Metals sector update - Angel Broking

Global positives fuelling rally in metal stocks lately: Over the past one year, we have seen declines in stock prices alongside frequent earnings downgrades for Metals and Mining sector companies. This is because global and domestic metal and base metal prices have broadly slid during CY2013 (upto August 2013). However, Metals & Mining stocks have rallied by 5-35% over the past one month on the back of positive news flows across the globe, especially China, alongside INR depreciation against the USD.

Some gains for steel companies likely: For steel companies, these factors make a case for increase in realizations and better volume growth (due to higher export prospects and also import substitution due to INR depreciation). However, domestic steel demand remains weak in the near-term. Steel consumption growth declined to multi-year lows to 3.3% yoy during FY2013. Further, real steel consumption in India rose by just 0.3% yoy during April - August 2013 due to low demand from construction and automotive sectors. Nevertheless, we expect a 3-4% improvement in realizations for domestic steel companies during 2HFY2014, compared to announced price hikes of 6-7%.

Base metal stocks to benefit the most due to weak INR: Base metal companies (mainly aluminium and zinc producers) price their products based on LME spot prices which are dollar-denominated. These companies are likely to be the real beneficiaries on the back of INR depreciation against the USD as there is high level of consolidation in the aluminium and zinc sectors in India. Hence, INR depreciation makes a strong case for increases in realizations of zinc and aluminium companies, but not of steel companies where low domestic demand coupled with fragmented domestic industry play a spoilsport.

We upgrade some stocks: For steel makers, a weakening rupee raises landed cost of steel imports, thus giving higher pricing power to domestic steel players. It also raises coking coal costs (a key raw material in steel making) which partially offsets the impact of price hikes. Steel companies have also announced price hikes in the range of 3-7% effective September 2013. However, weak domestic demand (April-August real consumption grew only 0.3% yoy) alongside fragmented domestic industry is likely to partially spoil the party; these hikes will be partially rolled-back in the form of discounts, in our view. Nevertheless, we continue to like companies with captive assets, strong visibility on earnings growth over the coming few years, low leverage levels and inexpensive valuations. Tata Steel, Hindustan Zinc and NMDC still remain our preferred bets.

Source : Equity Bulls

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