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TABLE OF CONTENT
Sl No Descriptions Pg No
1. Industry Overview 3
2. Quarter at a Glance 6
3. Industry Aggregate Financials 7
4. Steel Prices 8
5. Raw Material Prices 10
6. Production Data 11
7. Non-Ferrous Metal Prices 13
8. Other Parameters 14
9. Sector Analysis for 3QFY09 15
10. Net Sales Growth 19
11. EBITDA Growth 19
12. PAT Growth 19
13. EBITDA Margins 21
14. PAT Margins 21
15. Companies’ 3QFY09 Result Update 22
Hindalco Industries Limited 23
Hindustan Zinc Limited 28
JSW Steels Limited 32
National Aluminium Company Limited 38
Steel Authority of India Limited 42
Sterlite Industries Limited 46
Tata Steel Limited 52
16. Financial Highlights 56
17. Disclaimer 59
Industry Overview
As we mentioned in our previous sector update ‘Tough Season Begins’, it proved to be the toughest quarter over last
five years. Nonetheless, the dilemma is that we are nowhere near improvement during this quarter also, since the
average price this quarter would be lower than Dec’08 quarter. The only silverline for Indian producers can be found
on the volume front, which is expected to improve from Dec’08 quarter, but would remain lower than Mar’08
quarter. The recent IMF projection of 0.5% growth of world GDP for 2009, lowest since World War II, would
certainly have prolonged effect on global economy as well as metal sector. The revival in the metal sector would
largely depend on the effective implementation of approximately $2 tn stimulus package announced by major
countries like US and China. Domestic demand would also depend on stimulus package announced by Indian
government, which are basically meant for infrastructure sector.
Demand has deteriorated significantly
Recession in developed countries and slowdown in emerging markets have taken a heavy toll on demand across the
metal categories. Major user segments like auto and housing are featuring in the worst affected sector of this credit
crisis, whereas engineering and consumer durables are also affected sector. One of the most disturbing factor of this
crisis is projected change in consumption pattern of developed countries e.g. their more inclination towards saving
would worsen the situation. This along with substantial reduction in investment towards real economy would force
demand to stabilize at lower levels and hence the peak activity seen in 2008 would be nowhere in the horizon.
Production cuts are the order of the day
Sudden evaporation in demand has resulted in sharp production cuts across the globe in all metals. Collectively,
there has been approximately 15-20% production cut in global production for metal as well as mining products. The
European steel producers were the most aggressive with over 35% production cut, while China and US steel sector
has seen production cut to the tune of 15%. Non-ferrous metal and mining sectors has seen production cut in the
similar extent in order to restore the demand scenario. Major Indian producers has not seen much production cut
and Jan’09 month has seen utilization resorting to Sep’08 quarter levels, however, Indian SME producers have seen
significant production cut and hence able to sell unutilized power at very lucrative rate.
Inventories are rising steadily
Despite sizeable cut in production, inventory levels across the exchanges are rising very speedily, which implies the
severeness of the demand plunge. The aluminium sector is faring the worst among all metal, where LME inventory
has touched all time high level over last three decades. This LME inventory signifies nearly 4 weeks consumption
compare to 1.5 week’s consumption inventory for zinc and copper. Apart from lead, inventory level for all metal
copper, aluminium and zinc has almost trebled in last one year on LME. High inventory level would ensure any
positive surprise in demand to be easily absorbed from inventories.
Prices are unlikely to recover in near term
Considering the above factors, we believe, this downturn is a structural deterioration in demand and the recovery to
the 2008 demand level is going to take very extensive period. Metals price across the category has nosedived to the
tune of 50-75% from their peak, making it one of the worst crisis in the recent century. The last commodity bull run
of five year has created a capacity glut in the system, which along with production cut has resulted in very large
difference between production and rated capacity. Therefore we believe, stabilization in demand would be entirely
absorbed with resorting to earlier production level or operating at rated capacity. One of the argument for price
improvement is current price below marginal cost of production, however, considering the past downcycle, prices
can trade below marginal cost of production for a long period of time.
Cost of production is falling
Robust metal prices till mid-2008 have led to very high prices across the value chain, particularly last year, when
long-term coking coal prices contracted at over 200% above previous year level. Given the decline in steel prices, this
year contracts are expected to be a substantial lower rate for coking coal as well as iron ore. This along with
reduction in energy & freight cost and operational cost cutting across the companies would result in lower cost per
unit. Non-ferrous raw material prices are also linked to the LME metal prices, which have registered free-fall in last
six months. The only exception would be mining sector and integrated producers, which would see very marginal
reduction in their cost of production. However, this will enable reduction in marginal cost of production, which
would support our argument of bearish price outlook.
