Ind-Ra: FY19 Metals Outlook Revised to Stable, Realisations to Peak with Moderation in Input Prices

India Ratings and Research (Ind-Ra) has revised the outlook on the metals sector to stable for FY19 from FY18's negative for both steel and base metals. The agency expects the sector companies to benefit from an uptick in demand, softening of raw material inputs and Chinese capacity closures.

Ratings to Remain Stable: Ind-Ra expects its portfolio ratings to remain largely stable during FY19. While steel and zinc segments are likely to post steady margins, aluminium segment margins may improve with softening of input prices, countered by weak premiums in export markets. Copper operations might face margin pressure with a fall in treatment and refining charges for 2018 and absence of inventory gains with prices likely to moderate through 2HFY19. Overall, sector companies will continue to generate a steady operational cash flow and largely deleverage the balance sheets, despite steady capital expenditure plans.

Softening of Input Prices: Ind-Ra expects the prices of key raw materials (iron ore, metallurgical coal and thermal coal) to moderate through FY19 on the back of improving supplies. This will lead to softening of realisations during 2HFY19. While all other metals players will benefit from the fall, steel, aluminium and zinc smelters might do better than Copper smelters, given the current demand-supply equation. Slowing Chinese real estate is likely to put pressure on base metal prices through FY19 with re-start of winter capacity cuts. This is because Chinese consumption is broadly about half of the global consumption of major metals.

Likely Higher Demand Growth: Domestic demand growth is likely to be higher in FY19 than that in FY18, led by continued government infrastructure spending and a higher consumption demand. The agency expects the demand for metals from the real estate sector to remain subdued with high ready inventories and liquidity constraints with tier II and tier III developers following the implementation of RERA in FY18. However, other key end-user segments including automobiles, machinery and engineering equipment, fabrications and infrastructure could post higher demand growth in FY19.

Supportive Tariff Structure: Indian steel players are likely to operate in an environment conducive to growth, with continued effective restrictive measures and moderation in global prices through FY19. Environment protection-led Chinese capacity cuts may mean lower competition in the international markets. Given the higher importance of steel than other metals for the overall manufacturing sector, the steel sector will continue to enjoy better regulatory support. However, increasing global protectionism could impact exports, especially for steel.

Global Trade: Steel is likely to be a more or less balanced trade in FY19 than net exports in FY18. However, base metals' net exports continue to increase with new capacity commercialisation. London Metals Exchange Futures for aluminium and copper are trading in contango while zinc futures trade in backwardation, indicating divergent views for the demand-supply equation. A US interest rate hike will be negative for prices as it discourages financial trades and as producer countries obtain better realisations in local currency.

Cohesive Consolidation: The steel sector is likely to consolidate in FY19 with the acquisition of large stressed assets by domestic majors. The agency believes the top three players including Steel Authority of India Ltd ('IND AA-'/Negative), JSW Steel Ltd ('IND AA-'/Negative), and Tata Steel Ltd ('IND AA'/RWE) could constitute 60%-65% of India's steel production. Consolidation will benefit large steel players with economies of scale and better bargaining power on sourcing. Domestic base metals have been a concentrated industry with only a handful of players including Vedanta Ltd ('IND AA'/Positive), Hindalco Ltd and National Aluminium Company Ltd ('IND AAA'/Stable).

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