Sector review | Metals

August 24, 2012 Bhavesh Chauhan

Tel: 022- 39357800 Ext: 6821 bhaveshu.chauhan@angelbroking.com

1QFY2013 Result Analysis

Margins succumb to cost pressures
Mixed top-line performance: For 1QFY2013 the metal companies in our
coverage showed a mixed top-line performance. Steel players like Tata Steel and JSW Steel reported a growth in net sales of 33.2% and 2.5% respectively, whereas all the non-ferrous players except Sterlite Industries (Sterlite) saw their top-line cripple due to lower prices of aluminium and zinc coupled with lower volumes. Among the miners, except for Sesa Goa, all the other companies showed a moderate increase in their top-lines aided by higher volumes. Margins remain under pressure: The operating profits declined for all of the nonferrous players due to lower realizations and higher input costs. Among the steel players only Tata Steel reported a fall in operating profits and margins due to higher labor costs at its European operations. Mining companies also faced severe margin pressures during the quarter due to lower ore prices and higher input and staff costs. Further, some companies like SAIL, Sesa Goa and Sterlite reported forex losses for the quarter due to a 21.0% yoy depreciation of the INR against the USD. Outlook: Globally, sea-borne iron ore prices have declined sharply over the past five months in line with a decline in other metal prices. Contracted coking coal prices have declined gradually over the past one year. Moreover, spot coking coal prices have declined sharply over the past two months (down 20% to US$175/tonne) the lowest in two years. Decline in coking coal prices is expected to benefit Indian steelmakers during 2HFY2013, although INR depreciation would partially offset the coking coal price decline. A subdued demand, escalating eurozone debt crisis and falling iron ore and coking coal prices have resulted in a decline in steel prices globally over the past five to six months. However, domestic steel prices have remained flat on account of INR depreciation against the USD. Hence, we expect steel companies margins to improve y-o-y during FY2013. Non-ferrous companies are expected to face a double whammy of declining product prices coupled with higher input costs during FY2013. Base metal prices have declined steeply over the past six months and hence realizations for companies are expected to decline during FY2013 (partially offset by INR depreciation against the USD). Further, although several aluminium companies (globally) have announced production cuts, we are yet to see any meaningful decline in production. Thus, lower realizations coupled with higher prices of key inputs such as imported coal, caustic soda, CP pitch and petroleum coke are expected to hit margins of non-ferrous companies during FY2013 in our view. Nevertheless, we expect prices to improve in FY2014 as announced production cuts restore demand-supply mismatch during FY2014. Valuations inexpensive, but we remain selective: Metal stocks have been battered over the past six months on account of escalating Eurozone debt crisis, subdued domestic demand, decreasing prices, rising input costs and delays in obtaining procedural clearances for mines. Nevertheless, we believe that the recent fall has left some stocks undervalued. We like companies with captive assets, strong visibility over its expansion plans, low leverage levels and inexpensive valuations. Hence, our top picks are Tata Steel, NMDC and Hindustan Zinc.
Please refer to important disclosures at the end of this report

Vinay Rachh
Tel: 022- 39357600 Ext: 6841 vinay.rachh@angelbroking.com

Metals | Sector review

Mixed top-line performance: Steel companies reported a mixed top-line performance during 1QFY2013. JSW Steel and Tata Steel saw a net sales growth of 33.2% and 2.5% yoy respectively whereas SAIL reported a 1.6% yoy decline in net sales mainly due to lower volumes during the quarter. Among the non-ferrous players only Sterlite reported a 7.8% yoy increase in net sales on the back of higher volumes; however, the top-line of the rest of the players fell on an average by 1.7% due to lower prices of aluminium and zinc. Among the miners, except for Sesa Goa, all other companies showed a moderate increase in top-line aided by higher volumes.

