Base metal rally not in sync with fundamentals

Higher prices, however, will continue to boost profit at Hindalco, HZL and Vedanta in near term

Base metal prices on the London Metal Exchange continue to rally, helping Hindalco, Vedanta and Hindustan Zinc to touch their all-time or 52-week highs.

While zinc has been the best performing base metal, with LME prices almost doubling from the lows seen at the start of the year, other metals follow. Copper prices are at levels earlier seen 16 months earlier; aluminium and lead have made smart gains.

A rally last month was on hope that a Trump-led administration would boost infrastructure spending in America, spurring demand. In contrast to sentiment at the start of year, wherein concerns of a global recession led by the US and slowing China demand had pulled down prices. With capacities getting curtailed and sentiment improving, there was a rebound.

Metals

Investors perceive zinc as the metal with the tightest supply situation, given the multitude of closures over two years. A Bloomberg report said industrial metals rallied almost 30 per cent in 2016 as demand stabilised in China and Donald Trump pledged to invest in infrastructure and revitalise the US economy, while mine closures curbed supply. Chinese investors have added to the speculative binge, it added.

The rising base metal prices bode well for non-ferrous makers, which have seen a reversal in fortunes. Companies have posted improving operating profits quarter after quarter. Hindalco, for example, posted an 88 per cent improvement in Ebitda (earnings before interest, taxes, depreciation and amortisation) during the September quarter at a standalone level, largely driven by aluminium. With the rebound in copper, the expectation on improved performance has risen. With its US subsidiary also doing well, it is not surprising that Hindalco trades at Rs 176, close to the 52-week high of Rs 184.75 last Friday.

Hindustan Zinc has given a good return to investors, with stock prices at Rs 282.25 near their all-time high of Rs 286.95 on Monday. The improvement in its prospects add to parent Vedanta's, the natural resources major, prospects; at Rs 229.75, the stock is close to its 52-week high of Rs 233.65 earlier this month. The rising metal prices will not only improve realisations but also take away concerns on rising raw material prices squeezing profitability.

Still, analysts remain cautious at the current levels, as many think the rally could be premature. The belief is that prices are running far ahead on optimism, while actual plans on infrastructure revival are some time away. Analysts at JP Morgan have said that in the near term, the market’s reaction to the US election reinforces their view that base metal prices can continue to stay well supported into the year-end. They believe the overshoot will correct itself.

Also, as prices increase, the closed smelters will become viable, adding to supply. Analysts at Reliance Securities say with additional power subsidies worth $200/tonne announced by China, there is a risk of three million tonnes of capacity coming on stream there, which could put pressure on aluminium prices.