Metals Winter is coming; positive momentum to continue

Transcription

1 INSTITUTIONAL EQUITY RESEARCH Metals Winter is coming; positive momentum to continue INDIA METALS Sector Update 12 September 2017 The metals sector has continued with last year s dream run in 2017, driven by capacity curbs led by environmental crackdown and strong China demand. This is in line with the forecast in our April 2017 note. Actual capacity closures have driven the steel sector, while the aluminium sector has rallied in anticipation of expected winter curbs and closure of illegal capacities (recently announced). The steel sector should gain from industry consolidation both in India and Europe. Zinc continues to benefit from concentrate shortages, in addition to supply disruptions caused by various environmental inspections in China. We see positive metals trade continuing because in the run up to its presidential election, China will maintain its focus on supply side reforms; in addition, demand is strong. However, a shift in policy focus after China s presidential elections is a key risk. Steel: Capacity shutdowns driving spreads; industry consolidation is the next trigger Steel spreads have expanded sharply, driven by strong demand and +240mn tonnes of capacity closures over CY16 17 which helped China s steel capacity utilisations to rise to 85%+ in H1CY17 from about 66% in CY15. We expect the recent expansion in spreads to sustain through the rest of 2017, as the industry benefits from reduced supply once winter curbs begin. Consolidation is an added trigger for steel producers, ex China; the process has already started in Europe and is likely to begin in India over the next couple of quarters. Consolidation is beneficial for Tata Steel and JSW Steel. Aluminium: Price surge in anticipation of supply squeeze and strong ROW deficit Aluminium prices have rallied sharply in anticipation of a supply squeeze following various capacity closures announced in Xinjiang, Shandong, and Inner Mongolia, in addition to the winter curbs announced in 28 cities in China. Strong consumption growth has been supportive, but production and export trends are still not reflecting market tightness. Increased ROW (rest of the world) deficit has offset higher Chinese exports and supported buoyancy in prices. Winter curbs: Finally coming In a recent release, China announced that it targets a 15% reduction in PM 2.5 emissions this winter with the help of winter curbs. A read through across its detailed action plan shows that it is well prepared for implementation. Strict timelines for various tasks along with intent to penalise defaulters will lead to a supply squeeze in aluminium and steel. China s moves are likely to cause some production disruptions in other base metals as well. Strong Chinese demand surprises the street H1CY17 saw steel / aluminium consumption grow by 9.8% / 10.2%. In our April 2017 note, we had pointed out that the infrastructure stimulus announced last year has significantly helped consumption growth. This growth was supported by stable demand from the realestate sector, which the street wasn t very sure about hence the surprise. We expect this positive momentum to continue in China, given upcoming presidential elections and the country s focus on maintaining strong demand. However, growth rates could moderate due to H2CY16 s high base. Strong consumption has also led to a 29% drop in China s steel exports YTD CY17, while its aluminium exports increased 6%. Outlook Stronger seasonality (highlighted in our April 2017 note) and winter curbs will keep metals stocks in focus; a stronger pricing environment will be the profit driver. Tata Steel continues to be our top pick. We have Buy ratings on Nalco, Vedanta and Hindalco, Neutral rating on JSW Steel and Hindustan Zinc, and Sell on SAIL. Companies Hindalco Reco BUY CMP, Rs 251 Target Price, Rs 295 Hindustan Zinc Reco NEUTRAL CMP, Rs 313 Target Price, Rs 330 JSW Steel Reco NEUTRAL CMP, Rs 269 Target Price, Rs 275 Nalco Reco BUY CMP, Rs 82 Target Price, Rs 100 SAIL Reco SELL CMP, Rs 63 Target Price, Rs 44 Tata Steel Reco BUY CMP, Rs 683 Target Price, Rs 870 Vedanta Reco BUY CMP, Rs 330 Target Price, Rs 380 Dhawal Doshi ( ) ddoshi@phillipcapital.in Page 1 PHILLIPCAPITAL INDIA RESEARCH

2 Table of Contents Steel: Capacity shutdown driving spreads; industry consolidation is the next trigger 3 Aluminium: Price surge in anticipation of supply squeeze and strong ROW deficit 8 Winter curbs: Finally here 12 Strong Chinese demand surprises the street 14 Companies Hindalco 19 Hindustan Zinc 21 JSW Steel 23 Nalco 25 SAIL 27 Tata Steel 29 Vedanta 31 Page 2 PHILLIPCAPITAL INDIA RESEARCH

