Despite a rebound, analysts see further upside
Non-ferrous metal producers Hindalco and Sterlite Industries have seen a good run-up on the bourses, rising 18-23 per cent since their closing lows on November 19, led by a jump in underlying commodity prices on the London Metal Exchange (LME).
Per tonne LME aluminium prices have rebounded 14 per cent from the sub-$1,900 levels at the start of November to $2,163. Copper is up six per cent from $7,550 to $8,000, while zinc has surged 14 per cent from $1,780 to $2,050. Coupled with the under-ownership of stocks and low valuations, this is responsible for the stock price gains. Given the improving outlook for Hindalco and Sterlite, analysts are positive on the stocks. Those at JP Morgan believe the stocks could see similar gains (about 40 per cent) as was seen in the beginning of 2012.
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Prices, demand up
The FY14 outlook for base metal prices, which recently rebounded from lows on the LME, remains good. Analysts at Bank of America Merrill Lynch see aluminium, zinc and lead average prices at $2,063, $2,238 and $2,500 a tonne during FY14. This would mean a gain of eight to 20 per cent, given the average prices so far in FY13. For copper, the Tc/Rc margins (on treatment and refining charges), a key profitability barometer, are also expected to perk further in FY14.
|In Rs crore||Hindalco||Sterlite|
|% change y-o-y||-8.8||14.9||15.0||14.1|
|% change y-o-y||-12.3||22.1||8.2||31.8|
|E: Estimates; Sterlite figures are consolidated and include those of Sesa Goa, with whom it is being merged Source: Analyst reports|
Apart from weak metal prices impacting realisations, the operating performance of companies has been impacted by regulatory uncertainty, project delays and weak demand. The National Investment Board proposal and coal price-pooling proposal also going to the cabinet are positive and provide hope that clearances of stalled projects could pick up. If the projects of these companies get clearances, it would improve long-term visibility. At the macro level, any cut in interest rates in calendar year 2013 should help prop demand and support prices.
More important, the news flow from China (the largest consumer of metals) is showing some improvement. Key Chinese indicators such as fixed asset investment growth, industrial production, floor space sold and the Purchasing Managers Index are showing signs of stabilisation and a possible reversal. With these indicators improving recently from three-year to six-year lows, analysts at Edelweiss Securities see prospects of a recovery for Chinese metal demand in 2013. They see a similar picture for India, as lead indicators point towards demand pick-up in FY14.
The commissioning of Hindalco’s Utkal project, estimated at the start of FY14, will provide a big boost to its performance. Analysts say the facility is a cost-effective alumina producer and its cost of production will further decrease from $200 to $170 a tonne, once the conveyer belts get commissioned. Analysts at Barclays see cash flow visibility improving over FY14, adding the Utkal refinery can potentially generate a rate of return significantly above the cost of capital.
In the longer run, Hindalco will also reap the benefits of the large capacity expansion currently on. For instance, it had got a nod for the Mahan coal project, which would benefit its Mahan smelter. However, the gains will accrue after FY14, as the mines are still in a development stage. On the whole, most analysts are positive on Hindalco (now at Rs 127), given its low-cost production and expansion plans, with price targets as high as Rs 160.
Apart from improving metal prices, this stock has also got a boost from expectation of buying out the government’s residual 29.5 per cent stake in Hindustan Zinc Ltd (HZL), a company which has been driving revenues for Sterlite. Complete control of HZL will simplify the Vedanta group structure. More important, as analysts at Enam Securities say, the existing cash balances of HZL could be used for repayment of debt taken by Sterlite to buy remaining stake, while future cash flows from merged zinc operations could come as a relief for servicing existing debt. This would prove helpful, given the pressure (due to regulatory headwinds) on the iron ore business, a cash cow (Sesa Goa; with whom Sterlite’s merger is expected in a few months).
However, of late, reports indicate the HZL deal might not come through quickly, as certain quarters in the government are not keen. This might lead to some correction in the stock and an opportunity for investors to buy.