Exhibit 1: 1QFY2013 - Top-line growth

35,000 30,000 25,000 1QFY13 1QFY12

Exhibit 2: Top-line - variance from expectation

30 20 10

(` cr)

15,000 10,000 5,000

Coal India Hindalco NMDC Nalco SAIL Tata Steel MOIL Sterlite HZL

(%)

20,000

0 (10) (20) (30)

SAIL

Tata Steel

NMDC

Nalco

Coal India

Sesa

Source: Company, Angel Research

JSW Steel

Source: Company, Angel Research

Higher input costs dent operating profits: Among the steel companies, Tata Steel reported a 23.1% fall in operating profits due to higher labor and power costs. SAIL reported a healthy 15.1% increase in operating performance due to lower raw material costs. JSW Steels EBITDA grew 33.0% yoy which was in line with increase in sales. In the non-ferrous sector all the four companies in our coverage reported 21.6% fall in operating profits on an average, mainly due to lower prices, higher power costs and lower by-product sales. Among mining companies, Sesa Goa and MOIL also faced severe margin pressures during the quarter; MOIL was hit by lower prices while Coal Indias margins were hit by higher staff costs.

Exhibit 3: 1QFY2013 Operating profit growth

6,000 5,000 4,000

Exhibit 4: Operating profit - variance from expectation

40 30 20 10 0 (10) (20) (30) (40) (50)

(`cr)

2,000 1,000 0

MOIL

SAIL

Tata Steel

NMDC

Nalco

Coal India

Hindalco

HZL

JSW Steel

Sesa

Sterlite

(%)

3,000

MOIL

SAIL

Tata Steel

NMDC

Nalco

Coal India

Hindalco

HZL

1QFY13

1QFY12

Source: Company, Angel Research

Source: Company, Angel Research

August 24, 2012

JSW Steel

Sesa

Sterlite

JSW Steel

Sesa

Sterlite

Hindalco

MOIL

HZL

Metals | Sector review

Other income boosts adjusted PAT growth for some companies: Among the steel players, both JSW Steel and SAIL reported a healthy growth in other income by 83.2% and 435.0% yoy respectively which boosted their bottom lines. However, Tata Steel was an exception where other income fell by 92.5% yoy due to a higher base on account of a one-time other income realized by the company in 1QFY2012. All the non-ferrous players reported an average increase of 30.8% yoy in other income due to higher cash balance and increased yields; however except for Hindustan Zinc, the increase in other income failed to boost their bottom-lines because of higher interest costs for the quarter. Due to a 21.0% yoy depreciation of INR against the USD, some companies (SAIL, Sesa Goa, JSW Steel and Sterlite) reported forex losses.

Exhibit 5: Other income growth in 1QFY2013

4,500 4,000 3,500 3,000 2,500 2,000 1,500 1,000 500 0

Exhibit 6: Some companies reported forex losses

100 0 (100) (200) (300) (400) (500) (600) (700) (800)
SAIL Tata Steel NMDC Nalco Coal India Hindalco MOIL Sesa HZL HZL JSW Steel JSW Steel Sterlite

(` cr)

SAIL

Tata Steel

NMDC

Nalco

MOIL

Coal India

Hindalco

Sesa

HZL

JSW Steel

Sterlite

(` cr)

1QFY13

1QFY12

1QFY13

1QFY12

Source: Company, Angel Research

Source: Company, Angel Research

Exhibit 7: 1QFY2013 Adjusted PAT

5,000 4,500 4,000 3,500 3,000 2,500 2,000 1,500 1,000 500 0

Exhibit 8: Adj. PAT -Variance from expectation

40 30 20 10 0 (10) (20) (30) (40) (50)
SAIL Tata Steel NMDC Nalco Coal India Hindalco MOIL Sesa Sterlite

(` cr)

MOIL

SAIL

Tata Steel

NMDC

Nalco

Coal India

Hindalco

HZL

1QFY13

1QFY12

JSW Steel

Sesa

Sterlite

Source: Company, Angel Research

Source: Company, Angel Research

August 24, 2012

(%)

Metals | Sector review

Exhibit 9: Reported PAT declined for most players

6000 5000 4000

Exhibit 10: Interest costs remains high

1,200 1,000 800

(` cr)

(`cr)

