No visibility on demand recovery, volume outlook remains weak
Indian metals and steel companies are among the worst performing names in the sector on a global and regional basis. Over the last three months, when Chinese and European names in steel have moved up/stabilised, Indian names have fallen sharply. At the margin, the commodity pricing environment has worsened only in aluminum, while in steel, global HRC prices have stabilised at lower levels. China listed names are the best performing stocks globally, benefiting from a local market rally; even European, US and Japanese names have done better.
News flow improves on the regulatory front…: Finally, after years of delay and court interventions, the regulatory issues are behind us. The mining law and the coal law are in place, approved by Parliament, which effectively regularise mining, and allows visibility of volume growth. Companies like Tata Steel and Steel Authority of India (Sail) have their iron ore mine issues resolved, while Hindalco and Sesa Sterlite have increased access to coal, and more importantly, coal production outlook has materially improved.
…But investors not interested: However, investor interest is low even as P/B (price-to-book) valuations are now at multi-year lows, and regional and global underperformance increases. The key push-back is, there is no visibility on demand recovery on the ground and volume outlook remains weak; costs (royalty, DMF—payment to district mineral foundation) have been increased by the government but there is no protection against rising imports (steel imports have been elevated from China, Russia, Japan, Korea); the rupee’s relative strength against non-dollar currencies has made the industry reduce competitiveness even as local costs have spiked up and Chinese demand outlook remains very weak and hence China would continue to export (particularly steel).
Is there a case for the relative underperformance to ease: We expect the government to increase steel import duties over the coming weeks (peak tariffs were raised in the Budget but not effective customs duty). This would somewhat level the playing field. Demand recovery should start in the next few months. These combined with stability in commodity prices, particularly steel (scrap prices have stabilised but iron ore remains weak), should allow investors to have a better grip on earnings and hence cash flows, as companies come to an end of the multi-year multi-billion dollar capex cycle.
Which names can bounce from here: Sesa Sterlite, Tata Steel and JSW Steel are names where we see a sharp bounce if the investor interest comes back as they have more near term/immediate catalysts. Any imposition of steel import duty would allow domestic prices to stabilise/inch up, benefitting the steel names.
Tata Steel is in the process of commissioning its 3 million tonnes-steel plant, and with the mining law in place, captive iron ore sourcing visibility has improved. For Sesa Sterlite, the regulatory narrative has continued to improve and with possible reduction in iron ore export duty, it would allow Goa exports to restart. While the zinc segment faces higher costs (DMF charges), there is more visibility on new mining leases.
Hindalco has come off sharply, but aluminum is under pressure. Hindalco is a relatively well owned name versus Tata Steel, Sesa Sterlite and JSW Steel.