3 Steel: Capacity shutdown driving spreads; industry consolidation is the next trigger Steel is the one of the early few commodities that has seen the positive impact of China s supply side reforms. Not only have utilisations of Chinese steel producers improved, but the profitability of global steel producers has also gone up. China has shut down more than 240mn tonnes of steel capacity (including 120mn tonnes of low quality induction furnaces) since CY16, far higher than its initial target of mn tonnes (excluding low quality induction furnaces) set in CY16. Capacity closures have helped China s overall steel capacity touch a decade s high in terms of utilisations (which were at a low of 66% in CY15) despite only a 6% jump in CY17 production (annualised) from CY15. With utilisations above 85%, and strong consumption growth (discussed in detail in sections below), steel spreads should stay elevated. Lower Chinese exports and declining steel inventory, as seen from the charts below, will support higher spreads. Upcoming winter curbs will squeeze supply further, which is beneficial for pricing and spreads. China has shut down more than 240mn tonnes of steel capacity since CY16 With utilisations above 85%, and strong consumption growth steel spreads should stay elevated. China: Steel production and capacity utilisations 900 Production Utilisation (rhs) 100% % mn tonnes % 70% 60% 500 CY10 CY11 CY12 CY13 CY14 CY15 CY16 CY17 50% Source: Bloomberg, PhillipCapital India Research. CY17 is annualised for Jan July 2017 The data in the chart above assumes the entire 120mn tonnes induction furnace capacity closed as legitimate capacity. Out of this, any unreported capacity or production could lead to discrepancies in the utilisation data mentioned above. China steel export growth 120% 100% 80% 60% 40% 20% 0% 20% 40% 60% Jan 11 May 11 Sep 11 Jan 12 May 12 Sep 12 Jan 13 May 13 Sep 13 Jan 14 May 14 Sep 14 Jan 15 May 15 Sep 15 Jan 16 May 16 Sep 16 Jan 17 May 17 Source: Bloomberg, PhillipCapital India Research Page 3 PHILLIPCAPITAL INDIA RESEARCH

4 Global steel inventory, excluding EU mn tonnes Source: Bloomberg, PhillipCapital India Research Capacity closures and strong demand drives spreads northwards The sharp increase in utilisations driven by both capacity closures and strong demand has seen gross steel spreads expand to almost decade highs. Spreads jumped higher majorly after (1) China shut its low quality induction furnaces, and (2) a sharp rise in demand from June More importantly, the recent spread expansion is at steel price levels that are lower than they were in the initial part of the decade. The recent spread expansion is at steel price levels that are lower than they were in the initial part of the decade The spread expansion seen in August 2017, if sustained, will lead to another round of earnings upgrades and remains an upside risk to our call. Given strong demand momentum and upcoming winter curbs to control air pollution (recently reiterated by the government), we believe that there is a strong possibility of this happening. However, it may not be linear, and could see some volatility. Gross steel spreads (USD / tonne) 750 China export HRC price Gross Spreads (RHS) Jan 12 Apr 12 Jul 12 Oct 12 Jan 13 Apr 13 Jul 13 Oct 13 Jan 14 Apr 14 Jul 14 Oct 14 Jan 15 Apr 15 Jul 15 Oct 15 Jan 16 Apr 16 Jul 16 Oct 16 Jan 17 Apr 17 Jul Source: Bloomberg, PhillipCapital India Research Industry consolidation: The next big trigger can see earnings momentum Globally, an expansion in spreads has driven steel players profits. Industry consolidation is an added trigger that is likely to help players in India and Europe. Tata Steel should be the key beneficiary of consolidation because it benefits in Europe and India. Expected consolidation in India will help JSW Steel and SAIL. Expected consolidation in India will help JSW Steel and Tata Steel Page 4 PHILLIPCAPITAL INDIA RESEARCH

