. So, it should be passed on. Demand is slowly improving. In the first half demand will still be slow but next fiscal onwards we expect substantial pickup in demand. So, maybe initially it will not appear to be passed on but eventually it should be done so.Ekta: Your note indicates that Hindustan Zinc is possibly going to have the maximum EBITDA impact. So, in terms of any sort of EPS tweaking and valuation tweaking would it be very significant for FY15?A: On the ferrous side, the impact would be for Steel Authority of India (SAIL) considering that its EBITDA per tonne is among the lower side as compared to most of the companies. So, in FY16 there is a potential impact of 6 percent if there is no price hike and there is no other change in cost, etc. However, we are not changing the numbers; we expect a pass-on. On the non ferrous side, Hindustan Zinc will have some impact because from the 8-8.4 percent royalty for zinc it has gone to 9.5-10 percent level. This is not a formal notification but that is what the reports are. So, there is definitely somewhat of an increase and that would be on a pro forma basis, a 3 percent impact at the EBITDA level. However, there are other conservative assumptions that we have taken which can easily mitigate it. Potentially local premiums can also go up because the local premiums are based on local costs as well. So, at this stage we are not changing any numbers; it is just a pro forma impact of around 3 percent EBITDA level.

Anuj: What would be your top two or three picks in the metal space and what would be your price targets on them? A: Overall in the metal space our three top picks are JSW Steel, Sesa-Sterlite and Hindalco. We are more positive on non ferrous side because there the price action will be much higher. We see much higher price upside in non ferrous than in ferrous.For example, zinc prices we expect USD 2450 on LME as compared to USD 1900. Similarly, on the aluminium side we expect USD 2100 next fiscal as compared to FY14 sub USD 1800 level. So, certainly the price action will be far better on the non ferrous side. So, Sesa-Sterlite, Hindalco would definitely be top picks for us. They have volume growth as well in addition. For Sesa-Sterlite we have a price target of Rs 392. Hindalco we have a price target of Rs 240. On the ferrous side our top pick is JSW Steel. Tata Steel is also a buy. JSW we have a price target of Rs 1856, Tata Steel price target is Rs 670. Ekta: You have an estimate that the Indian Steel industry will grow at 6.5 odd percent in FY15. Just compare that to what FY14 did? A: 6.5 percent is for FY16; in FY14 we had a 1 percent demand growth. In Q1 as per the JPC data, it shows around 1 percent growth. However, there is an interesting sideline to it. The past numbers for JPC data for Q1 are restated upwards. If we take the older base then for Q1 FY15 the steel demand growth in India is 5.5 percent. So, in a sense the pick up is already happening. It is just that data is getting little revised upwards in the past. However, that is fine. The base is therefore definitely higher. So, that is a good thing. Nevertheless, this year still will be 3-4 percent growth. Next year, we expect 6.5 percent growth. Essentially, we expect that the GDP multiplier which is not working, which was far less than 1, it will go to 1x and with GDP growing at around 6.5 percent we should see steel demand also growing inline.