| Soft metal |
| Jitendra Kumar Gupta / Mumbai October 5, 2009, 0:19 IST |
While the run-up in prices have made metal stocks expensive, medium term prospects are unattractive due to weak demand and inventory pile-up.
The rally in domestic metal stocks is backed by the rise in metal prices, ranging from 30-100 per cent, since February 2009. Signs of a global economic recovery, surge in Chinese imports and weakness in the dollar had fuelled the rally in metal prices. This helped metal stocks move up higher than the broader markets. The BSE Metal index has gained 157 per cent against the 73 per cent rise in Sensex since January 2009. However, analysts now believe that the fortunes of the sector, although they remain intact from a longer term perspective, do not look attractive from the medium-term standpoint as metal prices are expected to correct following the recent rally and notably, the piling up of inventories (of non-ferrous metals at the London Metal Exchange; LME). Besides, there are worries regarding the recent global economic recovery, which may not be as strong as anticipated and might get prolonged. Last but not the least, metals stocks, too, are not attractive at current valuations. The BSE Metal index is trading at a price to book value of 2.37 times and PE of 15.18 times, which is higher as compared to its five-year average of 2.33 and 7.7 times, respectively. At current levels, share prices indicate that a lot of positives are already factored into valuations.
Industrial metals
Consequent to the demand destruction as a result of falling global economic activity, prices of non-ferrous metals dropped below their respective marginal cost of production and most companies opted to cut output. As a result, global non-ferrous metal production was cut by 10-15 per cent during April 2008 and February 2009. However, since then, demand has shown signs of revival on account of recovery in global industrial and economic activities. “People did not buy anything till 2008 and beginning of 2009, but as most government started spending too much of money to revive their economies, people have again started to buy and pile up inventories,” says Jim Rogers of Singapore-based Rogers Holdings and author of Hot Commodities.
The demand for industrial metals is closely linked with economic activity, which is why analysts believe that buying in metals started in the hope of an economic revival. The IMF, in its recent World Economic Outlook report, has projected world GDP growth of 3.1 per cent in CY2010. While it is significantly higher as compared to the 1.1 per cent decline projected in CY2009, it is still far from 5.2 per cent in CY2007. According to the data, the US, Europe, Japan and Russia are expected to see a strong recovery, but only in CY2010.
This is also a reason that most analysts believe that the long-term fundamentals of the metals sector are promising. However, from the near-term perspective as Tarang Bhanushali, analyst who tracks metals at India Infoline says, "Metal prices from here could consolidate within a range of about 10 per cent for some time given that China, which was earlier importing and building capacities have stopped doing so. Also, the new supplies (plants) which were earlier closed have (or will) come on stream due to the rise in metal prices.” This should restrict any rise in prices, unless global economic growth surprises on the upside.
"China’s imports are coming down, but in the rest of the world restocking is still happening in metals. As far as prices are concerned we do not think they will go up from these levels significantly, but at the same time there is little downside considering that metal prices are still trading at reasonable levels, which is marginally above the cost of production," says Rakesh Arora, who tracks the metals sector at Macquarie Securities.
“It is very unlikely that commodity prices will correct towards the low levels seen at the beginning of the year. This is mainly due to a combination of stabilising demand, ongoing stimuli, tight fundamentals and a weak dollar versus emerging market currencies," says Diego Parrilla, managing director and head of commodities-Asia Pacific, Merrill Lynch in an interview with Business Standard, last week.
Aluminium
Amongst the most widely used non-ferrous metals, aluminium has an edge over others as it will benefit the most in case of any revival in the global economy. Asia accounts for 43 per cent of world consumption, wherein economic growth is expected to be faster. According to IMF estimates, developing Asia’s GDP is expected to grow at 6.2 per cent in 2009 and 7.3 per cent in 2010. Also, the revival in automobile, packaging and construction sectors, which are the largest consumers of aluminium, as well as the demand from the power sector, would augur well for this metal. However, most of these benefits are seen accruing in CY2011, as major global economies are expected to see revival by end of CY2010. During 2009, despite an expected 6 per cent decline in world aluminium production to 37.25 million tonne, the surplus is expected to remain as consumption is expected to be lower at 34.63 million tonne. Also, analysts fear that spare capacities might be put to use in the near term if metal prices rise further. Any meaningful recovery in aluminium prices is seen only beyond CY2010; per tonne prices are expected to average at about $1,900-1,930 in CY2010 and $2,200 in CY2011, as compared to the current price of $1,850.
Copper & Zinc
Lower demand, a sharp cut in China’s copper imports recently, higher inventory at LME and over 100 per cent increase in copper prices since March 2009, are near-term concerns for copper prices. In CY2009, global copper production is expected to be lower by 3.6 per cent, but consumption is seen falling by 4.6 per cent. Copper fortunes are only seen improving in CY2010 when production and consumption are expected to grow at about six per cent each.
In CY2008, Zinc’s global consumption grew by 0.5 per cent as against 9.1 per cent rise in production. Even during January to July 2009, consumption fell by 10.77 per cent, while production slipped by a lower margin of 7.17 per cent. Thus, inventories have piled up from a low of 70,000 tonne in September 2007 to about 436,000 tonne currently. Despite this, zinc prices have been rising as China, which consumes about 30 per cent of global zinc production, continued to import and accumulate its inventory. However, as zinc prices are up 73 per cent since March this year and inventories have risen sharply, prices are expected to remain subdued going ahead. Also, slowing imports from China and incremental supplies coming at higher prices might cap zinc prices. Analysts estimate prices to trade at current levels of $1,855 per tonne during CY2010 and CY2011. Any recovery is only seen in CY2012, when prices are seen at about $2,125 per tonne.
Sterlite industries
Sterlite Industries’ edge is its low cost of production and any recovery should mean relatively more gains for the company. In copper, while refining margins have improved from their lows, it has signed long-term contracts at 67 per cent higher rates as compared to CY2008. This year, revenues are expected to drop by about 4-5 per cent given the lower realisations; in 2010-11 though, realisations are seen improving by over 25 per cent. More importantly, operating profit margins are expected to improve from 22.2 per cent in 2009-10 to 30 per cent in 2010-11 due to cost reduction, better realisations and contribution of power business. Sterlite will be commissioning a total of 2,500 mw of merchant power capacities by July 2010; of this 600 mw capacity is being commissioned in October 2009. The power business would contribute almost 30 per cent of earnings in 2010-11. Overall, revenues will also be aided by expansion of its zinc capacity by 2,10,000 tonne per annum and doubling of aluminium capacity at Balco, both by October 2010. On the sum of parts basis, analysts value the stock between Rs 750-850 per share due to its stake in different subsidiaries and cash in the books.
Hindalco Industries
Hindalco is a leading aluminium producer and among the low cost producers globally. The performance of Hindalco’s US subsidiary, Novelis (accounts for about 70 per cent of the consolidated sales), is seen improving as demand in two of its biggest markets (US and Europe) is stabilising. Due to steps towards lowering costs and the recent improvement in realisations, Novelis’ EBDITA per tonne is expected to improve from $83 per tonne in Q4 2008-09 to about $180 per tonne in 2009-10 leading to higher consolidated profitability. Overall, aluminium business is expected to do well with higher prices and volumes on account of expansion of capacities and higher shipments recorded by Novelis. Its copper business (26 per cent of revenues) is expected to report revenues in line with last year’s levels, given the lower demand and realisation (refining margins). Overall, while fundamentals are improving for the company, most of the gains are already reflected in its rich valuations.
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