Motilal Oswal expects metals sector to post worst quarterly performance in Q4FY15

1. April 2015 197
Sanjay Jain (SanjayJain@MotilalOswal.com); +91 22 3982 5412
Dhruv Muchhal (Dhruv.Muchhal@MotilalOswal.com); +91 22 3027 8033
Metals 4QFY15 results previews
Lower metal prices - a new reality; roll over target prices to FY17
EBITDA contraction across sectors; Hindalco to benefit from higher volumes
Our m etals c overage u niverse is expected t o p ost o ne o f th e w orst q uarterly
performances i n 4 QFY15, w ith E BITDA d eclining 1 5% Q oQ a nd 2 6% YoY,; amid
weaker pricing across metals, tepid domestic demand and surging imports in case of
steel. Hindalco is expected to outperform the lot, posting an EBITDA growth of 6%
QoQ (9% YoY), on the back of a surge in aluminum volumes, partly offset by lower
LME. Steel companies are expected to report an EBITDA decline of 16% QoQ (-28%
YoY) on the back of sharp correction in steel prices (-6% QoQ). Steel sales volumes
are expected to decline 6% YoY (third consecutive quarter of contraction), led by
SAIL with volumes down 13% YoY. SSLT, amid lower crude oil prices and lower LME,
is expected to post EBITDA de-growth of 28% QoQ (-22% YoY),; while NMDC will
suffer be hit on account of lower realization (-2% QoQ) and volumes (-27% YoY).
Readjusting to lower metal prices
We exp ect th e a verage s teel p rice r ealization to d ecline f urther i n F Y16
w.r.tcompared to. 4QFY15 as the full impact of price correction over the last three
to four 3-4 months flows in. Although global steel pricing remains under stress due
to oversupply of steel and its raw materials, Indian prices are likely to stabilize on
stricter q uality n orms f or im ports, e xpected an ti-dumping a ctions or s afeguard
duties. Tata Steel and JSW Steel are expected to benefit from lower raw material
costs, while SAIL will only benefit from a fall in coking coal prices. Tata Steel’s iron
ore costs had surged during 2HFY15 due to closure of mines and iron ore imports.
SAIL is likely to be the most impacted from steel pricing pressure asbecause its iron
ore costs are sticky. As a re sultHence, there is a cut in EBITDA by 3-9% across for
FY16E/17E for steel companies. Introduction of DMF (district mineral fund (DMF),
equal to royalties for operating mines, will lead to higher costs for Tata Steel, SAIL
and Jindal Steel. We expect that the falling iron ore prices will eventually bring down
reduce the amount of royalties by nearly 50%, thus offsetting the impact of DMF.
We are rolling over the target prices to FY17E. The mMargins in 1HFY16E will have
distortions on account of inventory losses.
We h ave c ut our LME a luminum e stimates t o U SD1,900/t a nd U SD1,950/t f or
FY16E/17E from USD2,000/t each in the year earlier year. ResultantlyThus, EBITDA
for Hindalco/Nalco is cut by 3%/14% for FY16E. For FY17E, impact of lower LME is
offset by a change of USD/INR rate to 64 (from 62), driving 1%-3% EBITDA increase.
We move t o USD/INR of 6 3/64, f rom 6 2 e arlier, fo r F Y16E/17E. F or H ZL, w e
incorporate the impact of DMF at @100% of royalty for operating mines and cut in
the LME zinc estimate for FY16E to USD2,100 (from USD2,200). DMF and lower LME
drove EBITDA cut of 23%/15% for FY16E/17E. SSLT’s EBITDA is cut by 14%/3% forfor
the im pact o f D MF o n H ZL H industan Zin c an d lo wer c rude oil p rices. Aluminum
smelters of Hindalco, Vedanta and Nalco receive 3-4mtpa coal each through linkages
from C oal I ndia. T hus, a Any m ove t o au ction t he li nkages w ill affe ct margins f or
these companies.