3000 2000 1000 0

600 400 200 0

MOIL

SAIL

HZL

Tata Steel

NMDC

MOIL

Nalco

SAIL

Tata Steel

Coal India

Coal India

Hindalco

Hindalco

NMDC

Nalco

HZL
Apr-12 Jul-12

JSW Steel

1QFY13

1QFY12

1QFY13

1QFY12

Source: Company, Angel Research

Source: Company, Angel Research

Steel companies Outlook

Raw material prices have cooled off
Globally, sea-borne iron ore prices have declined sharply over the past five months in line with a decline in other metal prices. However, the current iron ore prices around US$100-110/tonne are near marginal cost of production for Chinese iron ore miners. Hence, we do not expect any further meaningful downside from the current price levels. Ironically, however, domestic iron ore prices have remained firm on account of mining ban in Karnataka and governments stricter stance on illegal mining in the mineral-rich states of Odisha and Goa. Contracted coking coal prices have declined gradually over the past one year. Moreover, spot coking coal prices have declined sharply over the past two months (down 20% to US$175/tonne) to the lowest level in two years. A decline in coking coal prices is expected to benefit Indian steelmakers during 2HFY2013, although INR depreciation would partially offset the decline in price of coking coal.

Exhibit 11: Iron ore prices and...

190 170

Exhibit 12: ...coking coal prices have come off

400 350 300
(US$/tonne)

(US $/tonne)

150 130 110 90

250 200 150 100 50 0

Jul-08 Jul-09 Jul-10 Jan-08 Jan-09 Jan-10 Jan-11 Jul-11 Apr-08 Apr-09 Apr-10 Oct-08 Oct-09 Oct-10 Apr-11

Feb-10

Feb-11

Dec-09

Dec-10

Dec-11

Feb-12

Jun-10

Jun-11

Aug-10

Aug-11

Jun-12

Aug-12

Apr-10

Apr-11

Oct-10

Oct-11

Apr-12

Iron ore fines CFR 63.5% Fe

Coking coal contract prices (fob, Australia)

Source: Bloomberg, Angel Research

Source: Bloomberg, Angel Research

.and steel prices have declined globally

Subdued demand, escalating Eurozone debt crisis and falling iron ore and coking coal prices have resulted in a decline in steel prices globally over the past five-six months. However, domestic steel prices have remained flat on account of INR depreciation against the USD. Hence, we expect steel companies margins to improve yoy during FY2013.
August 24, 2012

Oct-11

Jan-12

JSW Steel

Sesa

Sesa

Sterlite

Sterlite

Metals | Sector review

Exhibit 13: Globally steel prices have declined...

900 800

Exhibit 14: ...while domestic prices remained flat

400 350 300

(US$/tonne)

700 600 500

(US$/tonne)

250 200 150 100 50 0

Jul-08

Jul-09

Jul-10

Jul-11

Dec-10

Jan-08

Jan-09

Jan-10

Jan-11

Jun-11

Jan-12

Jun-12

Apr-08

Apr-09

Apr-10

Apr-11

Jan-12

Aug-10

Mar-10

Mar-11

Aug-11

Mar-12

Apr-10

Apr-11

Oct-08

Oct-09

Oct-10

Nov-10

Nov-11

Feb-11

Oct-11

Feb-12

Sep-10

May-10

May-12

World HRC price

USA Domestic HRC price

CIS export HRC price

Coking coal contract prices (fob, Australia)

Source: Bloomberg, Angel Research

Source: Bloomberg, Angel Research

Steel imports on a rise

Steel imports have continued to rise over the past one year. Indian steel players continue to face threat of higher steel imports from FTA countries (which attract lower import duty). During January- August 2012, steel imports by India have increased by 48.4% yoy to 4.6mn tonne.

Exhibit 15: Steel imports have risen over the past one year
7,000 6,000 800 700 600 500 400 300 200 100

(000 tonnes)

4,000 3,000 2,000 1,000 0

0 (100) (200)

Jul-11

Mar-11

Nov-10

May-11

Nov-11

Mar-12

Sep-10

Sep-11

Net production
Source: Bloomberg, Angel Research

Real consumption

Net imports - RHS

Non-ferrous companies Outlook

Margins to remain under pressure Non-ferrous companies are expected to face a double whammy of declining product prices coupled with higher input costs during FY2013. Base metal prices have declined steeply over the past six months and hence realizations for companies are expected to decline during FY2013 (partially offset by INR depreciation against the USD). Further, although several aluminium companies (globally) have announced production cuts, we are yet to see any meaningful decline in production. Thus, lower realizations coupled with higher prices of key inputs such as imported coal, caustic soda, CP pitch and petroleum coke are expected to hit margins of non-ferrous companies during FY2013 in our view. Nevertheless, we expect prices to improve in FY2014 as announced production cuts restore demand-supply mismatch during FY2014.
August 24, 2012

May-12

Jan-11

Jan-12

Jul-12

(000 tonnes)

5,000

Oct-11

Apr-12

Jul-10

Jul-11

Jul-12

Jul-12

Metals | Sector review

Exhibit 16: Despite decline in aluminium price...

