Amid key concerns, metal stocks may see soft trend in medium-term

Cloud over domestic demand, rising global supplies and high valuations are key concerns

For the past two quarters, steel and other industrial metals have been bright spots. The metals cycle changed with renewed demand as the global economy resumed activity. In India, iron and steel companies, and also non-ferrous producers, saw huge jumps in profitability. A recent report from Credit Suisse (CS) suggests the cycle may be peaking and the Indian steel industry, in particular, may be vulnerable.

The Q4 results of 16 listed steel companies saw aggregated YoY rise of 47 per cent in revenues (Rs 77,183 crore against Rs 52,823 crore a year ago) and Rs 11,843 crore in PAT against Rs 1,140 in net losses a year ago. Hindalco has 189 per cent rise in PAT to Rs 1,928 crore and 38 per cent rise in sales. Three smaller non-ferrous metal companies aggregated 56 per cent rise in sales and 86 per cent rise in PAT.

So, what are the clouds on the horizon? The Q1FY22 sales would be affected by lower domestic demand and lower production due to diversion of oxygen for medical purposes. But in general, steel, copper, aluminium, zinc, etc., tend to have long up-cycles (and long down-cycles).

Supply chain disruptions have eased globally, demand is weaker than hoped for, China is threatening to impose price controls, and ex-China production is catching up with demand. India’s domestic prices are at 18 per cent discount to imports, which is a buffer for domestic firms.

But it may not be enough if global prices do fall from here. Global iron ore prices are levelling off while domestic ore prices remain high. Hence, input costs for domestic steel may rise while global import prices fall.

If demand does not rise sharply, if China does not cut steel production, and if there are no supply issues with iron ore, the profitability of Indian steel producers may be at risk. That’s a lot of 'ifs' but demand is unlikely to rise sharply. China has targeted cutting production by 20 per cent due to weaker local demand. Global supply chain disruptions appear to be easing, especially where ore production and transport is concerned.

Inventory levels are low in the US and Europe. This could buoy up prices. CS also says, if global ore prices are high, Indian steel will outperform global peers. However, steel stocks are at decadal high in terms of valuations.

Hence the CS advisory suggests booking some profits. CS has switched to 'neutral' from 'outperform' for Tata Steel and JSPL. JSW Steel is now 'underperform' from 'neutral'. Indian steelmakers have profited from exports given weak local demand and large price differentials. India also exported 28 per cent of ore production in FY21.

Two quarters of good profitability have helped shore up balance sheets. Prices levelling off from peaks could be a near-term risk, with the cycle picking up again, a few months later. But high valuations should make investors cautious. The NSE Metal Index has a terrific 12-month return of 185 per cent and a one-month return of 10.65 per cent. But the selloff yesterday may trend into a medium-term correction.