Result review | Metals

August 23, 2013 Bhavesh Chauhan

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

1QFY2014 Result Analysis

Profit remains under pressure
Weaker-than-expected top-line performance: Most of the companies in the metals sector reported weaker-than-expected top-line with the exception of NMDC. Nalco, JSW Steel, Hindalco and Coal Indias top-line performances were significantly lower than our expectations. SAIL and Tata Steel both saw a net sales decline of 22.7% and 3.0% yoy, respectively, whereas JSW Steel reported a marginal 2.3% yoy improvement in its net sales. All the non-ferrous players except Hindustan Zinc (HZL) reported a decrease in net sales on the back of lower volumes and realizations and their top-line growth was also lower than expectations. Metal companies margins remained under pressure: Metal companies had a mixed performance on the operating profit front. While Tata Steel surprised us positively on the operating performance, Nalcos operating profit was disappointing. In the non-ferrous sector, except for Hindalco and HZL, all the remaining companies reported a decline in operating profits due to lower realizations. Among mining companies NMDC and Coal India both faced severe margin pressures due to higher employee costs and overheads. Outlook on steel: Globally, sea-borne iron ore prices have increased since June 2013. However, domestic iron ore prices have come off sharply over the past three quarters due to sluggish steel demand in India. Contracted coking coal prices have declined gradually over the past one year. A decline in coking coal prices is expected to benefit Indian steelmakers during FY2014; however, it will be partially offset by INR depreciation against the USD. Nevertheless, a weakening rupee raises landed cost of steel imports, thus giving higher pricing power to domestic steel players. Hence, although we expect domestic steel demand to remain weak over the coming one year, we expect steel companies to raise steel prices during 2HFY2014. Outlook on non-ferrous: Non-ferrous companies are expected to continue to face a double whammy of declining product prices coupled with higher input costs. Base metal prices have declined steeply over the past one year; we expect realizations growth to remain muted during FY2014 (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 and sticky prices of key inputs are expected to hit margins of non-ferrous companies during FY2014 in our view. Nevertheless, we expect prices to improve in FY2015 as announced production cuts restore demand-supply mismatch during FY2015. Selectively, we like some stocks: Metal stocks have underperformed over the past one year on account of global overcapacity, 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 on earnings growth over the coming few years, low leverage levels and inexpensive valuations. Hence, our top picks are NMDC, Hindustan Zinc and Tata Steel.
Please refer to important disclosures at the end of this report

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

Metals | Result review

Weak top-line performance: Most of the companies in the metals sector reported a weaker-than-expected top-line with the exception of NMDC. Nalco, JSW Steel, Hindalco and Coal Indias top-line performances were significantly lower than our expectations. SAIL and Tata Steel both saw a net sales decline of 22.7% and 3.0% yoy, respectively, whereas JSW Steel reported a marginal 2.3% yoy improvement in net sales. All the non-ferrous players except Hindustan zinc reported a decrease in net sales on the back of lower volumes and realizations and their top-line growth was also lower than expectations. Among the miners, Coal Indias top-line was flat yoy while NMDC showed a rise in top-line due to higher volumes.

Exhibit 1: 1QFY2014 - Top-line performance

35,000 30,000 25,000 1QFY14 1QFY13

Exhibit 2: Top-line - variance from expectation

10 5 0

( ` cr)

20,000

(%)

15,000 10,000 5,000 0

(5)

(10) (15)

MOIL

SAIL

Tata Steel

NMDC

Nalco

Coal India

Hindalco

HZL

JSW Steel

(20)

Sterlite

MOIL

SAIL

Tata Steel

NMDC

Nalco

Coal India

Hindalco

HZL

Source: Company, Angel Research

Source: Company, Angel Research

Higher power and labor costs dent operating profits: Metal companies had a mixed performance on the operating profit front. While Tata Steel surprised us positively on the operating performance, Nalcos operating profit was disappointing. Among the steel companies, both SAIL and JSW Steel reported a 36.2% and 1.3% fall in operating profits respectively due to higher labor costs and other expenses. Tata Steels EBITDA grew 8.4% yoy due to cost efficiencies and better performance from the European operations. In the non-ferrous sector, except for Hindalco and HZL, all the remaining companies reported a decline in operating profits due to lower realizations. Among mining companies NMDC and Coal India both faced severe margin pressures during the quarter due to higher employee costs and overheads. MOIL, however, posted strong growth in operating profit.

