Metals: Q3 to be mixed bag

Earnings of most metal firms to remain weak, on falling prices and forex losses.

The metals and mining sector has grown at a spectacular pace since 2004. As the world economy expanded, the consumption of metals rose steadily, triggering mega capacity expansion by many players. But most metal stocks declined by 40-55 per cent in 2011 and are trading between 0.5-1 times book and 5-7 times Ebitda.

At the start of the last financial year, the expectation was that even though growth would moderate in some developed parts of the world, India and China would hold up. But with growth cooling in these two economies, metal prices have corrected. Coupled with this, demand has come under pressure even in the domestic market, especially for steel. Going forward, analysts expect rising cost pressures and lower profitability to hurt the metal stocks for some more time.

Compared to the second quarter of the current financial year, prices of most metals have fallen by 11-19 per cent in dollar terms. While non-ferrous commodity prices have declined by up to 12-19 per cent quarter-on-quarter, average aluminium realisation is down 2.8 per cent. According to Kotak Institutional Equities, companies with lower reliance on raw material imports stand to benefit. Hindustan Zinc and Hindalco stand out in this respect.

For steel companies, too, the outlook remains bleak. According to ICICI Securities, higher raw material costs and stickiness in pricing will lead to an estimated 400 basis points year-on-year margin drop for Tata Steel, SAIL and JSW Steel. The brokerage expects Tata Steel to post an Ebitda loss of $30 a tonne in the third quarter.

The only commodity where Indian companies have retained profitability is zinc. Analysts say Hindustan Zinc has outperformed its global and regional peers across the value chain. According to ICICI Securities, Sterlite continues to reel under investor concern of possible equity reinfusion in Sterlite Energy and Vedanta Aluminium. Analysts say though the fall in the rupee would cushion lower realisations due to fall in prices globally, companies with forex loan exposure would also have to provision for marked to market losses. In a report on the sector’s third quarter outlook, Kotak Institutional Equities, says: “We expect Ebitda/tonne of Rs 4,967 (-27.5 per cent QoQ, -17.9 per cent YoY) from JSW Steel and Ebitda of Rs 1,030 crore (-25.9 per cent QoQ). This combined with forex loss of Rs 210 crore will result in the company reporting net loss of Rs 50 crore in the third quarter FY12 as against net income of Rs 290 crore in the third quarter of FY11.”