After a strong rally in 2021, prices of steel and aluminum across the globe have softened on weak macro and demand concerns in China, forcing analysts at Jefferies to lower their optimism on India’s metal sector. “We lower our optimism on India metals as we enter 2022. Weak macro and demand concerns in China are weighing on metal prices,” a report by Jefferies said. The brokerage firm added that easing policy could lift demand in China but they added that the risk-reward is much lower than a year ago. Tata Steel has been downgraded to ‘Hold’ from ‘Buy’ and JSW Steel has been cut to ‘Underperform’ from ‘Buy’.
Hindalco is Jefferies’ top metal pick in India as analysts are positive on Novelis’ downstream business, and prefer aluminum to steel. Novelis, Hindalco’s 100% owned downstream subsidiary, contributes 55-60% of its EBITDA. It is benefiting from the structural shift to aluminum from steel in autos. “Hindalco’s 1.2x FY23E PB is attractive for 16% FY23E ROE and low earnings risk at Novelis. It has historically traded at average 0.8x PB for 9% ROE,” the report said. A target price of Rs 660 per share hints at 33% upside.
Tata Steel: HOLD
Jefferies has downgraded Tata Steel to a ‘Hold’ rating. Analysts expect Tata Steel’s cash flows to remain strong though with margins still high in absolute terms and working capital pressure from rising commodity prices behind. “We find TATA’s 1.2x FY23E PB for 17% FY23E ROE undemanding especially in the context of the rising share of India volumes; historically average is 1.0x PB for 8% ROE. However, we believe the stock is unlikely to perform until earning visibility improves,” they added. A target price of Rs 1,240 per share has been set on Tata Steel, implying a 9% upside.
JSW Steel: Underperform
JSW Steel has been downgraded to ‘underperform’ rating as the stock is trading at 7.1x/6.7x FY23E/FY24E EV/EBITDA versus long-term average of 6.1x despite a weakening margin outlook. “We see healthy 19-22% ROE in FY23-24E, but the stock is already at 2.1x FY23E PB, leaving little room for earnings disappointment,” analysts said. A target price of Rs 600 suggests 7% downside.
Why bearish on metal stocks: Gone are the days
Global commodity prices charted a secular up-move in the second half of 2020 and the first half of 2021. With the demand faltering in China in the second half of 2021, prices of metals have been softening. Although there are signs of China’s PMI bottoming out, which clubbed with easing policy measures may lift the demand for commodities. “However, there is still a risk of subdued growth in absence of a big property sector revival as the real estate and related industries account for about 30% of the country’s GDP,” Jefferies said.
Metal stocks in India saw a strong up-move during 2021. With SAIL gaining 150% between the last week of January and the first week of May, Tata Steel zoomed 105%, JSW Steel gained 100%, and Hindalco soared 82%. India’s HRC steel price doubled from June 2020 to October 2021, on the back of a sharp rally in Asian steel prices. However, with Chinese prices correcting, prices in India are down as well. “We believe margins for Indian steel companies have peaked in 1HFY22 and will fall sharply by FY23, albeit settle above historical levels,” analysts said. Jefferies has cut FY23 EPS for Tata Steel and JSW Steel by 18%/26%– the first big cut in more than a year.