Metal stocks rally despite decline in corporate earnings in Sept quarter

Bright future for sector could be a reason, say experts

The sharp reversal in the net profit of metal and mining companies in the second quarter of the 2022-23 financial year (Q2FY23) is yet to show in the stock price and market capitalisation of these companies.

The combined net profit of 32 listed metal and mining firms in the Business Standard sample is down 82 per cent year-on-year (YoY) in Q2FY23 and 72 per cent quarter-on-quarter (QoQ). But the share price of most of the stocks in the sector has either rallied or is unchanged during the period. As a result, the combined market capitalisation of 32 metals and mining companies in our sample is 1.3 per cent in the last 12 months and is up nearly 10 per cent since the beginning of Q2FY23.

Metal stocks were also among the top performers on Friday as the BSE Metal index was up 2.27 per cent compared to 1.95 per cent rally in the benchmark BSE Sensex. Among individual stocks, Tata Steel was up 2.72 per cent, JSW closed with gains of 2.53 per cent and Hindalco rallied 3.53 per cent. All these top metal producers reported sharp decline in earnings in Q2FY23.

Analysts attribute the dichotomy between a company’s financial performance to its stock performance to investors' optimism about the future earnings trajectory of the firm. “Many investors believe that the sharp decline in the net profit of metal companies in Q2FY23 is temporary and most companies in the sector will start reporting earnings growth soon,” says Dhananjay Sinha, director and head–research, strategy and economics at Systematix Group.

Sinha, however, sees more downside for the metal and mining stocks given a decline in steel production and demand in China in the first nine-months of the 2022 calendar year and a decline in the prices of key industrial metals and ores such as steel, iron ore, aluminium and copper, among others.

According to him, the recent rally in the metal space is an exit opportunity for investors, given the poor outlook for the sector in the near to mid-term. “The post-Covid-19 boom in the metal prices and earnings of metal producers is over for now. Going forward, we expect a steady deterioration in the financial ratio of metal companies due to the combined effect of lower earnings and rising finance cost as interest rates go up,” he adds. 

Metal companies are also facing headwinds from a relatively high energy price which has translated into higher operating costs and lower margins.

Bulls however believe that the worst is over for metal producers and companies will report margin improvement and higher profits in the second half of FY23.

“With the monsoons over, we expect steel prices to pick up from the middle of November driving margin improvement. Further, a reduction in coking coal prices in the third quarter should also help margins,” write Vishal Chandak of Motilal Oswal Securities in his latest report on Tata Steel. Tata Steel’s consolidated adjusted net profit was down 87 per cent YoY in Q2FY23 but its share price is up nearly 10 per cent since the end of September this year.

The recent rally in metal stocks has however led to an expansion in their valuations even though the sector continues to trade at a discount to the broader market. The metal stocks in our sample are now trading at a trailing price to earnings multiple (P/E) of 9x, up from a low of 5.3x at the end of June this year and highest since September last year. In comparison, the Sensex is currently trading P/E of 23x.