Dalal Street turns positive on metals as outlook improves

Lower debt, cost-cutting measures, improved product mix to drive profits

The beaten-down metals sector could be seeing some light at the end of the tunnel. During FY14, which proved a challenging year for the sector, demand remained flat year-on-year and realisations were weak on falling global prices of most metals. Other than the optimism surrounding elections, the metal sector has fundamental triggers in place on the basis of which select analysts have upgraded the sector.

Over the past two years, metal producers have done several things to get their house in order; so, the Street is willing to upgrade the sector even though the global outlook for commodities isn’t going to change dramatically. The listed metals players have taken various including managing their costs better. While Hindalco is shifting focus to high-margin automobile products, JSW Steel is concentrating on high-margin steel products in the domestic market and is also doing several things to cut costs in its new units.

The market is also optimistic about improving capital structures. Tata Steel and Hindalco have substantially pared their debt levels. Tata Steel’s net debt/equity has fallen to 1.6x from 1.9x and the company is expected to be cash flow positive at the consolidated level in FY15. Hindalco, too, has brought down its debt/equity ratio from 1.4x to 1x and is expected to be cash-flow positive from this financial year. JSW Steel also fits the bill on all counts as it has pared debt/equity to 1.1x from 1.6x. Citi's research team notes: “Lower capex and growth/self-help should help leverage ratios improve. Further upside could come from sale of non-core assets and an improved macro.”

Other than core fundamentals, analysts also believe there could be some event-based triggers for the sector. A major event-based trigger would be resumption of iron ore mining in Goa, as it would aid cash flows and improve profitability. Globally, too, there is a trigger for the aluminium industry. Global aluminium producer Alcoa has guided there would be a deficit in the global aluminium market of 730,000 tonnes in 2014 as many players have cut capacities.

Edelweiss Securities says: “Alcoa has announced capacity cuts of 420,000 tonnes a year in primary aluminium and 200,000 tonnes a year in can sheet segments. This is a significant change from previous quarter’s view of global surplus of 106,000 tonnes in 2014. The company maintained guidance for global aluminium demand growth at seven per cent to 52.6 million tonnes in 2014.”