Result review | Metals

November 22, 2012 Bhavesh Chauhan

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

2QFY2013 Result Analysis

Profit remains under pressure
Mixed top-line performance: Metal companies reported a mixed top-line performance during 2QFY2013. Among steel players JSW Steel and Tata Steel saw a net sales growth of 16.5% and 4.1% yoy, respectively, whereas SAIL reported a 1.6% yoy decline in net sales. Among the non-ferrous players Sterlite and Hindustan Zinc both reported an 8.8% yoy increase in net sales; however, the top-line of the rest of the players fell due to lower aluminium realization. Except for Coal India, all other miners showed a decrease in top-line aided by lower volumes.
Margins remain under pressure: Among the steel companies, Tata Steel reported a 16.0% fall in operating profits due to higher labor and power costs; SAIL also reported a 16.4% fall in operating performance due to higher other expenditure. Amongst the non-ferrous companies, except for Sterlite the remaining three companies in our coverage reported an average 14.2% fall in operating profits mainly due to lower realizations coupled with higher costs. Mining companies also faced margin pressure led by lower volumes and/or higher costs. Outlook: Globally, sea-borne iron ore prices declined sharply during April August 2012; however, the prices have risen sharply from August. Contracted coking coal prices have declined gradually over the past one year. Coking coal contract price for October December 2012 have been signed at US$170. 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 six months. Domestic steel prices have also declined lately; however, INR depreciation against the USD has partially muted the decline in steel prices. Non-ferrous companies are expected to continue to face a double whammy of declining product prices coupled with higher input costs during 2HFY2013. 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 high and sticky 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 2HFY2013 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 underperformed over the past one year on account of 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 and MOIL.

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

Please refer to important disclosures at the end of this report

Metals | Result review

Mixed top-line performance: Steel companies reported a mixed top-line performance during 2QFY2013. JSW Steel and Tata Steel saw a net sales growth of 16.5% and 4.1% 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 Sterlite and Hindustan Zinc both reported an 8.8% 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 1.3% due to lower prices of aluminium. Among the miners, except for Coal India, all other companies showed a decrease in top-line aided by lower volumes. Sesa Goas top-line declined by 62.7% yoy due to mining ban in Goa.

Exhibit 1: 2QFY2013 - Top-line performance

35,000 30,000 25,000 2QFY13 2QFY12

Exhibit 2: Top-line - variance from expectation

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

(` cr)

15,000 10,000 5,000 0

(%)

20,000

SAIL

Tata Steel

NMDC

Nalco

MOIL

Coal India

Hindalco

Sesa

HZL

NMDC

Source: Company, Angel Research

Sterlite

Source: Company, Angel Research

Higher input costs dent operating profits: Among the steel companies, Tata Steel reported a 16.0% fall in operating profits due to higher labor and power costs at its European operations. SAIL also reported a 16.4% fall in operating performance due to higher other expenditure. JSW Steels EBITDA grew 9.9% yoy which was in line with increase in sales. In the non-ferrous sector, except for Sterlite the remaining three players in our coverage reported a 14.2% fall in operating profits on an average on the back of lower realizations, higher power costs and lower byproduct sales. Among mining companies, Sesa Goa faced severe margin pressures during the quarter due to mining ban in Goa. NMDCs margins were hit by lower volumes while Coal Indias EBITDA grew by only 1.3% yoy despite a 10.8% growth in net sales due to higher staff costs.

November 22, 2012

JSW Steel

Tata Steel

SAIL

Nalco

MOIL

Coal India

Hindal co

Sesa

HZL

JSW Steel

Sterlite

Metals | Result review

Exhibit 3: 2QFY2013 Operating profit growth

3,000 2,500 2,000 1,500 1,000 500 0 (500)

Exhibit 4: Operating profit - variance from expectation

3,000 2,500 2,000 1,500 1,000 500 0 (500)

(`cr)

SAIL

(`cr)

Tata Steel

SAIL

Tata Steel

NMDC

NMDC

HZL

Nalco

Hindalco

Nalco

MOIL

MOIL

Coal India

Coal India

JSW Steel

Hindalco

Sesa

Sesa

HZL
HZL

2QFY13

2QFY12

2QFY13

2QFY12

Source: Company, Angel Research

Source: Company, Angel Research

Debt levels of metal companies remain high: Steel players reported a modest fall in debt for 2QFY2013 over the previous year 2QFY2012. However, the debt for non-ferrous players such as Hindalco and Sterlite increased by 88.9% and 8.1%, respectively. These companies interest costs declined yoy as a part of interest was capitalized and did not flow through the income statement (most debt was raised to fund capex).