6.0 5.0 4.0 3,200

Exhibit 17: ...production cuts are not visible yet

4.5 4.0

(US$/tonne)

(mn tonnes)

3.0 2.0 1.0 0.0

2,200 1,700 1,200

(mn tonnes)

2,700

3.5 3.0 2.5 2.0

Sep-08

Feb-09

Jul-09

May-10

Dec-09

Jun-07

Jan-07

Aug-06

Nov-07

Feb-07

Feb-08

Feb-09

Feb-10

Feb-11

Feb-12

LME aluminium inventories

LME aluminium price - RHS

Aluminium production - World

Aluminium consumption - World

Source: Bloomberg, Angel Research

Source: Bloomberg, Angel Research

Exhibit 18: Aluminium production in China steady...

2.0 1.5

Exhibit 19: ...however, imports of inputs have declined

7.0 6.0 5.0 0.8 0.7 0.6 0.5 0.4 0.3 0.2 0.1 -

(mn tonnes)

Mar-11

Aug-11

Apr-08

Jun-07

Jun-08

Jun-09

Jun-10

Jun-11

Oct-06

Oct-07

Oct-08

Oct-09

Oct-10

Oct-11

Jun-12

Oct-10

Jan-12

(mn tonnes)

1.0 0.5 -

4.0 3.0 2.0 1.0 0.0

Dec-10

Dec-11

Jun-11

Jan-11

Mar-11

Jan-12

Mar-12

Aug-11

Apr-11

Nov-10

Nov-11

Feb-11

Sep-10

May-11

Sep-11

Feb-12

Oct-10

Oct-11

Apr-12

May-12

Jun-12

Jul-11

Aluminium production - China

Aluminium consumption - China

Source: Bloomberg, Angel Research

Source: Bloomberg, Angel Research

Exhibit 20: Zinc prices have declined

1.2 1.0 4,400 3,900

Exhibit 21: World production remains steady

1.4 1.2
(US$/tonne)

(mn tonnes)

0.8 0.6 0.4 0.2 0.0

3,400 2,900 2,400 1,900 1,400 900

1.0
(mn tonnes)

0.8 0.6 0.4 0.2 0.0

Mar-08 Aug-08 Nov-09 Dec-11 Jan-09 Jun-09 Oct-07 Apr-10 Feb-11 Sep-10 Jul-11 May-12

Apr-07 Jul-07 Oct-07 Jan-08 Apr-08 Jul-08 Oct-08 Jan-09 Apr-09 Jul-09 Oct-09 Jan-10 Apr-10 Jul-10 Oct-10 Jan-11 Apr-11 Jul-11 Oct-11 Jan-12 Apr-12 Jul-12

LME zinc inventories

LME zinc price

Source: Bloomberg, Angel Research

Source: Bloomberg, Angel Research

August 24, 2012

Jul-10 Aug-10 Sep-10 Oct-10 Nov-10 Dec-10 Jan-11 Feb-11 Mar-11 Apr-11 May-11 Jun-11 Jul-11 Aug-11 Sep-11 Oct-11 Nov-11 Dec-11 Jan-12 Feb-12 Mar-12 Apr-12 May-12 Jun-12

Bauxite imports - China

Alumina imports - China - (RHS)

Zinc slab consumption - World

Zinc slab production - World

(mn tonnes)

Jun-12

Metals | Sector review

Exhibit 22: Chinese zinc production remains high...

