Pressure mounts on non-ferrous metal producers

Lower LME prices have compounded the worries for Sterlite Industries and Hindalco, which are already grappling with other issues

Companies in the non-ferrous space like Sterlite Industries and Hindalco are expected to face pressure in coming months as the prospects for industrial commodities such as aluminium, copper and zinc are weakening. Recent major events such as indication of lower bond purchasing (also known as quantitative easing) by the US Fed, slowdown in China’s consumption and higher inventories at the LME have together taken a toll on international non-ferrous prices, which have fallen by 6-8 per cent in last fortnight.

The worries also stem from demand side as a result of slower GDP growth in the developed countries in the December 2012 quarter and lower than expected manufacturing PMI (Purchasing Managers Index) data in Europe, China and Japan for the month of February 2013. In fact, to deal with the emerging situation, some of the global aluminium producers have already started cutting output.

Hence, even though the share prices of companies in this space such as Hindalco, Sterlite, Hindustan Zinc (Sterlite’s listed subsidiary) and Nalco have fallen by 5-11 per cent in last one month, analysts believe there could be more pain. “Non-ferrous companies are expected to continue to face a double whammy of declining product prices coupled with higher input costs," said Bhavesh Chauhan who tracks the sector at Angel Broking.

The international non-ferrous prices have fallen recently and thus the impact on financials of the companies will be seen in the coming months. "We have already seen margin pressure due to lower volumes and rise in input cost in December (2012) quarter. Cost will remain high and if the prices continue to fall there will be further pressure on the margins and earnings. Only thing that can save these companies is growth in volumes, which we need to monitor going forward," said Goutam Chakraborthy, who tracks the company at Emkay Global.

Analysts have already lowered their expectations and cut the earnings forecast by 2-4 per cent for FY2014. Part of this is already reflected in share prices. And if the situation worsens, their estimates could see further cuts.

Hindalco has seen the highest cut in earnings estimate, which is also a reason that its share price has fallen the most. Hindalco also came into the limelight due to the issue of transport of bauxite and lockout at its plant at Silvassa (Gujarat), which has 30,000 tonnes per annum aluminium foil and converted products manufacturing capacity. On the positive side, given the beaten down share prices (stock at 42 month low) valuations are supportive, while commissioning of new capacities could help boost volumes.

"In our view, the current stock price of Hindalco (Rs 101.10) is only pricing in Novelis and a part of the current India business in FY14. With project commissioning on the way and India ally (aluminium volumes) recovery (as production stabilises), we expect the sharp discount to our fair value estimate to narrow," said Pinakin Parekh of JP Morgan in a note.

Sterlite Industries, too, has been facing issues relating to project delays in the aluminium business and weak prospects of Sesa Goa (into which Sterlite will merge to form Sesa Sterlite), given the mining issues in Karnataka and Goa. But, similar to Hindalco, Sterlite’s stock is also not far from its four-year low. And, analysts say, in terms of risk-reward, Sterlite is better placed.

“I think, Sterlite is better placed because most of the negative news is already in the price,” said Chakraborthy. Its stock is trading at Rs 100, whereas the value of its 64.9 per cent stake in Hindustan Zinc alone is about Rs 69 a share. Further, Sterlite is relatively more diversified and if it buys out the minority stake in Balco and Hindustan Zinc, it could create more value. Its debt levels are also reasonable (net debt of about Rs 8,200 crore).

For investors, the situation isn’t easy. Although valuations look attractive, the business prospects are weakening with possibility of further pain. Hence, monitoring these developments and global events (including prices) and awaiting a revival would be prudent.