Metals
Company name
Hindalco
Hindustan Zinc
Jindal Steel & Power
JSW Steel
Nalco
NMDC
SAIL
Sesa Sterlite
Tata Steel
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2. April 2015 198
Exhibit 1: Expected quarterly performance summary
Sector Sales (INR m) EBDITDA (INR m) Net Profit (INR m)
CMP
(INR)
RECO Mar-15
Var
% YoY
Var %
QoQ
Mar-15
Var
% YoY
Var %
QoQ
Mar-15
Var
% YoY
Var %
QoQ
Hindalco 135 Buy 265,976 9.2 -0.8 27,072 9.1 6.4 5,922 -32.6 7.0
Hindustan Zinc 163 Buy 41,729 14.6 8.3 21,509 22.5 3.0 21,913 16.5 -7.9
JSPL 154 Neutral 51,509 0.9 -0.3 12,239 -6.8 -14.1 -1,518 PL PL
JSW Steel 900 Buy 105,599 -15.4 -8.2 14,740 -41.0 -30.4 520 -93.5 -89.1
Nalco 48 Buy 18,596 1.2 -2.4 3,761 21.6 -28.7 2,947 43.1 -16.9
NMDC 128 Sell 25,380 -34.7 -13.8 12,632 -48.9 -35.2 12,033 -37.2 -24.5
SAIL 70 Sell 116,515 -13.8 4.9 8,091 -33.7 -33.0 -477 PL PL
Sesa Sterlite 191 Buy 182,559 -12.2 -5.0 51,422 -22.8 -16.3 10,305 -21.9 -28.3
Tata Steel 318 Buy 345,671 -18.5 2.8 31,999 -36.1 4.0 3,821 -64.7 143.2
Sector Aggregate 1,153,533 -9.9 -0.7 183,465 -22.7 -13.0 55,465 -37.7 -27.1
Top picks: Hindalco, Nalco, Tata Steel and JSW Steel
Hindalco: H indalco’s major c apex phase i s n ow behind a nd i s p oised t o r eap t he
benefit of gradual ramp-up of aluminum capacities. We expect aluminum volumes
to g row to 1.22mt b y F Y17E, f rom 0.79mt i n F Y15E, o n r amp-up at M ahan a nd
Aditya s melters. I n th e r ecently c oncluded c oal a uctions, Hindalco w as ab le t o
secure 6 5% o f it s M ahan an d A ditya’s s melter r equirement, w hich w ould aid
smoother o perations an d re move u ncertainty over ra w- material a vailability
(bauxite is 100% captive). We value Hindalco at INR221/share based on FY17E SOTP.
Maintain Buy.
Nalco: Nalco is currently trading at 1.4x F Y17E EV /EBIDTDA, which we b elieve is
significantly cheap compared to any of metal stockpeers. With (a) uUnder-utilized
capacity – currently operating at 65% utilization, (b) healthy balance sheet – cash
balance of INR21/share at the end- of FY14 (which will rise to nearly INR35/share by
end- of FY17) and (c) p ositive o utlook t owards al umina p rices, we b elieve th e
discount to the long term average multiples is unjustified. We value Nalco at 6.0x
FY17E EV/EBITDA, with a target priceTP of INR90. Re-iterate Buy.
Tata Steel: While steel price outlook remains un-endiscouraging, Tata Steel is likely
to b enefit fro m lo wer ra w material c ost, as t he high c ost i mported iron ore
inventory is gradually phased out. Moreover, commissioning of Kalinganagar (3mt)
will add to margins, through higher operating efficiency. We expect Tata Steel India
business EBITDA/t to improve to ~INR13,000 by FY17E, from ~INR8,470 in 4QFY15E.
We value Tata Steel at 6.0x FY17E EV/EBITDA, with a target priceTP of INR 505.
Global iron ore prices, which we believe are the key drivers of lower steel prices, are
closing towards nearing the bottom, with incremental risk o f o nly ~USD7-12/t, in
our view. Factoring in this risk and current differential between import parity and
domestic steel prices, our target priceTP reduces to INR343, still implying an upside
of ~8% to current prices. Risk return ratios have turned favorable. Maintain Buy.
JSW Steel: Despite the pressure of steel prices, JSW Steel’s non-integrated business
model will help it wade through the difficult times. The mMargins are expected to
bounce back as iron ore and coking coal start to ease with a lag. Expected recovery
March 2015 Results Preview | Sector: Metals

3. April 2015 199
in d omestic d emand a nd a nti-dumping ac tions ag ainst t he d eluge o f im ports w ill
stabilize domestic steel pricing. Volume growth from the capital efficient Brownfield
expansions at Dolvi will d rive earnings g rowth. W e value J SW S teel at
INR1,126/share. Maintain Buy.