August 23, 2013

JSW Steel

Sterlite

Metals | Result review

Exhibit 3: 1QFY2014 Operating profit growth

7,000 6,000 5,000 1QFY14 1QFY13

Exhibit 4: Operating profit - variance from expectation

40 30 20 10 0 (10) (20) (30) (40) (50) (60) (70)

( ` cr)

3,000 2,000 1,000 0

(%)

4,000

MOIL

SAIL

Tata Steel

NMDC

Nalco

Coal India

Tata Steel

Hindalco

Hindalco

NMDC

Nalco

SAIL

Coal India

MOIL

HZL

HZL
HZL

JSW Steel

Source: Company, Angel Research

Source: Company, Angel Research

Higher interest costs and depreciation dent PAT for a few players
Tata Steels bottom-line was better than expected due to better-than-expected profitability from its European operations. Interest costs for JSW Steel and Hindalco increased 57.8% and 82.5% yoy and depreciation costs also grew by 37.7% and 7.4% yoy respectively. This led to their adjusted PAT declining by 27.0% and 8.0% respectively.

Exhibit 5: 1QFY2014 Adjusted PAT

5,000 4,500 4,000 3,500 3,000 2,500 2,000 1,500 1,000 500 0 1QFY14 1QFY13

Exhibit 6: Adjusted PAT -Variance from expectation

140 120 100 80 60 40 20 0 (20) (40) (60)

(` cr)

(%)

Tata Steel

NMDC

MOIL

SAIL

SAIL

Tata Steel

Nalco

HZL

Hindalco

NMDC

MOIL

Nalco

Coal India

Coal India

Hindalco

Source: Company, Angel Research

JSW Steel

Source: Company, Angel Research

Steel companies Outlook

Raw material prices have come off sharply
Globally, sea-borne iron ore prices have increased from June 2013. The current iron ore prices are in the range of US$130-140/tonne. Going forward, we do not expect significant decline in iron ore prices as current iron ore prices are just above marginal cost of production from Chinese miners. However, we do not expect meaningful rise in iron ore prices considering anticipated increases in supplies by three global iron ore giants, Rio Tinto, BHP Billiton and Vale. Domestic iron ore prices have also come off sharply over the past three quarters due to sluggish steel demand in India. Nevertheless, we do not expect iron ore prices to slide meaningfully from the current levels given that we expect some improvement in steel prices during 2HFY2014.

August 23, 2013

JSW Steel

Sterlite

Sterlite

JSW Steel

Sterlite

Sterlite

Metals | Result review

Contracted coking coal prices have declined gradually over the past one year. A decline in coking coal prices is expected to benefit Indian steelmakers during FY2014; however, it will be partially offset by INR depreciation against the USD.

Exhibit 7: Global Iron ore prices have risen recently

165 155 145

Exhibit 8: ..while coking coal prices continued to decline

350 300 250

(US $/tonne)

(US$/tonne)
Dec-12 Jan-13 Jun-13 Mar-13 Nov-12 May-13 Aug-13 Sep-12 Feb-13 Oct-12 Apr-13 Jul-13

135 125 115 105 95 85

200 150 100 50 0

Feb-12

Dec-11

Dec-12

Feb-13

Jun-11

Jun-12

Aug-11

Aug-12

Apr-12

Oct-11

Iron ore fines CFR 63.5% Fe

Hard coking coal price

Source: Bloomberg, Angel Research

Source: Industry sources, Angel Research

.while steel prices have stabilized

Overcapacity in the steel industry, slowing global demand and falling coking coal prices have resulted in a decline in steel prices globally until May 2013, post which steel prices have increased modestly across regions. Domestic steel prices continued to decline until August 2013 due to subdued demand in the country. Steel consumption growth declined to multi-year lows to 3.3% yoy during FY2013. Further, steel consumption in India rose by just 0.2% yoy during April July13 due to low demand from construction and automotive sectors.