Exhibit 5: Debt levels of coverage companies

70000 60000 50000 88.9 100.0 80.0 60.0 8.1 (9.4) 40.0 (11.6) (5.1) (11.3) (5.8) 20.0 (20.0) (40.0)

Exhibit 6: Interest costs show a mixed trend

1,200 1,000 800
(%)
(` cr)

(` cr)

40000 30000 20000 10000 0

600 400 200 0 (200)

MOIL SAIL Tata Steel NMDC Nalco Coal India Hindalco JSW Steel Sesa Sterlite

SAIL

Tata Steel

NMDC

Nalco

MOIL

Coal India

Hindalco

Sesa

HZL

JSW Steel

Sterlite

2QFY13

FY12

2QFY12

% change over 2QFY12

2QFY13

2QFY12

Source: Company, Angel Research

Source: Company, Angel Research

Exhibit 7: 2QFY2013 Adjusted PAT

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

Exhibit 8: Adjusted PAT -Variance from expectation

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

(` cr)

SAIL

Tata Steel

NMDC

Nalco

Coal India

Hindalco

MOIL

Sesa

HZL

MOIL

NMDC

Nalco

SAIL

Coal India

Hindalco

HZL

2QFY13

2QFY12

Source: Company, Angel Research

Source: Company, Angel Research

November 22, 2012

JSW Steel

Sesa

Sterlite

(1,000)

JSW Steel

Sterlite

(500)

(%)

(120)

JSW Steel

Sterlite

Sterlite

Metals | Result review

Steel companies Outlook

Raw material prices have come off sharply
Globally, sea-borne iron ore prices declined sharply during April - August 2012; however, the prices have risen sharply from August. 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 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. Coking coal contract price for October December 2012 has been signed at US$170. 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 9: Iron ore prices and...

190 170
(US $/tonne)

Exhibit 10: ...coking coal prices have come off

400 350 300 250 200 150 100 50 0

150 130 110 90

Dec-09 Dec-10 Dec-11 Jun-10 Jun-11 Aug-10 Aug-11 Jun-12 Aug-12 Apr-10 Apr-11 Oct-10 Oct-11 Apr-12 Feb-10 Feb-11 Feb-12 Oct-12

(US$/tonne)

Jul-08

Jul-09

Jul-10

Jul-11

Jan-08

Jan-09

Jan-10

Jan-11

Jan-12

Apr-08

Apr-09

Apr-10

Apr-11

Apr-12

Jul-12

Oct-08

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

Subdued demand, escalating Eurozone debt crisis, slowdown in Chinese demand and falling coking coal prices have resulted in a decline in steel prices globally over the past five-six months. Domestic steel prices have also declined lately; however, INR depreciation against the USD has partially muted the decline in steel prices.

November 22, 2012

Oct-09

Oct-10

Oct-11

Oct-12

Metals | Result review

Exhibit 11: Global steel prices have been declining

900 800
(US$/tonne)

Exhibit 12: Domestic prices have declined only lately

39,000 37,000 35,000
( ` /tonne)

700 600 500

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

33,000 31,000 29,000 27,000 25,000

Jul-11 Jul-10 Sep-11 Jul-12 May-10 Sep-10 May-11 May-12 Mar-11 Nov-10 Nov-11 Mar-12 Sep-12 Jan-11 Jan-12

World HRC price

USA Domestic HRC price

CIS export HRC price

Indian HRC price

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- September 2012, total steel imports by India have increased by 46.3% yoy to 5.9mn tonne.

Exhibit 13: Steel imports have risen over the past one year
8,000 7,000 6,000 800 700 600 500 400 300 200 100 0 (100) (200)

(000 tonnes)

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

Jul-11

Mar-11

Mar-12

Sep-11

Jul-12

Nov-10

May-11

Nov-11

Net production

Real consumption

Net imports - RHS

Source: Bloomberg, Angel Research

Non-ferrous companies Outlook

Margins 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 during 2HFY2013. 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 and sticky 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

November 22, 2012

May-12

Sep-12

Jan-11

Jan-12

(000 tonnes)

Metals | Result review

view. Nevertheless, we expect prices to improve in FY2014 as announced production cuts restore demand-supply mismatch during FY2014.

Exhibit 14: Despite decline in aluminium price...

6.0 5.0 4.0
(mn tonnes)

Exhibit 15: ...production cuts are not visible yet

3,200
(US$/tonne)

4.0 3.5
(mn tonnes)

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

Sep-07 Sep-09 Sep-10 May-07 May-10 May-08 May-11 May-12 May-09 Sep-12 Sep-08 Sep-11 Jan-09 Jan-07 Jan-08 Jan-10 Jan-11 Jan-12

3.0 2.0 1.0 0.0

3.0 2.5 2.0

Dec-09 Jun-07 Jan-07 Aug-06 Nov-07 May-10 Mar-11 Aug-11 Apr-08 Sep-08 Feb-09 Oct-10 Jan-12
-

LME aluminium inventories

LME aluminium price - RHS

Aluminium production - World

Aluminium consumption - World

Source: Bloomberg, Angel Research

Source: Bloomberg, Angel Research

Exhibit 16: Aluminium production in China rising...

