With commodities stocks one needs to be lucky twice; one, when buying them and second, when selling them. Of late, those holding commodity stocks are a grumpy lot as the Thomson Reuters CRB Index is trading at a 13-year low due to the underlying weakness in global energy and metal prices. Given this pessimism around low demand and oversupply, nobody is willing to stick their neck out and bottom-fish. But like most cycles, this too will turn. The billion-dollar question is when and hence it makes sense to watch out for players who are cost efficient, have negligible debt and the staying power to live through this downturn. The following are our best picks.
Zinc, which is largely used in steel-making, has seen its share of pain post the Chinese slowdown. Over the past year, LME zinc price has fallen by 37% to $1,680 per tonne. This sharp fall has raised question marks about the viability of quite a few players. Even Glencore’s stock price took a beating. While high-cost players will struggle or consolidate, Hindustan Zinc has some leeway as its cost per tonne is around $770 per tonne. As Glencore has announced to take some supply off the market, analysts expect prices to stay around the current level.
Post the 2008-09 crisis, global zinc prices had tumbled to around $1,300 a tonne from a high of around $4,400 a tonne in 2008. During that period Hindustan Zinc's operating margin had fallen from a peak of 75% in FY07 to 48% by FY09. In Q2FY16, it reported an operating margin of 52.5% which is good enough insurance in the down cycle. Production in Q2FY16 was 200,000 tonne as against 174,000 tonne in the corresponding quarter last year. The company is debt-free and has cash and cash equivalent of close to ₹82 per share against its current market price of ₹142 per share. "Valuation is already at the 2009 level and it has never breached 5 times EV/EBIDTA (current 5.89 times)," says Kamlesh Bagmar, who tracks the company at Prabhudas Lilladher.
This PSU, which is into exploration and production, has seen its profit fall due to lower realisation on crude oil, which accounts for 65% of its revenues. It current gross realisation of $46.4 a barrel is still much higher compared to its cost of production of around $30 per barrel. No wonder even after lower realisation, in Q2FY16 it reported a healthy 52.5% EBIDTA margin as against 56.56% last year. Along with the lower global gas prices, the government has recently reduced the gas price to $3.8 mmbtu as against earlier pricing of $4.66 which too has impacted its gas business accounting for 35% of the revenues.
While the impact is already visible in falling margins, due to its low cost of production, the company can withstand the down cycle. "I think both the crude oil cycle and valuation have bottomed. I do not see much downside, especially in the light of cash per share of almost ₹150, which is close to 35% of its current market price at ₹378 per share," says Vaibhav Chowdhry, analyst at brokerage KR Choksey. The company currently trades at 8X FY16 estimated earnings and also has a 5% stake in Indian Oil which is worth over ₹5,000 crore.
International iron ore prices have fallen 45% from $90 a tonne last year to $50 a tonne. While this has certainly led to margin erosion for NMDC, it still remains competitive as its cost of production is $18 to $20 a tonne. In Q2FY16, its realisation fell to ₹2,480 per tonne , which is 42% lower compared to the corresponding quarter last year. But thanks its strong margin, even after the dip it reported operating margin at 56.3% and a EBIDTA per tonne of $22 indicating that the company has far more leeway in terms of the facing the down cycle. While the pain in its user industry, steel, may be far from over, the domestic industry is marginally insulated due to import duty.
Though this eases some worry, the larger concern about earnings remains. Most analysts believe that because of the downturn, earnings will remain muted for 1-2 years and fall even more if iron ore prices drop further. International iron ore prices have already fallen below the low of 2009. What holds the company in good stead is its low debt and cash equivalent of ₹46 per share as against its current market price of ₹95. Additionally, it is forward integrating into steel, where it has a capital work-in- progress of ₹8,000 crore (₹20 per share). This drain should help when times improve.