Exhibit 9: Global steel prices have risen slightly..

800 750 4,500 4,000 3,500

Exhibit 10: ..while domestic prices have stabilized

37,000 36,000

(Yuan/tonne)

(US$/tonne)

700 650 600 550 500

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

35,000

( ` /tonne)

34,000 33,000 32,000 31,000

Oct-12

Feb-12 Mar-12

Feb-13 Mar-13

Apr-13

Jun-12 Jul-12

Sep-12 Oct-12

Apr-12 May-12

Dec-12

Jun-12

Aug-12

Jan-13

Jun-13

Mar-13

Nov-12

May-13

Aug-13

Oct-12

Sep-12

Feb-13

Apr-13

USA HRC/tonne

China HRC/tonne

Indian HRC price

Source: Bloomberg, Angel Research

Source: Bloomberg, Angel Research

..however, INR depreciation paves way for steel price hikes

Over the past one month, INR has depreciated sharply against the USD. A weakening rupee raises landed cost of steel imports, thus giving higher pricing power to domestic steel players. Hence, although we expect domestic steel demand to remain weak over the coming one year, we expect steel companies to raise steel prices during 2HFY2014. Further, we expect steel imports to decline during FY2014 (during FY2013, net steel imports by India have increased by 33.2% yoy to 3.6mn tonne).
August 23, 2013

Apr-13 May-13

Nov-11 Dec-11

Nov-12 Dec-12

Jan-12

Aug-12

Jul-12

Jul-13

Jan-13

Jun-13 Jul-13

Jun-13

Metals | Result review

Exhibit 11: INR depreciation against the USD

70 65 60 55 50 45

Dec-12

Apr-13

Apr-13

Aug-12

Nov-12

Nov-12

Mar-13

May-12

May-12

May-13

Source: Bloomberg, Angel Research

Non-ferrous companies Outlook

Realizations to remain under pressure
Non-ferrous companies are expected to continue to face a double whammy of declining product prices coupled with higher input costs. Base metal prices have declined steeply over the past one year; we expect realizations growth to remain muted during FY2014 (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 and sticky prices of key inputs are expected to hit margins of non-ferrous companies during FY2014 in our view. Nevertheless, we expect prices to improve in FY2015 as announced production cuts restore demand-supply mismatch during FY2015.

August 23, 2013

Aug-13

Jul-12

Jul-12

Oct-12

Sep-12

Sep-12

Feb-13

Jun-13

Jun-12

Jan-13

Jan-13

Jun-13

Jul-13

Metals | Result review

Exhibit 12: Despite decline in aluminium price...

6.0 5.0 3,200

Exhibit 13: ...production cuts are not visible yet

4.0 3.5

(mn tonnes)

(US$/tonne)

4.0 3.0 2.0 1.0 0.0

2,700 2,200 1,700 1,200

(mn tonnes)

3.0 2.5 2.0

Feb-08

Feb-09

Feb-10

Feb-11

Feb-12

Feb-13

Jan-11

Jan-12

Mar-10

Mar-11

Mar-12

Jan-13

Nov-10

Nov-11

May-10

May-11

May-12

Nov-12

Mar-13
0.8 0.7 0.6 0.5 0.4 0.3 0.2 0.1 -

Sep-10

Sep-11

Sep-12

Jul-10

Jul-11

Jul-12

LME aluminium inventories

LME aluminium price - RHS

Aluminium production - World

Aluminium consumption - World

Source: Company, Angel Research

Source: Company, Angel Research

Exhibit 14: Aluminium production in China steady

1.9 1.8 1.7 1.6 1.5 1.4 1.3 1.2 1.1 1.0

Exhibit 15: Bauxite imports of inputs have risen

8.0 7.0 6.0

(mn tonnes)

(mn tonnes)

