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Profitability reduces, but growth intact; deleveraging on

In Q2FY22, Metals companies reported strong earnings on higher volumes and realization despite being hit by seasonally slow demand and impact of higher input cost inflation. We observe that debt reduction has continued in the current quarter despite increase in working capital requirement for a few companies. Among ferrous companies, operating profits of JSW Steel (JSTL) and JSPL have been largely in line with our estimates, but SAIL and TATA missed estimates by 10-22% primarily due to higher CoP and one-offs like higher provisioning of employee cost in SAIL. In non-ferrous, higher aluminum and zinc (average LME up 3-10% QoQ) prices helped to offset lower volumes, resulting in in-line EBITDA for Hindustan Zinc and Vedanta, while HNDL reported better than expected operating profits. COAL and NMDC’s operating profits were higher than expected owing to lower employee cost and higher realizations, respectively.

Ferrous: Volume pick-up and higher realization offset by input cost inflation

In Q2FY22, all domestic steel producers posted lower margins (down 1,970-6,880/t QoQ, with maximum decrease for JSPL followed by JSTL, SAIL and TATA) but recorded sequential EBITDA growth, driven by higher volumes and steel prices. EBITDA was up 1- 12% QoQ. Higher volumes were facilitated by higher exports, offsetting slow domestic demand amid monsoons (up 5-32% QoQ). Average increase in steel realization was Rs1,600-3,400/t QoQ. The above two offset the impact of higher coking coal cost (up Rs800-Rs3,900/t) for all steel producers and iron ore cost for JSTL (up Rs1,600/t QoQ) and JSPL (up Rs5,550/t QoQ as it exhausted free iron ore inventory in Q1FY22). During the quarter, all steel companies witnessed increase in working capital due to input cost inflation and higher steel prices led to increase in overall inventories except for SAIL and JSPL. As a result, despite higher operating profits, net debt of coverage companies was down by just Rs166bn (vs Rs118bn reduction in Q1FY22). The maximum net debt reduction was in SAIL (down Rs78.8bn) to Rs247bn, followed by TATA (down by Rs51bn QoQ) and JSPL (down Rs40bn QoQ). JSTL’s net debt increased marginally by Rs4bn QoQ.

Non-ferrous: Profitability improves on higher commodity prices

During the quarter, average base metal prices rose by 3-10% QoQ, with aluminum rising the most and zinc, the least. Higher aluminium prices and better geographical mix led Hindalco India to deliver better than expected EBITDA of Rs33bn, up 36% QoQ. Lower volume (down 11% QoQ) offset by higher zinc prices (up 4% QoQ) enabled Hindustan Zinc (HZ) to report in-line EBITDA of Rs33.3bn. Vedanta reported in-line EBITDA of Rs103.6bn, up 10% QoQ, driven by higher commodity prices partly offset by lower zinc volume and higher CoP in aluminum, zinc international, and steel. Ex-HZ, EBITDA was Rs70.8bn, up 10% QoQ due to higher commodity prices partially offset by lower volumes in iron ore and steel and higher CoP in aluminum.

Q3FY22: Higher CoP to dent profitability, but it should still remain elevated

During Q3FY22, domestic demand is expected to improve sequentially. Hence, sales volumes should remain high. Amid significant rise of coking coal prices to ~USD400/t (alltime high), we expect increase in coking coal cost by USD50-130/t (lowest for JSPL, highest for SAIL), which will be partly offset by higher steel realization (up by Rs2,500- 4,000/t), leading to fall in operating profits. While operating cost of aluminum is expected to increase, affecting Hindalco and Vedanta, zinc CoP should fall QoQ, benefiting HZ. We expect NMDC prices to fall QoQ, offsetting higher volumes. COAL volumes should pick up in Q3FY22 and aid in higher earnings.

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