Exhibit 2: Comparative vValuation
Sector / Companies CMP RECO EPS (INR) PE (x) EV/EBIDTDA (x) RoOE (%)
(INR) FY15E FY16E FY17E FY15E FY16E FY17E FY15E FY16E FY17E FY15E FY16E FY17E
Hindalco 135 Buy 11.7 11.4 19.1 11.5 11.8 7.1 8.3 7.1 6.0 9.9 9.0 13.6
Hindustan Zinc 163 Buy 20.0 14.9 16.4 8.2 11.0 9.9 4.8 5.4 4.2 20.5 13.3 13.4
JSPL 154 UR
JSW Steel 900 Buy 64.2 50.7 62.1 14.0 17.8 14.5 7.1 7.0 6.6 7.0 5.4 6.5
Nalco 48 Buy 4.9 5.6 6.5 9.7 8.4 7.3 3.5 2.5 1.4 10.1 10.8 11.6
NMDC 128 Sell 16.1 10.5 10.4 8.0 12.2 12.3 4.2 7.5 7.7 20.3 15.5 11.4
SAIL 70 Sell 4.2 1.3 2.6 16.6 51.6 27.0 10.7 11.3 9.3 4.0 1.3 2.4
Sesa Sterlite 191 Buy 18.1 10.1 11.6 10.6 18.9 16.5 4.4 5.6 4.6 7.1 3.9 4.4
Tata Steel 318 Buy 15.7 38.3 74.4 20.3 8.3 4.3 7.6 7.1 5.2 5.5 11.6 19.7
Sector Aggregate 10.5 14.5 10.8 6.4 7.2 6.0 8.6 6.1 7.7
Source: MOSL
Iron and steel companies: earnings adjustment and& rollover ofto target
pricess to FY17
We h ave c ut th e es timates f or Steel c ompanies b y 3 %-9% p rimarily on w eak
realization trends and have rolled over the target prices by one year to FY17.
Exhibit 3: Summary of estimates change – iIron and steel companies
EBITDA (INR b) Adj. PAT (INR b) TP
Comments
4QFY15E FY16E FY17E 4QFY15E FY16E FY17E
Tata
Steel
Old 39 174 230 7.7 44.9 79.0
Down primarily on cut to realization cut by 1% for
4QFY15E and by 5%/3% for FY16E/17E respectively.
New 32 159 219 3.8 39.0 74.0 505
Change -17% -8% -5% -51% -13% -6%
SAIL
Old 14 53 67 4.3 7.5 10.5
4QFY15E cut on lower- than- expected volumes (cut
by 12%). FY16E/17E cut on lower realization.
New 8 48 65 -0.5 3.7 8.8 38
Change -43% -9% -3% -111% -50% -16%
JSW Steel
Old 25 98 100 5.8 19.7 19.3
4QFY15E lower oncut on 2% lower realization and 8%
cut to volumes. FY16E/17E on lower realization.
New 16 93 100 -1.8 12.2 15.0 1126
Change -37% -5% 0% -130% -38% -22%
JSPL
Old 15 71 68 1.0 41.6 34.8
The rating and FY16E/FY17E estimates are under
review due to cancellation of coal mines.
New 12 71 68 -1.5 41.6 34.8 UR
Change -21% 0% 0% -247% 0% 0%
NMDC
Old 13 43 44 12.0 41.3 41.4
No change.New 13 43 44 12.0 41.3 41.4 106
Change 0% 0% 0% 0% 0% 0%
Source: MOSL, Company
Exhibit 4: India import parity HRC prices
Source: MOSL, Company
26,000
29,000
32,000
35,000
38,000
Mar-14
Apr-14
May-14
Jun-14
Jun-14
Jul-14
Aug-14
Sep-14
Oct-14
Nov-14
Nov-14
Dec-14
Jan-15
Feb-15
Mar-15
Mar-15
HRC Mumbai (INR/t)
Domestic import parity HRC
prices are down 16% QoQ
in 4QFY15.