5 Europe: Consolidation process has already started Flat segment accounts for ~50% of the 195mn tonne European steel market. Arcelor Mittal s recent acquisition of the Ilva steel plant gives it around 40% market share in this segment. With the proposed JV of Tata Steel and ThyssenKrupp s European steel operations, the combined entity will account for about 25% market share in the flat segment. After this transaction, the Tata ThyssenKrupp JV and Arcelor will account for 65% of the European flat steel market. Tata Thyssenkrupp JV and Arcelor will account for ~65% of the European flat steel market Europe: Steel market structure Longs Flats Others, 35% Arcelor + Ilva, 40% Proposed Tata Thyssen JV, 25% Source: Industry, PhillipCapital India Research Given the consolidated market structure, we expect pricing anomalies in different steel markets in Europe to correct over the next few months. Rising imports into Europe since CY14 saw South Europe s price discount to North Europe increasing (see chart below). Steel price discount: South Europe vs. North Europe 20% 15% 10% 5% 0% 5% 10% 15% Jan 10 Jan 11 Aug 11 Nov 11 Jan 12 Apr 12 Jul 12 Sep 12 Dec 12 Feb 13 May 13 Aug 13 Oct 13 Jan 14 Mar 14 Jun 14 Sep 14 Nov 14 Feb 15 Apr 15 Jul 15 Oct 15 Dec 15 Mar 16 Jun 16 Aug 16 Nov 16 Jan 17 Apr 17 Jul 17 Source: Bloomberg, PhillipCapital India Research Given the consolidated industry structure, we expect discounts to narrow once antidumping duty investigations conclude on HRC imports from Brazil, Iran, Russia, Ukraine, and Serbia. Media reports indicate duties of 5.3% to 33% on imports from Brazil, Iran, Russia, and Ukraine, with Serbia and Iran likely to be excluded from the levies. The final outcome should come in by October However, if a price threshold is put in place (one above which duties would not apply suggested by some media reports) the duty will become ineffective in the current context. We expect discounts to narrow once anti dumping duty investigations conclude on HRC imports from Brazil, Iran, Russia, Ukraine, and Serbia Page 5 PHILLIPCAPITAL INDIA RESEARCH

6 Anti dumping duty on China HRC and anticipated duties on other countries have already had impact on pricing in Europe. While the European steel price premium has moved up over China and CIS prices (see chart below), we believe there is further room for further expansion, once anti dumping duties are levied on imports from other countries. Europe HRC price (three month moving average) premium 50% 40% Europe CIS Europe China 30% 20% 10% 0% 10% Jul 06 Jan 07 Jul 07 Jan 08 Jul 08 Jan 09 Jul 09 Jan 10 Jul 10 Jan 11 Jul 11 Jan 12 Jul 12 Jan 13 Jul 13 Jan 14 Jul 14 Jan 15 Jul 15 Jan 16 Jul 16 Jan 17 Jul 17 Source: Bloomberg, PhillipCapital India Research Despite anti dumping duties levied on imports from China, overall imports into the EU have not slowed down because the EU price premium has increased. As seen from the chart below, imports continue to rise and growth in flat steel imports outpaces total import growth. This trend can reverse after the imposition of anti dumping duties on other countries. This is positive for European steel producers because volumes will positively impact profitability, even if the price premium does not improve from current levels. EU steel imports 000 tonnes Flat Steel imports % yoy (rhs) Total Steel import growth (rhs) 100% 80% 60% 40% 20% 0% 20% 40% 60% Jan 12 Apr 12 Jul 12 Oct 12 Jan 13 Apr 13 Jul 13 Oct 13 Jan 14 Apr 14 Jul 14 Oct 14 Jan 15 Apr 15 Jul 15 Oct 15 Jan 16 Apr 16 Jul 16 Oct 16 Jan 17 Apr 17 Source: Bloomberg, PhillipCapital India Research India: Consolidation yet to kick in, but process benefiting other producers Unlike Europe, the consolidation process is yet to begin in India. Five steel companies have been admitted by NCLT (National Company Law Tribunal) under the Insolvency & Bankruptcy Code (IBC). These companies cumulatively have a capacity of ~21mn tonnes with 75 80% of the capacity in the flats segment. Various global and Indian steel producers have evinced interest in acquiring these companies. In the event of JSW Steel or Tata Steel acquiring any of these companies in the flat segment, they will Five steel companies have been admitted by NCLT under the Insolvency & Bankruptcy Code Page 6 PHILLIPCAPITAL INDIA RESEARCH

7 be able to consolidate their stronghold in the flat segment further, giving them an edge in domestic pricing. While the process is likely to take a couple of quarters to conclude, production disruptions at these companies (under IBC) benefit other players with better pricing and volumes. Channel checks indicate the companies under IBC are operating at much lower utilisations, given their difficulty in raising funds. This helps the balance companies to easily push through higher prices, given robust global steel prices. Production disruptions at companies under IBC benefit other players with better pricing and volumes If JSW Steel and Tata Steel manage to acquire any of the five companies under IBC, we believe it would be a significant positive for them. The acquisitions will give them access to already operating companies, thereby enabling volume growth, especially as both companies are operating close to their rated capacity. The possible acquisitions are likely to come with some haircut to existing debt, hence may not be significantly leveraged. We expect bids to be a trade off between the cost of setting up new capacities and acquiring already operational ones. Bhushan Steel, Bhushan Power & Steel, and Monnet Ispat are likely to be a strategic fit for JSW Steel based on regional diversification (JSW will get a foothold in eastern and central India). Similarly, for Tata Steel, Essar Steel (west market exposure) and Electrosteel (additional long capacity and operates at close to existing facility) are likely to be strategic fits. Page 7 PHILLIPCAPITAL INDIA RESEARCH

