Q1 preview: Triple whammy-Vol, ASP and Mix; non-ferrous to standout
* During the quarter, most companies reduced production as domestic demand tumbled. Pricing took a hit as globally metal prices plummeted and companies resorted to substantial increase in exports to continue the mill operations while ensuring evacuation of inventory. Even though demand remained robust from China as it recovered from the pandemic, it was largely limited to semis like billets (steel) and ingots (aluminum). Finished Goods and Value-add production was severely impacted in both ferrous and non-ferrous categories.
* Ferrous: While ASP has corrected sharply due to erosion of demand amid the pandemic, volumes also took a hit and companies rushing to the export market with semis further dented realization. We expect non-ferrous to report better results owing to utilization near peak. Steel prices slid in Apr-May due to lockdown. However, recovery was seen in both volume and price (to a lesser extent) in June and is expected to continue. Steel production volumes dropped between 25% and 30% in Q1 with RM production dropping between 30- 43%. We believe volumes will recover in Q2 onward for most players. However, the deleveraging targets of the steel companies look to be deferred by a year at least due to the pandemic. Stainless steel also suffered demand destruction with higher closure time more prominent as the companies operate EAFs instead of BF for large carbon steel mills.
* Non-ferrous: During the quarter, Cu/Al/Zn/PB/Ni prices declined 5%/11%/8%/9%/4%, driven by the pandemic globally. However, we believe that the plants operated at near capacity levels barring copper smelters and standalone downstream units which were shut for some period. Compared with ferrous, non-ferrous metals are globally more aligned and hence exports were a quicker way out to evacuate production as domestic demand took a beating. Input costs remained soft during the quarter for these companies, though exports reduced the premium earned in the domestic market. Input costs remained soft during the quarter which should reflect in RM costs. We believe that LME prices remain the key drivers for these stocks going forward.
* Mining: Mining was also impacted by the pandemic as volumes/pricing remained subdued. Power plants were flush with coal inventory due to low power offtake amid the nationwide lockdown and subsequent demand destruction, Coal India itself was carrying huge inventory of 75mt at pithead, resulting in throttled production. Iron ore and Mn Ore demand remained subdued as steel production was down.
* Things to watch out for: We expect profitability to bottom out in Q1FY21 as mills/mines continue to ramp up on a mom basis. We believe this quarter is largely a lost cause, with investors already looking ahead to how demand would pan out in H2 and that will be the barometer for assessing the stock valuations. Robust demand from China remains the key to the profitability of the sector. Key stock ideas: Among ferrous names, we remain positive on SAIL due to govt contracts and Rails products in its product basket, somewhat insulating it from the severe downturn faced by other steel companies. We also like Coal as the spot auction premium has increased on a mom basis and expect restoration of 20% premium over base price in eauction from Q3. In the non-ferrous space, we prefer Hindalco and Vedanta over Nalco and HZL
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