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4. April 2015 200
Exhibit 5: China steel spreads with raw material
Source: MOSL, Company
Exhibit 6: Domestic steel demand growth – trailing 12- month (YoY %)
Source: MOSL, Company
Exhibit 7: India steel - sales volumes - (mt)
Source: MOSL, Company
Exhibit 8: India steel – EBITDA/t (INR)
Source: MOSL, Company
140
185
230
275
320
Dec-10
Mar-11
Jun-11
Sep-11
Dec-11
Mar-12
Jun-12
Sep-12
Dec-12
Mar-13
Jun-13
Sep-13
Dec-13
Mar-14
Jun-14
Sep-14
Dec-14
Mar-15
HRC Rebar
1.9
1.6
-1.6
-3.1
-5.0
-2.5
0.0
2.5
5.0
Apr-13
May-13
Jun-13
Jul-13
Aug-13
Sep-13
Oct-13
Nov-13
Dec-13
Jan-14
Feb-14
Mar-14
Apr-14
May-14
Jun-14
Jul-14
Aug-14
Sep-14
Oct-14
Nov-14
Dec-14
Jan-15
Feb-15
Trailing 12m Growth (%) Trailing 12m Growth (ex-imports) (%)
1.89 2.28 2.01 2.04 2.07 2.41 2.10 2.11 2.13 2.10
2.75
3.20 2.62 3.02 2.97
3.47
2.76 2.94 2.86 3.20
2.17
2.43
2.55
3.13 3.08
3.10
2.88 3.07 3.03 3.00
8.2
9.4
7.8
8.9 8.9
9.7
8.5 8.8 8.7 9.2
3QFY13 4QFY13 1QFY14 2QFY14 3QFY14 4QFY14 1QFY15 2QFY15 3QFY15 4QFY15
Tata Steel SAIL JSW Steel JSPL
0
5,000
10,000
15,000
20,000
3QFY10
4QFY10
1QFY11
2QFY11
3QFY11
4QFY11
1QFY12
2QFY12
3QFY12
4QFY12
1QFY13
2QFY13
3QFY13
4QFY13
1QFY14
2QFY14
3QFY14
4QFY14
1QFY15
2QFY15
3QFY15
4QFY15
Average Tata Steel SAIL JSW Steel JSPL
Steel spreads for Chinese
Mills compressed in the
quarter.
While demand shows early
signs of improvement,
imports are crowding out
domestic mills.
March 2015 Results Preview | Sector: Metals

5. April 2015 201
Exhibit 9: India steel – realization (INR/t)
Source: MOSL, Company
Aluminum: earnings adjustment and& rollover of to target prices to FY17
We c ut LME alu minum forecast t o US D1,900 and USD1,950 for FY16E/17E from
USD2,000 earlier an d h ave ro lled o ver t he t arget p rices b y o ne y ear to F Y17E.
There is a positive impact of exchange rate change to USD/INR 64 from 62 earlier.
Exhibit 10: Summary of estimates changes – Aluminum companies
EBITDA (INR b) Adj. PAT (INR b) TP
Comments
4QFY15E FY16E FY17E 4QFY15E FY16E FY17E
Hindalco
(Standalone)
Old 10 44 47 4 12 16
Cut LME aluminum to USD1,900 for FY16E and
USD1,950 for FY17E from USD2,000 earlier.
New 9 41 48 3 9 16
Chg. -9% -8% 3% -19% -26% 4%
Hindalco
(Consol)
Old 28 117 126 7 27 38
Cut LME aluminum to USD1,900 for FY16E and
USD1,950 for FY17E from USD2,000 earlier.
New 27 114 130 6 24 39 221
Chg. -3% -3% 3% -11% -13% 4%
Nalco
Old 6 22 22 4 17 17
Cut LME aluminum to USD1,900 for FY16E and
USD1,950 for FY17E from USD2,000 earlier.
