Street betting on revival of metals cycle amid buzz of over-correction

High input costs leading to margin pressure, lower-than-expected realisations are among downside risks

The metals market has seen extreme volatility in the last few months. Part of this is due to supply concerns as Russia and Ukraine are big players. There are also fears of demand destruction as China has gone into lockdowns and global growth projections have been pared.

The metals market corrected by 15 per cent since mid-April, with individual shares down by 10-30 per cent. However, the market may have over-corrected. On Tuesday, there was a surge in the share prices of Hindalco and Vedanta – both big players in the non-ferrous market in the hopes of demand revival from China, as lockdown ended in Shanghai and the Chinese central bank cut interest rates. Apart from Vedanta and Hindalco, the shares of Nalco, Hindustan Copper, Tata Steel etc., were also up considerably.

The management commentary has highlighted concerns over volatile input costs, especially energy prices. Overall, industry watchers believe metals prices will remain high, given supply disruption and high input costs and there could be margin pressures for most metals companies.

Vedanta reported higher revenues and Ebitda for Q4, 2021-22. Consolidated revenue grew 41 per cent year-on-year (YoY) and 17 per cent quarter-on-quarter (QoQ) to Rs 39,800 crore. Consolidated EBITDA stood at a record high of Rs 13,600 crore, up 50 per cent YoY and 26 per cent QoQ. Adjusted PAT rose 90 per cent YoY and 6 per cent QoQ to Rs 6,200 cr. The growth in revenue and profitability is driven by a spike in LME prices. On a YoY basis, average LME prices in FY22 for zinc, lead and aluminium were higher by 34 per cent, 22 per cent and 40 per cent, respectively. The Oil and Gas segment also reported high EBITDA (Rs 2,100 crore, up 20 per cent YoY and 19 per cent QoQ), due to higher crude prices. The management guided for a muted production outlook for the zinc and aluminium industry in the near term. One positive is that the company has managed to hold down coal costs by switching the procurement mix.

Hindalco has yet to declare results but its subsidiary Novelis has declared in-line quarterly results. High energy costs and chip shortages (which affected the auto sector) led to lower profitability. Net sales, EBITDA, PAT for the quarter, came in at $4.8 billion, $431 million and $215 million respectively, which was sequentially 12 per cent higher, 15 per cent lower and 18 per cent lower respectively.

The guidance was for EBITDA of $500 per tonne or higher for the next quarter, based on assumptions of improved semiconductor availability. There is a potential upside if the Ukraine War ends. The company has a priority on debt reduction with a leverage of 2.2x of net debt to Ebitda.

Commodities analysts have cut LME aluminium per tonne price estimates to $2,900 or $2,850 for FY 2022-22 from the current levels of $3,300. The estimated reduction in price is due to no bans being imposed on Russian aluminium. Aluminium has already corrected from highs of $3,980. Novelis’ management guidance was positive in that demand is expected to grow across all regions. Aerospace is improving in terms of order book but the Automobile segment may continue to be adversely affected.

Most analysts are maintaining Buy calls on Vedanta and Hindalco. But target prices have been reduced. Hindalco is at Rs 429 with one analyst doing a sum-of-the-parts valuation of Rs 680. Vedanta is at Rs 321 with one analyst offering a target price of Rs 470. Both stocks have seen corrections of over 20 per cent in the last month.