The market seems to be at crossroads, with macro-economic indicators — that were supporting the rally — going through a pincer. Brent crude’s futures has inched up by 10% year till date (YTD), amid political instability in the world’s top oil exporter — Saudi Arabia. On the other hand, US Fed is set to embark on a rate hike, beginning December. Higher interest rates in the US, means a stronger dollar and weaker rupee, which could lead to raw materials getting dearer for Indian companies.
Not surprising that non-ferrous metal stocks within the Nifty metals pack have clocked an average return of 43% YTD, comfortably outperforming the benchmark Sensex, which has posted return of 25% during the same period. In CY17, aluminium and zinc prices on the LME have increased by around 25% each owing to restricted smelter capacity in aluminium and production constraints in zinc mines.
Metal analysts attribute non-ferrous metals’ rally to the demand-supply mismatch that has emerged after closure of certain capacities across the globe. “There has been a deficit situation in zinc and aluminum as quite a few zinc mines have shut down. In the case of copper, availability of concentrate has been a problem,” mentions Sanjay Jain, analyst, Motilal Oswal Financial Services. The big cuts are happening in China. “China’s aluminum capacity cuts seem to be on track with a large proportion of expected capacity curtailments underway,” adds Amit Dixit, analyst, Edelweiss Financial Services. The Chinese government’s crackdown on illegal aluminum capacities and the winter shutdown from November to March are likely to widen the demand-supply gap. “If the production cuts are implemented as planned, the supply deficit will remain and that will keep the prices higher,” says Tarang Bhanushali, analyst, IIFL Wealth and Asset Management. This could further fuel the rally in non-ferrous stocks.
Meanwhile, non-ferrous metal companies’ earnings are expected to grow at a compounded rate of nearly 45% over FY17-19. However, within the non-ferrous space, analysts have different picks. For Jain of MOFS, Hindalco is a top pick. “Hindalco is a low-cost producer, insulated from any alumina price increase as it has its own bauxite mines. Its coal supply is also in place as one-fourth of its requirements are fulfilled from its captive mines. Subsidiary Novelis, which supplies flat-rolled products, is seeing strong demand from the auto sector. The Novelis business’ is currently making Ebitda of $360 per tonne. The rising share of high-margin auto business in Novelis’ product mix also augurs well for the company’s profitability,” adds Jain.
Novelis, which operates on a conversion model, with aluminum prices being a pass-through, is looking at opportunities in the auto space to cater to the strong demand growth. With automakers warming up to the idea of electric vehicles, demand for lightweight aluminum components is going to increase. Analysts expect Hindalco’s earnings to grow at 69% CAGR over FY17-FY19. Hindalco continues to focus on accelerated deleveraging and allocation of capital in downstream assets, which is less capital intensive. It has already reduced Rs.7,800 crore of debt and plans to prepay another Rs.3,000 crore during FY18, according to analysts. Bhanushali of IIFL, however, prefers Vedanta. “It has multiple levers for growth and will benefit from higher commodity prices. Vedanta is expected to see volume growth in the aluminum and zinc business, at the same time, its oil and gas business is also expected to improve.”
Analysts expect Vedanta’s earnings to grow at 57% CAGR over FY17-19. Vedanta aims to increase zinc-lead mine production at a CAGR of 15% over FY17-20 to 1.6 MT. Vedanta is also the only player that has been ramping aluminum capacity since CY17. According to HSBC Global Research’s client note, deleveraging has been increasing at a brisk pace at Vedanta, with the company reducing its gross debt by Rs.11,000 crore in the last one year and net debt by Rs.3,300 crore over the past quarter.
Compared with ferrous players, analysts reckon that non-ferrous metals present a better opportunity, as they are expected to see better cash flow accretion and ROE expansion. Importantly, in terms valuation, too, non-ferrous metal stocks are trading at an attractive FY19 EV/Ebitda multiple of 6 times compared to their global peers. While thus far ferrous stocks (with 94% average returns in YTD) have led the metals rally, the favourable demand-supply conditions could help non-ferrous stocks catch up with their ferrous counterparts.
