Metal Stocks - Best buys !!

The metals sector has been facing a tough time, partly due to the correction in global commodities prices and also because of certain domestic developments like the ongoing CBI probe into the mining industry in Karnataka.

Many frontline metal stocks like JSW Steel, Tata Steel, Sesa Goa, Hindalco and Sterlite, to name just a few, have seen a severe contraction in prices. What has further compounded the problem is the ongoing crisis in the Euro Zone and the fear that China's metal demand may slow.

It is tough to say which metals segment — copper, steel or aluminium — would take a greater hit than the others or whether the producers catering to domestic demand would be spared from demand recession compared to companies like Tata Steel which has a significant presence in European markets.

But for long term investors, it would be tempting to know whether the current meltdown in metal stocks make them hot investments, even in the likelihood of further price correction in these shares. All the five metal stocks mentioned earlier have suffered serious erosion in value and three of them have seen their Price to Earnings (PE) ratio come down to single digits.

The extent of carnage the sector has suffered could be judged by taking a look at today's NSE closing prices compared to their year's high (given in brackets):

Sesa Goa - Rs 204.25 (Rs 383.65); Jindal Steel and Power – Rs 480 ( Rs 755.50); Tata Steel - Rs 420.70 ( Rs 737); Hindalco - Rs 126.10 (Rs 252.85) and Sterlite - Rs 113.35 (Rs 195.95).

But what is intriguing is that while the stocks of metal companies has seen a correction, it is not as if all metal prices have corrected. For instance, the steel prices have not gone down so much compared to the share price of steel stocks. Given the problem in mining in India, it is possible that domestic steel prices may remain firm, benefiting steel producers.

In an interview to Business Line, Mr Bhavesh Chauhan (Senior Research Analyst  — Metals & Mining), Angel Broking, Mumbai, shares his views on the metal sector's performance and what it holds for them in future. Excerpts:           

Metal stocks have taken a hammering. Do you consider them worthy of investment at current prices or is some more pain due?

The last 6-8 months have been bad for metal companies due to escalating debt crisis in Europe and stocks have been battered. As long as the situation in Europe remains grim, metal demand would remain weak and sentiment will keep metal prices lower. Monetary tightening in China has also played its part, although there hasn't been any huge decline in China's appetite for resources so far.

Different metal stocks (Sterlite (copper), Hindalco (aluminium), JSW Steel, Tata Steel and Sesa Goa) have suffered. Do you see any particular company recovering in the short term? Are all metal stocks in the same league?

Metal being a global commodity, all the stocks would be in the same league, although broadly we classify the companies as ferrous and non-ferrous and then we could have the classification in terms of steel makers and miners as well. Again, recovery of any stock would depend on how Europe shapes out. Also, there are concerns on US going into double dip too. So that factor has to be seen closely.

The reasons for the downslide in shares — controversy in the Karnataka mining sector and slowdown in Europe — are different. Do you think it would take some time for these negative factors to disappear?

 For Karnataka mining, it is more of a regional thing and it affects companies operating in Karnataka. I believe the Karnataka issue could be sorted out in 6-9 months. European slowdown is a big concern actually and how long it will take for these factors to disappear is a challenging question.

The economic slowdown has led to demand contraction resulting in fall in metal prices. But any economic recovery would see demand for metals picking up. So, do you feel the fall in prices is temporary or will it continue for a while?

Any recovery in Europe should see base metal prices recovering, although the way the scenario is today, it is difficult to give a time frame. At least in the near-term I do not expect any recovery in base metal prices.

Which are the sectors that would benefit due to metal prices falling — autos, housing, electrical goods, capital goods. Do they have any upside potential because of this?

Companies in capital goods and infrastructure will benefit if prices fall. However, steel prices have not fallen so far. Steel is the commodity which is used mainly as a raw material in machinery and construction. We do not expect any significant fall in steel prices anyway as prices of raw material remain high and are expected to remain firm due to supply concerns.

Though metal prices have fallen, the woes in Europe and US may not lead to pick-up in demand for products. How will Indian companies benefit?

Base metal prices have fallen. So, a little benefit will flow to some companies. However, steel remains the most widely used commodity.

How will the rise in dollar value and fall in rupee value affect the Indian metal cos? Hasn't the fall in rupee value neutralised any benefit of fall in commodity prices?

With the rupee depreciating, it helps companies selling metals as imports become expensive and hence domestic producers can raise prices. As far as importers of commodities are concerned, so far the falling rupee has offset falling commodity prices as you rightly say.

Have the frontline metal stocks become investment worthy after price correction? What are your picks and why?

We do feel that front-line metal stocks are now worth investing as we believe markets are discounting on the near term global macro issues (primarily Euro zone crisis). The current price levels do not discount the expansion plans by companies over the next 2-3 years. We like companies with captive resources and big expansion plans. With captive resources, these companies would generate higher return on capital employed at even current metal prices. Though we like Hindustan Zinc, SAIL, Sterlite amongst others, Tata Steel and Hindalco are our top picks –Tata Steel with a target price Rs 614 and Hindalco with a target price of Rs 196.

We like Tata Steel for its buoyant business outlook, driven by higher sales volume on completion of its 2.9 mt brown field expansion in Jamshedpur. The company's raw material projects are expected to be commissioned by 4Q FY2012 with lower off take initially; the full benefit is expected to accrue in FY2013E. Additionally, restructuring initiatives at Tata Steel Europe are likely to benefit the company going forward. We believe Hindalco is well placed to benefit from its aluminium expansion plans (capacity increasing by nearly two-three folds in the next two-four years). Most of its new capacities will be backed by captive mines leading to robust margins. Further, we expect steady EBITDA of $1 billion annually from Novelis.   

Steel prices have not fallen much but steel stocks have suffered. Because of the mining issue, steel prices may remain firm. Does that make steel stocks attractive for investment?

Steel prices have not fallen because prices of iron ore and coking coal across the globe are still firm. The mining problem is only India-specific and does not have any impact on the steel prices, which are globally determined. We believe steel stocks are attractive given that their margins have shrunk drastically over the last 9 months or so. We like steel stocks as coking coal prices are expected to fall, interest rates in India should fall sooner than later, capex cycle should pick up in the next six months. The stock prices have discounted all the negatives, leaving some of the stocks highly undervalued. 

Ingenious Investor
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