2.0 1.8
(mn tonnes)

Exhibit 17: ...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)

1.6 1.4 1.2 1.0

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

4.0 3.0 2.0 1.0 0.0

Aluminium production - China

Aluminium consumption - China

Source: Bloomberg, Angel Research

Source: Bloomberg, Angel Research

Exhibit 18: Zinc prices have been volatile lately

1.3 1.2 1.1
(mn tonnes)

Exhibit 19: World production remains steady

2,500 2,300
(US$/tonne)

0.9 0.8 0.7 0.6 0.5 0.4

Dec-10 Dec-11 Jun-11 Aug-11 Jun-12 Aug-12 Apr-11 Oct-11 Apr-12 Feb-11 Feb-12 Oct-12

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

(mn tonnes)

1.0

1.2 1.2 1.1 1.1 1.0 1.0 0.9 0.9 0.8 0.8 0.7
Dec-07 Dec-09 Aug-08 Aug-10 Dec-11 Aug-12 Apr-09 Apr-11

LME zinc inventories

LME zinc price- RHS

Source: Bloomberg, Angel Research

Source: Bloomberg, Angel Research

November 22, 2012

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 Jul-12 Aug-12

Bauxite imports - China

Alumina imports - China - (RHS)

Zinc slab consumption - World

Zinc slab production - World

(mn tonnes)

Jun-12

Jul-09

Metals | Result review

Exhibit 20: Chinese zinc production remains high...

550,000 500,000
(metric tonnes)

Exhibit 21: ...while imports have remained volatile

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

400,000 350,000 300,000 250,000 200,000 150,000 100,000

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

(metric tonne)

450,000

Sep-11

May-11

May-12

Dec-11

Mar-11

Mar-12

Aug-11

Aug-12

Sep-12

Feb-12

Jul-11

Jun-11

Jan-12

Apr-11

Apr-12

Jun-12

Jul-12

Oct-11

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 underperformed over the past one year on account of 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 and MOIL.

Exhibit 22: One year stock price performance

SAIL Nalco Hindalco NMDC Sterlite Tata Steel Sesa BSE Metal Index MOIL Coal HZL JSW (20) (10) 0 (%)
Source: Bloomberg, Angel Research

10

Nov-11

20

30

November 22, 2012

Oct-12

40

Metals | Result review

Exhibit 23: Recommendation summary

Companies MOIL Nalco NMDC SAIL Sesa Sterlite Tata Steel Coal India Hindalco HZL JSW Steel CMP (`)
241 46 170 78 167 97 366 355 108 133 715

Target price (`)

Reco.

Mcap (` cr)
4,048 11,803 67,003 32,259 14,570 32,800 35,561 224,420 20,740 56,238 15,989

Upside
8 17 10 13 26 9 -

P/E (x)
9.3 23.4 9.7 11.7 5.2 5.8 17.1 14.3 7.5 9.3 9.4 8.6 14.6 8.7 10.8 4.5 5.4 8.4 13.0 7.2 8.5 8.2

P/BV (x)
1.5 1.0 2.4 0.8 0.9 0.6 0.8 4.2 0.6 1.8 0.9 1.3 1.0 2.0 0.7 0.8 0.6 0.8 3.4 0.6 1.5 0.8

EV/EBITDA (x) FY13E

4.1 12.8 5.6 7.2 12.4 2.7 6.4 8.9 7.0 5.5 4.7 3.3 7.9 4.7 7.3 7.8 2.4 5.4 7.5 6.3 4.2 4.7

RoE
16.7 4.3 27.0 6.9 18.3 11.6 4.9 33.1 8.8 21.4 10.2 16.2 6.8 24.6 7.1 18.3 11.2 9.3 29.1 8.4 19.7 10.7

RoCE (%)
15.4 1.4 31.7 6.1 7.1 9.9 7.2 19.1 5.8 19.4 10.7 15.2 4.6 29.1 6.6 9.8 9.5 10.0 18.7 5.6 18.1 9.3

(%) FY13E FY14E FY13E FY14E

FY14E FY13E FY14E FY13E FY14E

261 Accum. - Neutral 198 Buy - Neutral 183 Accum. 110 Accum. 463 Buy - Neutral - Neutral 145 Accum. - Neutral

Source: Company, Angel Research

November 22, 2012

Metals | Result 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%)

November 22, 2012