We see a clear dichotomy in the sector with supply deficit in non-ferrous space and overcapacity in ferrous. While non-ferrous companies are expected to expand their margins led by stable prices (driven by global supply constraints) and lower cost of production due to low-priced domestic coal, profitability of ferrous companies is likely to come under pressure due to impending higher coking coal costs (from December). On valuation front, non-ferrous companies under coverage are trading at a discount to global peers, while ferrous companies are trading at par or premium. Maintain ‘buy’ on non ferrous players: Hindustan Zinc, Hindalco and Vedanta, and ‘reduce’ on ferrous players: Tata Steel, JSW Steel and SAIL, and ‘hold’ on NMDC and Jindal Steel & Power.
We are upbeat on outlook for zinc and aluminium mainly due to constrained supply. In case of zinc, YTD mined zinc production is down 11% Year-on-Year to just 7.95 million tonnes. Zinc inventory at SHFE and LME is down to 7-year low levels of 603 kt. As per the estimates of International Lead and Zinc Study Group (ILZSG), cumulative zinc deficit is expected to be 650KT through to Calander Year (CY)17, constituting 2% of global demand. In case of aluminum, price is being supported by rising cost curve of Chinese players.