New 5 19 22 3 15 17 90
Chg. -12% -14% 1% -33% -13% 1%
Source: MOSL, Company
Exhibit 11: Quarterly average aluminum prices – USD/t
Quarter
Aluminium Premium Aluminium total price Alumina
Avg. QoQ YoY Avg. QoQ YoY Avg. QoQ YoY Avg. QoQ YoY
4QFY15E 1,803 -8% 6% 320 1% 45% 2,124 -7% 10% 343 -3% 5%
3QFY15 1,966 -1% 11% 318 2% 72% 2,285 -1% 17% 355 10% 10%
2QFY15 1,987 11% 12% 311 8% 67% 2,298 10% 17% 322 2% 1%
1QFY15 1,798 5% -2% 289 31% 61% 2,088 8% 4% 317 -3% -3%
4QFY14 1,708 -3% -15% 221 19% 23% 1,929 -1% -12% 328 2% -4%
3QFY14 1,768 -1% -11% 185 0% 6% 1,953 -1% -10% 323 1% -1%
2QFY14 1,780 -3% -7% 186 3% 4% 1,966 -2% -6% 318 -3% 1%
1QFY14 1,834 -8% -7% 180 1% 28% 2,014 -8% -5% 327 -4% 3%
4QFY13 2,002 0% -8% 179 3% 80% 2,181 0% -4% 341 5% 8%
3QFY13 1,997 4% -4% 174 -3% 99% 2,171 4% 0% 326 3% -1%
2QFY13 1,918 -3% -20% 179 27% 105% 2,097 -1% -16% 316 0% -15%
1QFY13 1,978 -9% -24% 141 42% 62% 2,119 -7% -21% 317 0% -22%
Source: MOSL, Company
25
31
37
43
49
55
3QFY11
4QFY11
1QFY12
2QFY12
3QFY12
4QFY12
1QFY13
2QFY13
3QFY13
4QFY13
1QFY14
2QFY14
3QFY14
4QFY14
1QFY15
2QFY15
3QFY15
4QFY15
Realization(INR/T)
Average Tata Steel SAIL JSW Steel JSPL
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6. April 2015 202
Exhibit 12: E-auction volumes increased in 4QFY15…
Source: MOSL, MoC
Exhibit 13: …Driving spot auction price premiums lower
Source: MOSL, MoC
Exhibit 14: Average e-auction realized prices – INR/t (only SECL and MCL mines)
Coal Grade Apr-14 May-14 Jun-14 Jul-14 Aug-14 Oct-14 Nov-14 Dec-14 Jan-15 Feb-15
G3 4,698 4,091 4,527 4,445 3,910
G4 3,642 3,646 3,670 3,835 3,871 3,490 3,494
G5 3,259 3,308 3,578 3,515 4,675 4,303 3,845 3,566 3,090 2,867
G6 3,244 3,905 3,503 3,940 4,106 4,397 4,475 3,605 3,416
G7 2,586 2,913 3,281 3,607 3,865 4,101 3,085 3,318 2,539
G8 2,333 2,244 2,648 2,858 2,504 2,135 2,357
G9 3,533 2,512
G10 2,280 1,614 1,720
G11 2,060 1,859 2,169 2,194 2,433 1,141 1,866 1,808
G12 1,273 1,600 1,068 2,340 2,777 1,453 1,249 1,583
G13 1,891 2,607 1,026 1,559
Average 3,175 2,772 3,187 3,402 4,260 4,352 3,445 2,940 2,683 2,270
Source: MOSL, Steel Mint
Hindustan Zinc and SSLT
We incorporate the impact of DMF (at@ 100%) for Hindustan Zinc. We have also
lowered o ur F Y16E LME z inc e stimate t o US D2,100, fro m US D2,200 e arlier, a nd
rolled over the target prices by one year to FY17E.
