Metal stocks rally defies global peers, not backed by fundamentals

Metal and mining companies, such as Tata Steel, JSW Steel, Hindalco, and Coal India, have been among the top-performing sectors on the bourses in recent months. The S&P BSE Metal Index is up 13 per cent in the past three months, rallying 29 per cent in the past year, outperforming the broader market.
 

For comparison, the benchmark S&P BSE Sensex has only seen a 1.7 per cent increase in the past three months, with a 15 per cent gain since the end of September last year.
 

Metal stocks continued to rally last week, despite weakness in the overall market. The BSE Metal Index was up 2.2 per cent during the week ending September 29, compared to the 0.3 per cent weekly decline posted by the benchmark Sensex in the same period.
 

However, the rally in domestic metal and mining stocks is not backed by fundamentals.
 

International prices of industrial metals, such as steel, copper, and aluminium, remain weak, and metal and mining companies reported earnings contractions in the 2023-24 (FY24) April-June quarter (first quarter, or Q1).
 

The London Metal Exchange Index, which tracks the international prices of six key base metals, including aluminium, copper, and zinc, has remained flat in the past three months and is up only 4 per cent in the past year, underperforming the BSE Metal Index by a wide margin. Steel has fared even worse and has lagged behind base metals. The domestic spot price of hot-rolled steel in China, the world’s top consumer and producer of metal, has declined by 6 per cent in the past year.
 

Similarly, domestic metal producers continue to face earnings headwinds after experiencing a boom in their revenues and earnings in 2021-22. The combined net profit (adjusted for exceptional gains and losses) of the 10 companies that are part of the BSE Metal Index was down 38 per cent year-on-year (Y-o-Y) in Q1FY24. This marks the fifth consecutive quarter of Y-o-Y earnings decline for metal and mining companies. Additionally, these companies’ combined net sales were down 3 per cent Y-o-Y in Q1FY24, indicating weakness in demand and lower price realisation in the sector.
 

In comparison, metal companies’ net profit on a trailing 12-month basis was down 56 per cent Y-o-Y in Q1FY24, while their net sales were up just 1.5 per cent Y-o-Y in the same quarter. This disparity between earnings and stock price has resulted in the price-to-earnings multiple of companies in BSE Metal rising to a 22-quarter high of 15.4x on Friday, up nearly 600 basis points from 9.5x at the end of December 2022.
 

One basis point represents one-hundredth of a percent.

 

Some analysts attribute the rally in metal stocks without matching growth to a hope rally. "Many investors are hoping for a demand revival in China due to fiscal and monetary stimulus announced by the government there. This is expected to boost the international prices of ferrous and non-ferrous metals, thereby enhancing the earnings of domestic metal producers," says Dhananjay Sinha, head of equity strategy and research at Systematix Institutional Equities.
 

China accounts for more than half of the global demand for industrial metals, and higher demand from the country is the key determinant of metal, ores, and coal prices globally.
 

However, some analysts are betting on better earnings by metal producers in the second quarter of FY24, driven by higher domestic demand and improvements in the companies’ operating margins.
 

“Strong domestic demand led by infrastructure boom in an election year is expected to keep steel prices higher in the Indian market. We anticipate steel demand to grow at a compound annual rate of 8 per cent in the next decade compared to the 5 per cent compound annual growth rate growth in the last decade,” write analysts at Prabhudas Lilladher in their recent report on metals and mining companies.