After dull 2018, no silver lining in market cap for metals sector

Hindalco, JSW Steel, Tata Steel, which are structurally sound and have low capital and costs, will do better in 2019, say analysts

Most metal and mining stocks saw significant erosion in their market capitalisation in 2018, with the representative index — the S&P BSE Metal — losing almost a fifth of its previous levels. Global trade uncertainty, volatility in the sector and a fall in base metal prices had hurt sentiments. So has increase in raw material prices, especially in the energy sector.

Fears of slowing demand from China led to lower prices in the October-December quarter (Q3). This will have a negative impact on the profitability of most players. With earnings growth moderating due to falling prices, it is not surprising that Hindalco, Vedanta, Tata Steel, Jindal Steel and Power (JSPL) are down more than 20 per cent. Only JSW Steel has been an outlier, ending the year with gains.

Analysts feel the stress will continue into the fourth quarter (January to March, or Q4) too.

Motilal Oswal Securities said the domestic steel product prices, which saw a downward trend in Q3 of 2018-19 (FY19). The situation will aggravate in Q4.

The only saving grace for steel players was robust domestic demand growth. In October and November last year, it grew at 10 per cent. Sales also increased by 5 per cent sequentially in Q3FY19 and 4 per cent year on year (YoY).

However, steel exports have been hit sharply, halving in October and November, on a YoY basis, said analysts. Thus, benefits that players such as JSW Steel reaped from exports earlier might not happen in Q3FY19.  

Analysts at Kotak Securities estimated that operating profit for steel companies will decline 11-28 per cent, sequentially due to lower steel prices and increase in raw-material costs. Tata Steel’s earnings will also be affected due to lower volumes in Europe, owing to a shutdown and operational issues, said analysts.

For base metal players, concerns remain on falling aluminium prices that have increased which could weigh on Hindalco and Vedanta though both will benefit from rising volumes.

The per-tonne aluminium price on the London Metal Exchange (LME) was hovering around $2,250 at the start of October. But it has slipped to about $1,800 now.  

The December quarter may still have a limited impact on Hindalco. It is an integrated player. Vedanta, too, should benefit from rising zinc volumes. Concerns, however, remain for the near term, given the weak pricing environment.  

Analysts at ICICI Securities believe margins for aluminium companies, which are not integrated, are reaching levels not seen in a decade. They expect margins to worsen in Q4FY19.

While Vedanta has already reached near-breakeven levels in the aluminium business (Ebitda dropped 80-90 per cent, sequentially and YoY), current LME prices may lead to negative aluminium margins for Q4FY19, they added.

While Hindalco has seen its stock prices correct by about 22 per cent in last one year, Vedanta has seen 41 per cent correction.

Overall, the outlook for metal companies in the near term in likely to remain cautious given falling prices, demand worries, and unresolved trade dispute.

Looking at the uncertainties in macros, analysts prefer structurally efficient companies with low capital and operating cost.

Hindalco and JSW Steel stay the top picks of Motilal Oswal Securities while for Edelweiss Research they are Tata Steel and Hindalco. Kotak Institutional Equities, too, prefers Hindalco and is also positive about the prospects for Vedanta and Nalco. Motilal Oswal Securities also likes JSPL, which would benefit from capacity addition and a revival in the power sector, though the leverage levels are high.