Exhibit 15: Summary of estimates changes – Hindustan Zinc and SSLT
EBITDA (INR b) Adj. PAT (INR b) TP
Comments
4QFY15E FY16E FY17E 3QFY15E FY16E FY17E
HZL
Old 23 79 80 23 78 80
Incorporate for DMF (@100%) and cut LME zinc for
FY16E to USD2,100 from USD2,200 earlier
New 22 61 68 22 63 69 201
Change -7% -23% -15% -6% -20% -14%
SSLT
Old 57 212 213 16 49 40
Cut on impact at Hindustan Zinc and Cairn India.New 51 182 208 10 30 34 243
Change -10% -14% -3% -34% -39% -14%
Source: MOSL, Company
4.0
4.4 4.4
5.4 5.4 5.6
6.2 6.2
1.7
0.8 0.8
1.2
2.5
6.2
5.8 6.2
Jul Aug Sep Oct Nov Dec Jan Feb
FY2014 FY2015
74%
86%
97%
116%
92%
51% 53% 59%
Jul-14
Aug-14
Sep-14
Oct-14
Nov-14
Dec-14
Jan-15
Feb-15
E-Auction price premium over notified price (%)
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7. April 2015 203
Exhibit 16: Other base metals quarterly average prices – USD/t
Quarter
Zinc Copper Lead Silver (Rs/kg)
Avg. QoQ YoY Avg. QoQ YoY Avg. QoQ YoY Avg. QoQ YoY
4QFY15E 2,087 -7% 3% 5,771 -13% -18% 1,803 -10% -14% 37,099 1% -17%
3QFY15 2,235 -3% 17% 6,624 -5% -7% 2,000 -8% -5% 36,694 -14% -20%
2QFY15 2,311 11% 24% 6,995 3% -1% 2,181 4% 4% 42,691 2% -7%
1QFY15 2,073 2% 13% 6,787 -4% -5% 2,095 0% 2% 41,862 -7% -7%
4QFY14 2,029 6% 0% 7,040 -2% -11% 2,105 0% -8% 44,935 -3% -20%
3QFY14 1,906 3% -2% 7,153 1% -10% 2,111 0% -4% 46,099 0% -23%
2QFY14 1,859 1% -1% 7,073 -1% -8% 2,101 2% 6% 46,077 3% -17%
1QFY14 1,840 -9% -5% 7,147 -10% -9% 2,053 -11% 4% 44,837 -20% -18%
4QFY13 2,032 4% 0% 7,931 0% -5% 2,301 5% 10% 55,927 -7% 1%
3QFY13 1,946 3% 3% 7,908 3% 6% 2,198 11% 11% 59,949 8% 11%
2QFY13 1,885 -2% -15% 7,705 -2% -14% 1,974 0% -20% 55,755 2% -5%
1QFY13 1,927 -5% -14% 7,869 -5% -14% 1,973 -6% -23% 54,406 -2% -5%
Source: MOSL, Company
Exhibit 17: Relative performance -– three-month3m (%)
Source: Bloomberg, MOSL
Exhibit 18: Relative performance -– one-year1 Year (%)
Source: Bloomberg, MOSL
Exhibit 19: Comparative valuation
Sector / Companies CMP RECO EPS (INR) PE (x) EV/EBIDTDA (x) RoOE (%)
(INR) FY15E FY16E FY17E FY15E FY16E FY17E FY15E FY16E FY17E FY15E FY16E FY17E
Hindalco 135 Buy 11.7 11.4 19.1 11.5 11.8 7.1 8.3 7.1 6.0 9.9 9.0 13.6
Hindustan Zinc 163 Buy 20.0 14.9 16.4 8.2 11.0 9.9 4.8 5.4 4.2 20.5 13.3 13.4
JSPL 154 UR
JSW Steel 900 Buy 64.2 50.7 62.1 14.0 17.8 14.5 7.1 7.0 6.6 7.0 5.4 6.5
Nalco 48 Buy 4.9 5.6 6.5 9.7 8.4 7.3 3.5 2.5 1.4 10.1 10.8 11.6
NMDC 128 Sell 16.1 10.5 10.4 8.0 12.2 12.3 4.2 7.5 7.7 20.3 15.5 11.4
SAIL 70 Sell 4.2 1.3 2.6 16.6 51.6 27.0 10.7 11.3 9.3 4.0 1.3 2.4
Sesa Sterlite 191 Buy 18.1 10.1 11.6 10.6 18.9 16.5 4.4 5.6 4.6 7.1 3.9 4.4
Tata Steel 318 Buy 15.7 38.3 74.4 20.3 8.3 4.3 7.6 7.1 5.2 5.5 11.6 19.7
Sector Aggregate 10.5 14.5 10.8 6.4 7.2 6.0 8.6 6.1 7.7
Source: MOSL
92
104
116
128
140
Apr-14
May-14
Jun-14
Jul-14
Aug-14
Sep-14
Oct-14
Nov-14
Dec-14
Jan-15
Feb-15
Mar-15
Apr-15
Sensex Index MOSL Metals Index
90
93
96
99
102
Jan-15
Feb-15
Mar-15
Apr-15
Sensex Index MOSL Metals Index
March 2015 Results Preview | Sector: MetalsMarch 2015 Results Preview | Sector: Metals

8. 9 April 2015 4
Metals | Coal auction
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