Metals & Mining (Attractive): 1QFY18-a tad weak due to lower prices, one-offs - Kotak

1QFY18-a tad weak due to lower prices, one-offs. Domestic metal names will report sequential decline in earnings led by lower prices, increased input costs and lower volumes (a few cases of outages) We expect earnings of steel companies to decline sequentially due to lower steel realization (-3-4% qoq) and use of high cost coal inventory. Earnings of non-ferrous names will also be weak due to lower prices, increase in input costs and a few cases of plant outages. We expect earnings to improve beyond 1QFY18 past one-off factors (high cost inventories, outages) and on higher prices. We prefer VEDL (BUY), HNDL (BUY) JSP (BUY), JSTL (ADD) and TATA (ADD).

1QFY18 Ferrous-muted demand; lower prices, high cost coal inventories to depress margins

Domestic steel demand remained weak with 4% growth to 13.8 mn tons for April - May 2017. The demand was especially weak for long products due to subdued construction activity as off take of bars/rods and structural were flat yoy at 6.9 mn tons. Our channel checks also indicate that uncertainty over GST implementation led to weak sales in the month of June 2017. Given subdued domestic demand, export sales increased to 1.4 mn tons for April - May 2017 (+102% yoy), thereby aiding 6% growth in production for domestic steelmakers.

Lower steel prices and use of high cost coking coal inventories will result in sequential decline in operating margins of domestic steel companies. Steel prices for flat products declined by Rs1,500-2,000/ton qoq while long product prices increased by Rs800-1,000/ton. In addition, HRC export prices fell by ~Rs4,000/ton qoq. We do not expect any meaningful respite on the cost front as most companies carry two to three months of iron-ore & coking coal inventories. We estimate India EBITDA/ton for Tata Steel and JSW Steel to decline by 9-18% qoq.

Non-Ferrous-a weak quarter due to lower prices, volumes

We expect a sequentially weak quarter for non-ferrous companies due to lower prices and volumes. Zinc and lead prices declined by 5-7% qoq and even though aluminum prices were up 3% qoq, higher cost will result in weaker operating margins. The sequential decline in mined metal volumes at Hindustan Zinc (as per mine plan, 4QFY17 volumes were exceptionally high) and lower zinc, lead prices will result in 32% qoq decline in EBITDA (+127% yoy). We expect Vedanta to report lower earnings (EBITDA Rs54 bn, -26% qoq, +54% yoy) on the back of lower power and aluminum volumes (due to plant outage) besides lower EBITDA in HZ. We estimate 6% qoq decline in Hindalco's standalone EBITDA due to higher input costs, hedging losses and lower copper earnings (though Utkal will report higher earnings on improved realizations).

1QFY18-expect sequential decline across names

We expect 6-37% qoq decline (-16% to +48% yoy) in consolidated EBITDA for steel companies due to lower operating margins and seasonally lower volumes.

- Tata Steel. We expect consolidated EBITDA to decline by 37% qoq to Rs44 bn (+36% yoy) and adjusted net income of Rs13 bn (Rs3.2 bn in 1QFY17). We expect Tata Steel to also report one-off gain of Rs34 bn on the sale of Tata Motors stake. Tata Steel's India steel deliveries increased 29% yoy to 2.75 mn tons in 1QFY18 from the ramp-up of KPO. We estimate India EBITDA/ton to decline sequentially to Rs11,100 (+7% yoy, -18% qoq) due to a combination of lower steel prices, higher coking coal costs and lower ferro alloy income; 4QFY17 EBITDA included large one-offs. We expect Europe EBITDA/ton to decline to US$66 (US$103/ton EBITDA in 4QFY17) as higher cost coking coal inventories hit earnings.

- JSW Steel. We expect consolidated EBITDA to decline 13% qoq to Rs27.5 bn (-16% yoy). We expect EBITDA/ton to decline 9% qoq to Rs6,900 (-26% qoq) owing to a combination of lower steel prices and high cost coking coal from carry-over inventories. We estimate net income of Rs6.7 bn (-40% yoy, -34% qoq).