5.0 4.0 3.0 2.0 1.0 0.0

Feb-12

Sep-11

May-12

Sep-12

Feb-13

Jul-12

May-13

Dec-11

Dec-12

Jan-12

Jun-12

Aug-11

Mar-12

Aug-12

Jan-13

Mar-13

Apr-12

Nov-11

Nov-12

Oct-11

Oct-12

Apr-13

Aluminium production - China

Aluminium consumption - China

Source: Company, Angel Research

Source: Company, Angel Research

Exhibit 16: Zinc prices have declined during CY2013

1.3 1.2 1.1 1.0 0.9 0.8 0.7 0.6 0.5 0.4 2,500 2,300

Exhibit 17: World zinc production remains steady

1.2 1.2 1.1 1.1 1.0 1.0 0.9 0.9 0.8 0.8 0.7

(mn tonnes)

(US$/tonne)

2,100 1,900 1,700 1,500

(mn tonnes)

Dec-08

Dec-09

Dec-10

Dec-11

Dec-12

Jun-09

Jun-10

Jun-11

Jun-12

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 Jul-12 Aug-12 Sep-12 Oct-12 Nov-12 Dec-12 Jan-13 Feb-13 Mar-13 Apr-13 May-13

Bauxite imports - China

Alumina imports - China - (RHS)

Mar-09

Mar-10

Mar-11

Mar-12

Mar-12

Nov-11

Nov-12

Mar-13

Sep-11

Sep-12

May-12

LME zinc inventories

LME zinc price- RHS

May-13

Zinc slab consumption - World

Zinc slab production - World

Source: Company, Angel Research

Source: Company, Angel Research

August 23, 2013

Mar-13

Sep-08

Sep-09

Sep-10

Sep-11

Jan-12

Jan-13

Sep-12

Jun-13

Jul-12

Jul-13

(mn tonnes)

May-13

Jun-08

Jun-09

Jun-10

Jun-11

Jun-12

Oct-07

Oct-08

Oct-09

Oct-10

Oct-11

Oct-12

Jun-13

Metals | Result review

Exhibit 18: Chinese zinc production remains steady

500,000 480,000 460,000 440,000 420,000 400,000 380,000 360,000 340,000

Exhibit 19: Chinese zinc imports have come off lately

80,000 70,000 60,000 50,000 40,000 30,000 20,000 10,000 0

(metric tonnes)

Dec-11

Dec-12

Jun-12

Jan-12

Mar-12

Aug-12

Jan-13

Mar-13

Apr-12

Nov-11

Nov-12

Feb-12

Oct-12

May-12

Feb-13

Sep-12

Apr-13

May-13

Jun-13

Jul-12

(metric tonne)

Feb-12

Sep-12

Feb-13

Jul-12

May-12

May-13

Dec-11

Dec-12

Jun-12

Jan-12

Mar-12

Aug-12

Jan-13

Mar-13

Apr-12

China Monthly Zinc Production China

Zinc Slab Production China

China zinc imports

Source: Company, Angel Research

Source: Company, Angel Research

Selectively, we like some stocks: Metal stocks have underperformed over the past one year on account of global overcapacity, 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 on earnings growth over the coming few years, low leverage levels and inexpensive valuations. Hence, our top picks are NMDC, Hindustan Zinc and Tata Steel.

Exhibit 20: Three months metal stock price performances

SAIL JSW Nalco COAL BSE Metal Index Tata Steel Hindalco Sterlite Sesa NMDC HZL MOIL (25.0) (20.0) (15.0) (10.0) (%)
Source: Bloomberg, Angel Research: Note: CMP as of 22nd August 2013

(5.0)

Nov-12

Oct-12

0.0

Apr-13

August 23, 2013

Jun-13

5.0

Jul-13

Metals | Result review

Exhibit 21: Recommendation summary

Companies MOIL Nalco NMDC SAIL Sesa Sterlite Tata Steel Coal India Hindalco HZL JSW Steel CMP (`) 208 29 117 46 155
87

Target price (`)

Reco.

