Volatility in ferrous segment continues!

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1 India Equity Research Metals & Mining July 4, 217 Sector Update Emkay Your success is our success Volatility in ferrous segment continues! Refer to important disclosures at the end of this report Key observations In Ferrous space, steel CIS price remained subdued and rose marginally by 1.1% MoM to US$44/tn. On the other hand, prices of Iron Ore and China HR Sheet rallied by +17% MoM and +1% MoM, respectively due to better-than-expected demand from China. Post the cyclone, as expected, Coking Coal price remained rangebound and grew by.2% to US$15/tonne. We don t expect any significant change in Coking Coal prices at least till H1FY18. China PMI improved to 51.7 in June 17 from 51.2 in May 17. In Non-ferrous metals, Zinc, Lead and Copper rallied by 8% MoM, 9% MoM and 5% MoM, respectively to US$2754/tn, US$2274/tn and US$598/tn, whereas Aluminium declined by 1% to US$199. Labor unrest in Indonesia supported copper rally. For Indian players, subdued Coking Coal prices will reduce volatility pressure on margins. Iron Ore prices even though will remain un-capped, are likely to remain rangebound due to oversupply. Hindalco, Vedanta, and MOIL remain our top picks. Emkay view Contrary to the consensus view, Iron Ore price for both 62% and 58% grade rallied 16% and 17% MoM to US$65/tn and US$47/tn, respectively. This happened due to better-thanexpected demand from China, indicated by its June 17 PMI (improved to 51.7 from 51.2 in May 17 and 5 in June 16). However, our long-term view on Iron Ore remains bearish, primarily on the back of oversupply. Coking Coal prices, as expected, remained rangebound and stood at US$15/tn (+.2% MoM). At least till H1FY18, Coking Coal prices are expected to remain at cus$13-14/tn level. Steel CIS remained flat at US$44/tn (+1% MoM) due to subdued steel demand. Trade protection measures continued to pile up with Mr Donald Trump promising anti-dumping bill on Steel and Aluminium soon. In Non-ferrous space, except Aluminium (down 1%) all other Base Metals registered a positive growth. Labor unrest in Indonesia and snow storm in Chilean copper mines supported rally in Copper whereas Zinc is fundamentally well supported by supply deficit. In CY217, China is expected to cut c. 2-3mt Aluminium capacity, but new addition and restarting of old smelters continue to pose risk. Continuous weakness in global steel prices could pose challenges to India s exports. However, decline in coking coal price volatility should augur well for cost visibility. Nonferrous metals prices are likely to remain stable and range bound. We expect better clarity would emerge in H2FY18. Hindalco, Vedanta and Moil remain our preferred picks. Companies CMP TP Reco Coal India Hold Hindalco Buy HZL Hold JSW Steel Hold MOIL Buy NALCO 65 6 Reduce NMDC SELL SAIL Sell Vedanta Buy Tata Steel Hold Relative chart: Nifty vs CNX Metal Rs 22-1 Jul-17 US Dollar Index CNX Metal (LHS) Rel to Nifty (RHS) % Financial Snapshot (Consolidated) (Rs mn) EPS (Rs) EV/EBITDA (x) P/E (x) FY18E FY19E FY18E FY19E FY18E FY19E Coal India Hindalco HZL JSW Steel MOIL NALCO NMDC SAIL Vedanta Ltd Tata steel This report is solely produced by Emkay Global. The following person(s) are responsible for the production of the recommendation: Goutam Chakraborty goutam.chakraborty@emkayglobal.com Varun Singh, CFA varun.singh@emkayglobal.com ED: Hemant Maradia SA: D.SINHA