The bull driver ‘China’ has turned the biggest threat
The main driver of the commodity bull run, China, which has increased its production capacity across the metal by
3-5 times in last 7 years, has turned the biggest threat to the global metal sector. Horrific condition in US and other
developed countries has slowed down the China GDP growth to 6.8% in Dec’08 quarter, one of the lowest in last six
year, on account of large dependence on export segment. China, which controls 35-40% of demand as well as supply
for the all the metals, can unload its low cost production across the world due to its slowing economy, resulting in
huge surplus and therefore more decline in metal price. Chinese government assurance of cut in inefficient
operations and $586 bn stimulus package has not delivered the desired results so far.
Expansions has slowed in India, while deferred outside
Adverse demand environment and high cost of financing have forced several companies to review their expansion
plan. Every company is just focusing on preserving cash and therefore most of the global companies have deferred
already their expansion plans as well as acquisitions in view of current market condition for instance abandon of
multi-billion Rio Tinto acquisition by BHP Billiton and re-negotiation of Asarco deal by Sterlite Industries. Indian
companies are going ahead with their ongoing expansion, keeping the new greenfield projects in shelves only.
Nevertheless, we believe, it would be the most appropriate time for cash rich companies to go for acquisition
considering the reasonable valuation.
Even ongoing expansion can create capacity glut in India
Attributed to its high gestation period, the projects started in 2006-08, would be on the verge of commissioning
during 2009-11 period. According to our estimate, India is going to witness over 20 MT (~ 40% of current capacity) of
capacity addition during next three years. Considering the expected demand environment, lower capacity utilization
would be the key to balance the situation. Nonetheless, India, being a net importer country could see substantial
reduction in imports due to surplus capacity and refurbish its past history of net exporter country. Though, it would
be most complicated job to replace low cost Chinese & Taiwanese supplies.
INR has created more loss than gain
Approximately 25% depreciation in INR from Rs 40 level to Rs 50 has left most players distressed in the industry
except non-ferrous and mining companies. Non-ferrous and mining companies reaped the full benefit of INR
depreciation, while ferrous metal companies were highly affected due to its dependence on overseas coking coal.
Apart from this, companies with high foreign currency borrowings have provided large MTM provision affecting
their profit and net worth. Although economic condition improvement will appreciate currency, considering the
reduction in capital flow (FDI & FII) in last few months, INR is unlikely to appreciate at a rapid pace.
Indian operations are one of the best placed but overseas operation would face trouble
Despite all this global turmoil, Indian producers have one of the best operations across the globe due to its low cost
advantage. However, overseas acquisition from Indian companies e.g. Corus by Tata Steel, Novelis by Hindalco, US
plate & pipe operations by JSW Steel and expected Asarco by Sterlite Industries, are facing very nasty condition.
These acquired companies were not in their best position at the time of acquisition and substantial downturn in
global economy has left them rattled. Apart from this, it has left acquirer with very massive debt, constraining their
balance sheet as well as domestic expansion. e.g. Tata Steel is entirely focused to accomplish its debt covenant, which
otherwise may result in very tough condition for financing.
Strong Cash reserve provide more resilience amid slump economic environment
Robust commodity prices helped the companies to generate ample cash till Sep’08, but most of this cash was
invested for capacity addition or acquisition. However, there are some companies, which has been able to preserve
cash either due to delay in expansion or deliberately. Companies like Sterlite Ind, SAIL, Hindustan Zinc, NALCO
and Sesa Goa, which are hoarding a very large sum of cash compare to their operations may withstand this storm
more prudently than its counterparts. This will also allow them to gradually raise their capacity in order to
complement the demand arising from 2012 onwards, since gestation period would be 3-4 years for most of the
projects.
Valuation
Metal sector has seen one of the worst beating in the market registering 77% drop in BSE Metal index from the peak.
Largely, the metal companies have also witnessed 70-85% decline from their peak level. We believe at these prices,
many companies have largely factored all the surrounding negatives. We remain positive on those companies,
which will witness substantial reduction in cost and therefore we remain largely positive on steel sector, at the same
time, principally negative on non-ferrous metal and mining sector. SAIL, due to its adequate balance sheet and
massive expansion, remain our top pick followed by Sterlite Industries on account of very compelling balance sheet,
low cost operation and stable earning of power venture from FY10 onwards; however, acquisition price of ASARCO
remains the biggest risk to our recommendation. Tata Steel and JSW Steel will also be able to benefit from cost
reduction; nevertheless, their stretched leveraged balance sheet would put them in high-risk high return category.
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