D-street bets on a revival of metal cycle

High input costs, lower-than-expected realisations among downside risks

The metal market has seen extreme volatility in the past few months. Part of this is due to supply concerns as Russia and Ukraine are big players. There are also fears of demand destruction as China has gone into lockdown and global growth projections have been pared.

The metal market corrected by 15 per cent since mid-april, with individual shares down 10-30 per cent. However, the market may have over-corrected.

On Tuesday, there was a surge in share prices of Hindalco and Vedanta — both big players in the non-ferrous market — in the hopes of demand revival from China, as lockdown ended in Shanghai and the Chinese central bank cut interest rates.

Apart from Vedanta and Hindalco, the shares of Nalco, Hindustan Copper, and Tata Steel were also up considerably.

The management commentary has highlighted concerns over volatile input costs, especially energy prices. Overall, industry watchers believe prices of metals will remain high, given supply disruption and high input costs, and there could be margin pressures for most metal firms.

Vedanta reported higher revenues and earnings before interest, tax, depreciation, and amortisation (Ebitda) for the fourth quarter of 2021-22 (FY22). Consolidated revenue grew 41 per cent year-on-year (YOY) and 17 per cent quarteron-quarter (QOQ) to ~39,800 crore. Consolidated Ebitda stood at a record high of ~13,600 crore, up 50 per cent YOY and 26 per cent QOQ.

Adjusted profit after tax (PAT) rose 90 per cent YOY and 6 per cent QOQ to ~6,200 crore.

The growth in revenue and profitability is driven by a spike in London Metal Exchange (LME) prices. On a YOY basis, average LME prices in FY22 for zinc, lead, and aluminium were higher by 34 per cent, 22 per cent, and 40 per cent, respectively.

The oil and gas segment also reported high Ebitda (~2,100 crore, up 20 per cent YOY, and 19 per cent QOQ), due to higher crude prices. The management guided for a muted production outlook for the zinc and aluminium industry in the near term. One positive is that the company has managed to hold down coal costs by switching the procurement mix.

Hindalco is yet to declare results, but its subsidiary Novelis has declared in-line quarterly results. High energy costs and chip shortages (which affected the automotive, or auto, sector) led to lower profitability. Net sales, Ebitda, and PAT for the quarter came in at $4.8 billion, $431 million, and $215 million, respectively, which was sequentially 12 per cent higher, 15 per cent lower, and 18 per cent lower, respectively. The guidance was for Ebitda of $500 per tonne or higher for the next quarter, based on assumptions of improved semiconductor availability. There is a potential upside if the Ukraine war ends. The company has a priority on debt reduction, with a leverage of 2.2x of net debt-to-ebitda.

Commodity analysts have cut LME aluminium per tonne price estimates to $2,900, or $2,850, for FY22, from the current levels of $3,300. The estimated reduction in price is due to no bans being imposed on Russian aluminium.

Aluminium has already corrected from the highs of $3,980. Novelis’ management guidance was positive in that demand is expected to grow across all regions.

Aerospace is improving in terms of order book, but auto may continue to be affected.

Analysts are maintaining ‘buy’ calls on Vedanta and Hindalco. But target prices have been reduced. Hindalco is at ~429, with one analyst doing a sum-of-the-parts valuation of ~680.

Vedanta is at ~321, with one analyst offering a target price of ~470. Both stocks have seen corrections of over 20 per cent in the past month.