2 Exhibit 1: Key Economic Data Particulars Prev. Period Period Previous Value Current Value India PMI May'17 Jun' India WPI Apr'17 May' % 2.17% India CPI Apr'17 May' % 2.18% China PMI May'17 Jun' China IP Apr'17 May'17 6.5% 6.5% UK PMI May'17 Jun' Euro Zone PMI May'17 Jun' US PMI May'17 Jun' US IP Apr'17 May'17 1.1%.% Japan PMI May'17 Jun' Japan IP Apr'17 May'17 4.% -3.3% Source: Emkay Research, Bloombersg Exhibit 2: Only China and Euro Zone PMI improved...all other major economies PMI declined India PMI China PMI UK PMI Euro Zone PMI US PMI Japan PMI Previous Value Current Value Iron Ore: rallied against expectation of a decline due to better-than-expected demand from China our long-term view is still bearish expect more declines to come India: Iron Ore prices won t be capped as per cost plus formula! Trend: Ferrous metals Iron ore price (both 62% and 58% grade) rallied 16% MoM and 17% MoM to US$65/tn and US$47/tn, respectively as against expectation of a decline. This has been due to better-thanexpected demand from China, which saw its PMI improving to 51.7 in June 17 from 51.2 in May 17 and 5 in June 16. However, our long-term view on Iron Ore is still bearish, as we believe that the global oversupply and weak demand will prevail. Supply from China and Brazil, particularly from Vale s S11D mine (S11D exported 2.49mt in Q1CY17) and Anglo s Minas Rio mines is likely to keep prices fundamentally under pressure. In India, the Union Mines Ministry rejected a Steel Ministry proposal to regulate Iron Ore prices. This should augur well for mining companies like NMDC while steel manufacturing companies with no backward integration should remain vulnerable to volatility in Iron Ore prices with an upward bias. As expected, Coking Coal prices remained rangebound and stood at US$15/tn (+.2% MoM). At least till H1FY18, Coking Coal prices are expected to remain at c.us$13-14/tn levels. In India, the Steel Ministry is aiming to reduce import of Coking Coal by c.25%. This is likely to augur well for domestic steel manufacturers and Coal India. Steel CIS remained flat at US$44/tn (+1% MoM) due to subdued steel demand. Trade protection measures continued to tick up with Mr Trump promising anti-dumping bill on Steel and Aluminium soon. ED: Hemant Maradia SA: D.SINHA July 4, 217 2

3 Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec Jan Feb Mar Apr May Jun Jul Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec Jan Feb Mar Apr May Jun Jul Exhibit 3: Monthly price movement US$/tonne Price (US$) as on 1-1-Jul-17 Change (%) Iron Ore 62% Iron Ore 58% Hard Coking coal (Fob East Coast) Steel CIS Black Sea Export (FOB) China HR Sheet Exhibit 4: Steel Prices CIS (US$/tn) Exhibit 5: Iron Ore 62% price performance (US$/tn) Exhibit 6: Coking Coal price performance (US$/tn) Coking Coal: Post cyclone, price remained flat at 15$/tn Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec Jan Feb Mar Apr May Jun Jul Exhibit 7: CIS price rose by 1% to US$44/tn Exhibit 8: China HRC also rose by 1% to US$583/tn Steel CIS Export (US$/tonne) China HR Sheet (US$/tonne) ED: Hemant Maradia SA: D.SINHA July 4, 217 3

4 Exhibit 9: Western Europe HRC Prices fell by 6% to US$553/tn Exhibit 1: US steel import prices fell by 2% to US$55/tn North Europe D HRC Price (US$/tonne) US Steel Import HR Coil (US$/short ton) Exhibit 11: Iron ore prices (US$/tn) fell by more than 16% Exhibit 12: Premium Hard Coking Coal remained flat % 58% Premium Hard Coking Coal Export (FOB East Coast) (USD/mt) Exhibit 13: China Exports of Steel to India doubled tonnes Exhibit 14: Debar Export Price (US$/tn) remained flat at US$ China Exports of Steel To India - Quantity (Metric Tonne) Turkey Import Heavy Melt Scrap Steel Turkish Export Debar FOB (RHS) Exhibit 15: China iron ore inventory at ports rose by 4% to 132mt Mn Tonnes Exhibit 16: Baltic Dry Index rose by 6% to 91(US$/tn) China Weekly Iron Ore Inventory Baltic Dry Index ED: Hemant Maradia SA: D.SINHA July 4, 217 4

