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It may be the turn of the underperformers now. Last week, metals sector was the biggest gainer and BSE metals made 3.4% gain led by Tata Steel, Sesa Sterlite, Hindustan Zinc and Hindalco.
Street has turned positive on a selective basis on the metal companies after the news of better than expected growth in China's economy. Additionally, postponing of the US tapering issue has led to improvement in sentiments as that could possibly mean more liquidity infusion by the US central bank, supporting growth. This is good news for the world especially China, which is the export driven, and particularly for the metals as large part of the consumption is accounted by China.
Within the metal space, the biggest gains have come to Tata Steel, which rose almost 70% from its low in August to the current level of Rs 336 per share. Last week as well, the stock was up 12%. However, analysts attribute this is more to do with the stability in the Europe and lower valuations. Tata Steel is currently trading 0.8 times its book value and 6 times its enterprise value to operating profits. The domestic steel industry may face growth challenge as the demand in the user industries such as construction, automobiles and consumer goods could take more time to recover.
In a recent note, World Steel Association has lowered India's steel demand growth estimates to 3.4% in 2013 as against the earlier estimates of 5.9%. Analysts also believe that there could be pressure on the margins as a result of higher input cost and increase in freight rates.
In this context, Tata Steel, which is largely a global player, remains the top pick of analysts.
"Tata Steel remains our preferred play in the steel space as JSW Steel continues to grapple with ore procurement issues while SAIL is struggling with its inherent structural weaknesses of high costs and inefficiency," said Ashutosh Somani, who track the sector at JM Financial in a note. In case of JSW Steel, analysts have highlighted issues of lower earnings visibility because of the merger of ISPAT. Because of the merger, the broking house IIFL expects JSW’s EBIDTA per tonne to drop from Rs 7,110 per tonne in FY13 to Rs 5,998 per tonne in FY14. Both high cost operations of ISPAT and higher interest cost will hit the company’s earnings.
"We believe that non-ferrous companies are structurally better placed than steel companies in terms of demand and pricing scenario in India," said Motilal Oswal Securities in a recent note. However, within non-ferrous space as well, the analysts prefer the diversified players like Sesa Sterlite to benefit more likely not only on account of improvement in the price and demand but also on account of the valuations. Additionally, recent news about working permit for the iron ore mines in Karnataka, potential purchase of stake in Hindustan Zinc and expected higher dividend from Cairn India has led to positive views on the company.
Recently, except aluminium, which was down marginally, LME price of copper and zinc have seen about 2-3% improvement compared to average LME price in September quarter. If trend continues, nonferrous companies in the coming quarter should make better realisations and thus translate into higher earnings. However, pure aluminium players like Hindalco and other may remain in pressure because of the price and surplus capacity in the market.
"We remain negative on aluminium plays such as Hindalco which may be further adversely affected by the new warehouse norms," said Ashutosh Somani of JM Financial.
At current aluminium prices, industry experts believe that almost half of the world aluminium producers are making losses. This is because of less consumption. During January to August 2013, aluminium production exceeded consumption by about 1.1 million tonne compared to 0.5 million tonne in the same period last year.
"We have sell rating on Hindalco owing to uncertainty on the commissioning of the captive coal blocks and muted aluminium price or premium outlook. At current price it factors in high EBITDA of $720 per tonne from the enhanced domestic aluminium capacity of 1.3 million tonne compared to $500 per tonne in FY13 from existing domestic capacity," said Parita Ashar who tracks the sector at Ambit Capital
Instead, analysts prefer Nalco, which is relatively more competitive in terms of its cost of production and has large exposure to high-margin alumina business. Additionally, analysts believes that the company is sitting on huge cash which is almost Rs 19 per share or about 55% of the company's current share price at Rs 34.8 per share.
