Metals - Outlook 2021: Steer clear of steel/aluminium - ICICI Securities

Our outlook for metal stocks under coverage remains cautious to negative for CY21. We rate all metal stocks at either HOLD / REDUCE / SELL. In this report, we downgrade Tata Steel and Hindalco to HOLD from ADD and JSPL to REDUCE from ADD. The current margins, valuations clearly tell a story of caution. Chinese demand stimuli, artificial RM shortages through restrictions on scrap imports (helping all the commodities - iron ore and aluminium in particular) sustain the rally for now. Deleveraging, as a theme, is important but overhyped given such cyclically high margins, valuations.

What happened in CY20?

- Covid induced correction, followed by a sharp recovery. The extent of correction and the V-shaped recovery can be gauged from the fact that while Q1FY21 witnessed ~Rs6,000/te EBITDA for Tata Steel, it can very well be ~Rs18,000-19,000/te for Q4FY21.

- Chinese demand outlook improved. Chinese steel demand continues to surprise all through the year (even in November). Despite 12-13% production growth, there has hardly been any increase in exports. Consensus demand estimates for CY21 stands at 4-5% YoY, which is impressive given the base of CY20.

- Valuations are rich. We looked at asset valuations. Stock prices have doubled after touching 0.5x P/B or below. At current P/B, RoEs are already stretching and testing the upcycle RoE. The margin of safety is gone.

- Steel/Aluminium margin curves are testing cyclical highs. The same is true for Indian counterparts (Chart 1-3). Chinese BoF spreads are at levels where firms are making decent profits even while costs are challenged artificially - through restrictions of scrap and of late coking coal imports from Australia. Latest Chinese aluminium smelter profits (average) ~US$500-600/te.

- Strength in iron ore continues. Continuous restrictions of scrap imports in China have increased costs for Chinese EAF-led players, thereby, allowing relative BoF profitability at higher iron ore prices. Brazilian export recovery has been much slower than expected. Nov' 20 exports fell ~6% MoM, Vale has reduced production guidance for CY20. 400mnte Brazilian ore production has been pushed back to CY23. Indian iron ore mining witnessed disruption as expected, the same could hardly translate into returns for NMDC, given the additional incidence of premium to renew Karnataka mines. Yet supply stays constrained and is leading to elevated pellet prices (~ Rs 11000/te now) and margins for players like NMDC (Q3/Q4FY21 margins can be ~Rs2,600-2,700/te).

CY21 Outlook (India steel/iron ore/aluminium)

- We rate all metal stocks at either HOLD / REDUCE / SELL. In this report, we downgrade Tata Steel and Hindalco to HOLD from ADD and JSPL to REDUCE from ADD.

- With spreads at cyclical high, CY21 comes with a high probability of correction in spreads - across steel, aluminium. As spreads correct, so will valuations.

- Given that aluminium is a start-stop sector, increase in aluminium profitability is leading to a delayed response to increase in aluminium production. Hence, pricing response in alumina is a bit delayed.

- There is hardly any EV theme in conventional commodities (steel/aluminium/zinc) that we see. There is no copper miner in India barring Hindustan Copper, where there was newsflow of a possible merger with Coal India/NMDC.

- There are artificial supports to global spreads driven by Chinese restrictions on imports of scrap, and on restrictions of coking coal. It's not a matter of if, but when restrictions ease.

- Past cycle learnings. The trigger for directional change in margins cannot be anticipated. The downturn will be equally sharp. Avoid commodities is the call for CY21.

Source : Equity Bulls

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