5 Trend: Non-ferrous metals Zinc, Lead and Copper rallied 8% MoM, 9% MoM and 5% MoM, respectively to US$2754/tn, US$2274/tn and US$598/tn whereas Aluminium declined by 1% to US$199. Silver and Gold prices fell by 4% MoM and 2% MoM, respectively. Labor unrest in Indonesia and snow storm in Chilean copper mines led to the rally in copper! c. 2-3mt capacity cut in Aluminium expected in CY217 supply cut unlikely Zinc prices are expected to stay strong, as its demand will comfortably exceed supply in CY217. Zinc deficit is forecast to be at 226, tonne. Rally in copper prices was due to labor problems in Indonesia, as Freeport fired c.3, workers following a strike that lasted for more than 5 weeks. The workers were protesting against layoffs and furloughs. Also, Chilean copper mines halted operations, as the country was hit by snow storms. This month, there has been talks in the media that the Chinese government is likely to surpass Aluminium capacity cut targets initial estimates. China s current illegal Aluminium production capacity is c.6mt and c.2-3mt is expected to be cut in the current year. If successful, China s total aluminium capacity will drop to 42mt. However, we believe that any pick-up in prices will lead to re-starting of old smelters. Hence, any significant supply/production cut is unlikely. Exhibit 17: Fortnightly price movement (US$/tn) Commodity Price (US$) Average Price 1-1- (%) FY17 FY18 (as on date) Copper 5,637 5, ,148 5,665 Aluminium 1,93 1,99 (1.1) 1,687 1,91 Zinc 2,545 2, ,363 2,599 Lead 2,84 2, , 2,168 Silver (moz) (3.8) Gold (moz) 1,266 1,242 (1.9) Exhibit 18: Zinc LME and inventory US$ 3,2 3, 2,8 2,6 2,4 2,2 2, 1,8 1,6 1,4 ' tn Exhibit 19: Lead LME and inventory US$ 2,6 2,4 2,2 2, 1,8 1,6 1,4 ' tn 2 15 Zinc-LME Inventory (R.H.S) Zinc-LME Price (L.H.S) Lead-LME Inventory (R.H.S) Lead-LME Price (L.H.S) Exhibit 2: Copper LME and inventory Exhibit 21: Aluminium LME and inventory US$ 7, 6, 5, 4, ' tn US$ 2,5 2, 1,5 1, 5 ' tn 2,6 2, 1,6 1, 6 Copper-LME Inventory (R.H.S) Copper LME Price (L.H.S) Al-LME Inventory (R.H.S) Al-LME Price (L.H.S) ED: Hemant Maradia SA: D.SINHA July 4, 217 5

6 May/16 Exhibit 22: Cu LME 3M moves into Contango (US$/tn) Exhibit 23: Al LME 3M Spread also in Contango (US$/tn) Copper LME 3M Spread Exhibit 24: Zn LME 3M Spread signals supply contraction (US$/tn) Aluminium LME 3M Spread Exhibit 25: Pb LME 3M Spread signals price increment (US$/tn) Zinc LME 3M Spread Exhibit 26: Both US Midwest and MJP fell 14% and 4%, respectively Exhibit 27: Gold outperforms Silver Lead LME 3M Spread US Midwest Alum. Prem. MB Japan Alum. Ingot Prem. Gold Spot (US$/oz) Silver Spot (US$/oz) ED: Hemant Maradia SA: D.SINHA July 4, 217 6

7 Key company updates Exhibit 28: Tata Steel reported less-than-expected offtake at 2.75mt for Q1FY18 in mt Q1FY18 Q4FY17 Q1FY17 YoY (%) QoQ (%) Hot Metal % -3% Crude Steel % -8% Saleable Steel % -6% Sales % -14% Exhibit 29: Coal offtake came in 2.5% lower than expected at 45.67mt for Q1FY18 Particular Jun'18 Jun'17 May'18 YoY (%) MoM (%) YTDFY18 YTDFY17 YoY (%) Production ECL % -11.3% % BCCL %.9% % CCL % -2.7% % NCL % -1.% % WCL % -4.7% % SECL % -2.3% % MCL % -1.6% % NEC % -36.% % CIL % -2.6% % Offtake ECL % -2.8% % BCCL % -14.5% % CCL % -6.9% % NCL % 2.2% % WCL % -.3% % SECL %.% % MCL % -.3% % NEC % 14.3% % CIL % -1.6% % Moil MOIL has announced 4.6% average increase in the price of various grades of Manganese Ore. Also, price of Electrolytic Mangense Dioxide have been increased by 5%. This augurs well for the company s topline. We believe that Manganese Ore prices are likely to remain strong. In addition, MOIL has tightened its credit policy by reducing number of days of free credit facility from 9 days to 6 days and has reduced cash discount from 1.5% to 1% for LC/Bank Guarantee and other advance payments. This should augur well for cash flows. We continue to maintain our positive stance on MOIL with a target price of Rs425. ED: Hemant Maradia SA: D.SINHA July 4, 217 7

8 Exhibit 3: Valuation table for Emkay Metals & Mining universe Company M. Cap CMP (Rs) P/E (x) P/B (x) EV/EBITDA (x) (Rs bn) Chg (%) YoY Chg (%) FY18E FY19E FY18E FY19E FY18E FY19E Coal India 1, (7.) (16.8) Hindalco (4.9) HZL 1, JSW Steel MOIL (3.4) NALCO (4.1) NMDC (2.2) SAIL Vedanta Ltd Tata Steel Stock Recommendations From our coverage universe, we prefer Hindalco (BUY, Target price Rs24), MOIL (BUY, Target price Rs425) and Vedanta (Target price Rs294). ED: Hemant Maradia SA: D.SINHA July 4, 217 8

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ED: Hemant Maradia SA: D.SINHA July 4, 217 9