Metal & mining stocks big laggard on bourses over the long term

BSE Metal up just 164% since Jan '05 against 645% rally in Sensex

Metal and mining stocks have been star performers on the bourses so far in calendar year 2021 (CY21). The S&P BSE Metal index, which tracks the market capitalisation of the sector’s top 10 firms, has risen 39 per cent since January, against a 2 per cent rise in the benchmark BSE Sensex.

The industry’s superlative performance in the short-term, however, masks the fact that it has been a big laggard on the bourses over the long term. (See the adjoining charts)

Since January 2005, the BSE Metal index has risen just 164 per cent, against a 645 per cent rise in the BSE Sensex. The metal index closed on Friday at 16,017, up from 6,104 at the end of January 2005. Over the same period, the Sensex rallied from 6,556 to 48,832.

This translates to a compound annual growth rate (CAGR) of returns of just 6 per cent for long-term investors in the sector, which is similar to the inflation rate over this period at best, and less half the returns delivered by the broader market of 13.4 per cent, not including equity dividend earned by investors.

The poor show can be attributed to the low metal and ore prices and poor demand growth in the domestic market and internationally after global financial crisis.

This makes many long-term investors sceptical about the sector’s ability to deliver good returns, despite a favourable macroeconomic environment in the post pandemic economy. There has been a sharp surge in metal and ore prices in the last 8-9 months globally, leading to a spike in the margins and profits of metals producers and mining companies.

“Metal and mining is a highly cyclical sector with no certainty about the company’s earnings trajectory in the long term. This makes their share price highly volatile, unlike, say, companies in the IT or FMCG sectors. This makes them unsuitable for long-term investors,” says G Chokkalingam, founder and managing director of Equinomics Research & Advisory Services.

The volatility in the sector shows in the historical earnings. In the past 15 years, the combined net profit of top 10 companies in the sector has ranged from a high of Rs 39,000 crore in FY18 to a low of Rs 2,900 crore in FY16. That’s an earnings volatility of 1250 per cent. In contrast the earnings growth or contraction in consumer goods and IT services moves in a tight range.

Similarly, metal and mining companies’ return on equity has ranged from a record high of 50 per cent in FY05 to a low of 1.1 per cent in FY16.

Such a high year-on-year variation in the industry's earnings makes it tough to put a fair value to the stock price of these companies on the basis of usual metrics like price-to-earnings multiple or price-to-book value.

“The unpredictability of the sector makes it tough for investors to choose the right time to buy or sell these stocks. This greatly raises the chance of investors losing money on these counters,” adds Chokkalingam.

The industry is also plagued by high debt and boom-bust cycles, given its high capital intensity and the years required to bring a mine or a steel or aluminium plant on-stream.

On the bright side, however, metal and mining companies have the ability to generate copious amounts of free cash flows in industry’s upcycle. This can generate generous dividends for investors with dividend yield close to or even higher than the interest on long-term fixed deposits at least for 2-3 years in a row.

Hindustan Zinc, for example, has paid a cumulative equity dividend of Rs 43,000 crore in the past five years, translating into a dividend yield of 63 per cent for an investor who bought the stock in FY15 and stayed invested. Other companies with big dividend payouts include Coal India and NMDC.

This makes the sector a good tactical opportunity for investors, especially if they can catch a particular stock of the industry at the right point in the cycle.