Metals - Profit remains under pressure - 2QFY2013 Result Analysis - Angel Broking

Mixed top-line performance: Metal companies reported a mixed top-line performance during 2QFY2013. Among steel players JSW Steel and Tata Steel saw a net sales growth of 16.5% and 4.1% yoy, respectively, whereas SAIL reported a 1.6% yoy decline in net sales. Among the non-ferrous players Sterlite and Hindustan Zinc both reported an 8.8% yoy increase in net sales; however, the top-line of the rest of the players fell due to lower aluminium realization. Except for Coal India, all other miners showed a decrease in top-line aided by lower volumes.

Margins remain under pressure: Among the steel companies, Tata Steel reported a 16.0% fall in operating profits due to higher labor and power costs; SAIL also reported a 16.4% fall in operating performance due to higher other expenditure. Amongst the non-ferrous companies, except for Sterlite the remaining three companies in our coverage reported an average 14.2% fall in operating profits mainly due to lower realizations coupled with higher costs. Mining companies also faced margin pressure led by lower volumes and/or higher costs.

Outlook: Globally, sea-borne iron ore prices declined sharply during April - August 2012; however, the prices have risen sharply from August. Contracted coking coal prices have declined gradually over the past one year. Coking coal contract price for October - December 2012 have been signed at US$170. Decline in coking coal prices is expected to benefit Indian steelmakers during 2HFY2013, although INR depreciation would partially offset the coking coal price decline. A subdued demand, escalating eurozone debt crisis and falling iron ore and coking coal prices have resulted in a decline in steel prices globally over the past six months. Domestic steel prices have also declined lately; however, INR depreciation against the USD has partially muted the decline in steel prices.

Non-ferrous companies are expected to continue to face a double whammy of declining product prices coupled with higher input costs during 2HFY2013. 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 high and sticky 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 2HFY2013 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 underperformed over the past one year on account of 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 and MOIL.

Source : Equity Bulls

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