- Jindal Steel & Power. We expect JSP's consolidated EBITDA to decline by 6% qoq to Rs14.7 bn (+48% yoy). We expect standalone EBITDA to decline 8% qoq to Rs8.4 bn (+26% yoy). We model steel deliveries of 820,000 tons (+5% yoy, -11% qoq). We expect steel EBITDA/ton to increase 3% qoq to Rs10,200 led by higher long product realizations. We expect an improvement in Jindal Power's generation by 36% qoq to 3,180 mn units (+46% yoy) aided by good seasonal demand; we estimate power EBITDA of Rs4 bn (+5% qoq). We estimate net loss of Rs3.7 bn (Rs3 bn of net loss in 4QFY17).

- NMDC. We estimate EBITDA to increase by 36% qoq to Rs12.7 bn (+56% yoy)-the company's 4QFY17 EBITDA was weak due to high one-off costs. We model iron ore sales of 9.4 mn tons (-4% qoq, +21% yoy) led by higher sales from Chhattisgarh mines. We expect EBITDA/ton to increase sequentially to Rs1,350 (+42% qoq, +29% yoy) as 4QFY17 included one-off charges of Rs5 bn. We estimate net income of Rs8.9 bn (+25% yoy,).

Non- ferrous companies-sequentially weak due to lower prices and volumes

- Vedanta. We expect EBITDA to decline by 26% qoq to Rs54 bn (+54% yoy). We expect sequential decline in EBITDA due to (1) lower copper EBITDA (Rs3.4 bn, -23% qoq, -24% yoy) due to plant shutdown for 11 days, (2) lower aluminum (Rs8.5 bn, -14% qoq) and power EBITDA (Rs2.5 bn, -46% qoq) due to plant outage, (3) lower iron-ore EBITDA (Rs2.3 bn, -39% qoq) due to lower prices. We estimate oil & gas EBITDA at Rs9 bn (-19% qoq, +14% yoy). Lower HZ EBITDA (Rs25.6 bn, -32% qoq) due to lower mined metals volumes and zinc prices will also impact earnings in the quarter. We estimate net income of Rs18.6 bn (-37% qoq).

- Hindustan Zinc. We expect HZ's EBITDA to decline by 32% qoq to Rs25.6 bn (+127% yoy). We expect mined metal volumes of 227,500 tons (+79% yoy, -27% qoq); FY2018E quarterly mined metal production will be steady compared to wide variation seen in FY2017 quarterly volumes. We estimate (1) refined zinc volumes of 195,000 tons (+91% yoy, -9% qoq), (2) lead production of 35,000 tons (+39% yoy, -23% qoq) and (3) silver volumes of 110 tons (+23% yoy, -21% qoq). We estimate net income to decline by 38% qoq to Rs19 bn (+84% qoq).

- Hindalco. We expect standalone EBITDA to decline by 6% qoq to Rs12.7 bn (+12% yoy). We model aluminum deliveries of 320,000 tons (+10% qoq, -10% yoy) and aluminum EBITDA of Rs9 bn (+3% yoy, -2% qoq). Gains from higher aluminum prices are partially offset by higher input costs including of alumina and hedging losses. We estimate copper EBITDA of Rs3.9 bn (+49% yoy, -21% qoq). We build in qoq decline in EBITDA due to lower volumes and softening TC/RC and other custom smelting margins.

At Novelis, we estimate adjusted EBITDA before metal price lag at US$269 mn (flat yoy, -9% qoq). We expect volumes to increased 2% yoy but EBITDA/ton to decline 2% yoy due to lower South America EBITDA. We expect higher EBITDA in North America (US$ 99 mn, +8% yoy) and Europe (US$ 61 mn, +7% yoy) aided by higher automotive shipments. We expect South America EBITDA to decline to US$71 mn (-2% yoy, -29% qoq) due to lower Fx benefit.

Source : Equity Bulls

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