Is the recovery in metal stocks for real?

A sharp recovery in metal prices have rubbed off on metal stocks. But their valuations exude too much optimism


Investors who made a contrarian bet on metals must be a happy lot as their bets have paid off rather handsomely. The NSE Metal Index has gained about 71%, compared with the Nifty’s 22% in the past one year. The Nifty Metal Index is trading at an EV/EBIDTA of 6.8x, compared with its 10-year average of 6.2x. However, Neelesh Surana, fund manager, Mirae Asset says, “Valuations are reasonable. While last year, there was a lot of scope to make some easy money in the metals space, there is still enough money on the table considering that the companies are expected to benefit from the current pricing environment and increased volume growth providing some operating leverage.” According to him, FY18 will be the first year of normalised earnings since the downturn and valuations are still reasonable, given the earnings growth expected. FY16 was a tumultuous year for the industry with most companies reporting huge losses as a result of a significant drop in LME metal prices and lower demand in the domestic market, coupled with the impact of Chinese imports. While the recovery began in the second half of FY17, the impact in metal prices and volume gains of these companies can only be seen in FY18. According to estimates by Motilal Oswal Securities, the top nine listed metal companies are expected to record an average annual earnings growth of 40% during 2017-19. In FY18, the companies are expected to post a 58% growth in earnings, followed by 24% in FY19.

In Q3FY17, the top nine major metal companies made a cumulative profit of around Rs.5,900 crore as against a loss of Rs.1,000 crore during the same period a year ago. It is still half the profit they made in June quarter of 2012 (when HRC steel prices peaked at Rs.39,000 per tonne) and Rs.8,900 crore in March 2013. Currently, steel prices have moved up to Rs.37,000 a tonne from Rs.34,000 a tonne at the end of December 2016, indicating that the next couple of quarters will continue to be good for steel companies.

Investors are also counting on financial and operating leverage to kick in with higher volumes. For instance, JSW, which was operating at 76% capacity utilisation in FY16, has now improved its utilisation rates to 85%. Thanks to higher realisations and better capacity utilisation, JSW Steel will be making an operati


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