Mcap (` cr) 3,526 7,409 46,228 18,895 13,014

28,279

Upside 7 21 6
13

P/E (x) 8.2 10.5 7.6 10.0 5.7

5.0

P/BV (x) 7.9 1.1 0.6 1.5 0.5 0.7

0.5

EV/EBITDA (x) FY14E 2.3 3.2 3.3 7.0

36.6 2.2

RoE 14.6 5.9 21.2 4.5

12.9 10.8

RoCE (%) 13.7 6.0 20.0 4.9

12.5 11.2

(%) FY14E FY15E FY14E FY15E 1.0 0.6 1.4 0.4 0.6
0.5

FY15E FY14E FY15E FY14E FY15E 2.4 3.0 3.2 5.7

16.4 1.8

222 Accum. - Neutral 142 Buy - Neutral 164 Accum.

99 Buy

12.3 3.7 24.1 4.1

1.8 8.3

12.0 3.9 22.7 5.4

3.6 8.4

10.0 7.3 9.0 5.2

4.4

273 268 104 118 546

328

Buy

26,708 19,471 48,802 12,864

nd

20 21 -

7.0 10.6 7.5 7.5 8.0

4.9 9.9 6.1 6.7 7.1

0.7 2.6 0.5

1.3

0.6 2.2 0.5

1.2

4.7 4.5 7.0

3.6

4.1 3.8 5.7

2.5

10.6 33.3 7.5

19.0

13.6 33.1 8.7

18.3

9.2 19.7 5.5

15.8

11.0 19.7 6.1

15.5

- Neutral 170,068 - Neutral 143 Buy - Neutral

0.7

0.7

5.0

4.6

9.3

9.7

8.9

9.0

Source: Company, Angel Research; Note: CMP as of 22 August 2013

August 23, 2013

Metals | Result review

Research Team Tel: 022 - 39357800

E-mail: research@angelbroking.com

Website: www.angelbroking.com

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Analyst ownership of the stock MOIL Nalco NMDC SAIL Sesa Goa Sterlite Tata Steel Coal India Hindalco HZL JSW Steel No No No No No No No No No No No 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

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 23, 2013

Metals | Result review

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Research Team Fundamental: Sarabjit Kour Nangra Vaibhav Agrawal Bhavesh Chauhan Viral Shah V Srinivasan Yaresh Kothari Ankita Somani Sourabh Taparia Bhupali Gursale Vinay Rachh Amit Patil Twinkle Gosar Tejashwini Kumari Akshay Narang Harshal Patkar Nishant Sharma Technicals: Shardul Kulkarni Sameet Chavan Sacchitanand Uttekar Derivatives: Siddarth Bhamre Institutional Sales Team: Mayuresh Joshi Meenakshi Chavan Gaurang Tisani Akshay Shah Production Team: Tejas Vahalia Dilip Patel Research Editor Production Incharge tejas.vahalia@angelbroking.com dilipm.patel@angelbroking.com VP - Institutional Sales Dealer Dealer Sr. Executive mayuresh.joshi@angelbroking.com meenakshis.chavan@angelbroking.com gaurangp.tisani@angelbroking.com akshayr.shah@angelbroking.com Head - Derivatives siddarth.bhamre@angelbroking.com Sr. Technical Analyst Technical Analyst Technical Analyst shardul.kulkarni@angelbroking.com sameet.chavan@angelbroking.com sacchitanand.uttekar@angelbroking.com VP-Research, Pharmaceutical VP-Research, Banking Sr. Analyst (Metals & Mining) Sr. Analyst (Infrastructure) Analyst (Cement, FMCG) Analyst (Automobile) Analyst (IT, Telecom) Analyst (Banking) Economist Research Associate Research Associate Research Associate Research Associate Research Associate Research Associate Research Associate sarabjit@angelbroking.com vaibhav.agrawal@angelbroking.com bhaveshu.chauhan@angelbroking.com viralk.shah@angelbroking.com v.srinivasan@angelbroking.com yareshb.kothari@angelbroking.com ankita.somani@angelbroking.com sourabh.taparia@angelbroking.com bhupali.gursale@angelbroking.com vinay.rachh@angelbroking.com amit.patil@angelbroking.com gosar.twinkle@angelbroking.com tejashwini.kumari@angelbroking.com akshay.narang@angelbroking.com harshal.patkar@angelbroking.com nishantj.sharma@angelbroking.com

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August 23, 2013

10