600,000 500,000

Exhibit 23: ...while imports have remained volatile

60,000 50,000

(metric tonnes)

(metric tonne)

400,000 300,000 200,000 100,000 0

40,000 30,000 20,000 10,000 0

Feb-11

Feb-12

Jul-11

May-11

Sep-11

May-12

Dec-10

Dec-11

Jun-11

Jan-11

Mar-11

Aug-11

Apr-11

Jan-12

Mar-12

Dec-10

Dec-11

Jun-11

Jan-11

Mar-11

Aug-11

Jan-12

Mar-12

Apr-11

Feb-11

May-11

Nov-11

Sep-11

Feb-12

Oct-11

Apr-12

May-12

Jun-12

Zinc ores and concentrate production - China

China zinc imports

Source: Bloomberg, Angel Research

Source: Bloomberg, Angel Research

Valuations inexpensive, but we remain selective: Metal stocks have been battered over the past six months on account of escalating eurozone debt crisis, subdued domestic demand, decreasing prices, rising input costs and delays in obtaining procedural clearances for mines. Nevertheless, we believe that the recent fall has left some stocks undervalued. We like companies with captive assets, strong visibility over its expansion plans, low leverage levels and inexpensive valuations. Hence, our top picks are Tata Steel, NMDC and Hindustan Zinc.

Exhibit 24: Six months stock price performance

15 10 5 0 (5) (10) (15) (20) (25) (30)
COAL NMDC HZL

(%)

Sterlite

Nov-11

Jul-11

Oct-11

Nalco

Sesa

Apr-12

Jun-12

Source: Bloomberg, Angel Research

August 24, 2012

BSE Metal Index

Tata Steel

Hindalco

MOIL

JSW

SAIL

Jul-12

Metals | Sector review

Exhibit 25: Recommendation summary

Companies MOIL Nalco NMDC SAIL Sesa Sterlite Tata Steel Coal India Hindalco HZL JSW Steel CMP (`) 244 52 185 84 192 112 388 367 111 130 736 Target Reco. price (`) 271 Accum. 48 Reduce 214 Buy - Neutral - Neutral - Neutral 481 Buy Mcap (` cr) 4,183 13,401 72,217 34,799 16,512 37,354 37,794 21,152 54,760 15,991 Upside 11 (7) 16 24 5 11 P/E (x) 10.0 15.2 8.8 8.8 4.6 6.7 8.0 14.1 8.4 9.1 9.2 9.4 12.7 7.9 7.2 4.5 6.4 6.1 13.0 6.8 8.3 8.2 P/BV (x) 1.5 1.1 2.3 0.8 0.9 0.7 0.8 4.1 0.6 1.7 0.9 1.4 1.0 1.9 0.7 0.8 0.7 0.7 3.3 0.6 1.5 0.8 EV/EBITDA (x) FY13E 4.2 8.0 4.8 8.3 7.4 3.6 5.1 8.7 7.4 4.9 5.0 3.6 6.6 4.0 6.6 6.7 3.3 4.5 7.4 6.1 3.7 4.8 RoE (%) 16.0 7.4 29.6 9.4 22.3 11.3 10.5 32.5 7.8 20.5 10.4 15.5 8.4 26.5 10.6 19.2 10.7 12.4 28.1 8.9 18.9 10.6 RoCE (%) 16.4 5.7 35.8 7.0 12.2 9.9 10.3 31.5 5.4 19.4 10.1 16.3 7.1 32.1 8.8 11.5 9.3 11.9 27.7 5.7 18.3 9.3 (%) FY13E FY14E FY13E FY14E FY14E FY13E FY14E FY13E FY14E

385 Accum. 231,368 - Neutral 144 Accum. - Neutral

Source: Company, Angel Research

August 24, 2012

Metals | Sector review

Research Team Tel: 022 - 3935 7800

E-mail: research@angelbroking.com

Website: www.angelbroking.com

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Disclosure of Interest Statement

Analyst ownership of the stock Coal India Hindalco Hind. Zinc JSW Steel
MOIL

Angel and its Group companies ownership of the stock No No No No No No No No No No No

Angel and its Group companies' Directors ownership of the stock No No No No No No No No No No No

Broking relationship with company covered No No No No No No No No No No No

No No No No No No No No No No No

Nalco NMDC SAIL Sesa Goa Sterlite Inds Tata Steel

Note: We have not considered any Exposure below `1 lakh for Angel, its Group companies and Directors.

Ratings (Returns):

Buy (> 15%) Reduce (-5% to 15%)

Accumulate (5% to 15%) Sell (< -15%)

Neutral (-5 to 5%)

August 24, 2012