8 Aluminium: Price surge in anticipation of supply squeeze and strong ROW deficit Aluminium prices have seen a sharp 24% rally since the start of CY17. Major drivers of this rise are strong consumption growth in China and expectations of supply squeeze. While the impact of supply cuts is yet to reflect in numbers, announcements pertaining to supply curbs have driven prices higher. While strong Chinese consumption (covered in the section below) has been a big factor and a well known fact, increasing rest of world (ROW) deficit has also been an important factor that has offset increasing Chinese supply and exports in H1CY17. Announcements pertaining to supply curbs have driven prices higher China: Announcements driving prices; numbers yet to reflect the squeeze China has had the most important role to play in the aluminium price rally in CY17. Increasing confidence about China's supply side reforms with incremental announcements led to the price rally gaining momentum. At the start of CY17, the industry was sceptical about the implementation of China s reforms. However, with strong implementation in steel (one of the few early commodities where China announced supply side reforms) and increasing announcements about closures / restraints for aluminium, prices continued with their dream run. China announced winter curbs (from November to March), but their enforcement was questioned by many industry participants. Nation wide audits of aluminium smelters followed, to check various approvals, and compliance with emission norms. The audit was followed by various curbs/closures on illegal aluminium capacity, especially in Inner Mongolia, Shandong, and Xinjiang. Here are the series of announcements about capacity closures that impacted aluminium prices positively: Media reports suggested 1.25mn tonnes of total 3.71mn tonnes of capacity were at risk in Inner Mongolia. Xinjiang province halted construction of 2mn tonnes of smelters. 3.21mn tonnes of aluminium capacity closed in Shandong, including 2.68mn tonnes of capacity by China Hongqiao the world's largest aluminium producer. Recently, five smelters from Henan province, with a cumulative capacity of 0.21mn tonnes, agreed to transfer their capacity to a company called Tongliao in Inner Mongolia. This will not have a major impact on overall capacity, but will see some short term production disruptions. Industry estimates about overall capacity curtailments differ, but major producers expect total closures to be >5mn tonnes, which can squeeze supply sharply in the near future. The table below highlights the expectations of a few aluminium majors about China s capacity curtailments. Major producers expect total closures to be >5mn tonnes, which can squeeze supply sharply in the near future China aluminium capacity curbs Alcoa Rusal Illegal capacity closure Winter curbs impact * Total impact Source: Company, PhillipCapital India Research, * Annualised Note: Of the 5.1mn tonnes illegal capacity declared as per Rusal, 4mn tonnes have been shut between June and August It expects more capacity to be declared illegal, hence faces closure risk Capacity curtailment expectations led to a sharp surge in aluminium prices. However, unlike steel, these measures have not yet translated into any physical market tightness for aluminium. Against falling steel inventories, aluminium inventory at Shanghai actually increased in anticipation of lower supply towards the end of the year. However, the increase in SHFE inventory was offset by falling LME inventory recently. Net aluminium exports continued to grow, unlike declining steel exports. Page 8 PHILLIPCAPITAL INDIA RESEARCH

9 Production growth continued to be strong, but in line with consumption, and hence not much of a supply threat. China: Aluminium production growth vs. consumption growth 50% 40% 30% 20% 10% 0% 10% 20% Aluminium cons growth Aluminium prod growth 30% Jan 13 Apr 13 Jul 13 Oct 13 Jan 14 Apr 14 Jul 14 Oct 14 Jan 15 Apr 15 Jul 15 Oct 15 Jan 16 Apr 16 Jul 16 Oct 16 Jan 17 Apr 17 Source: Bloomberg, PhillipCapital India Research Aluminium inventories (mn tonnes) 6 LME SHFE (RHS) Source: Bloomberg, PhillipCapital India Research Recent trends in regional aluminium premiums also indicate no physical market tightness. Japanese premiums have fallen to around US$ 85 currently from US$ 125 at the start of FY18. This sharp drop reflects easy availability of the material in the market. The trend has been similar in developed markets, too, with premiums in the US declining sharply over the past few months. Regional aluminium premiums indicate no physical market tightness Page 9 PHILLIPCAPITAL INDIA RESEARCH

10 Regional aluminium premiums Japan US (rhs) $ / tonne cents / pound Jan 17 Feb 17 Mar 17 Apr 17 May 17 Jun 17 Jul 17 Aug Source: Bloomberg, PhillipCapital India Research We expect upcoming winter curbs and recent capacity closures to eventually lead to physical market tightness in aluminium, thereby driving prices. New aluminium capacities, which are expected to commission over , will eventually balance the market. However, this is assuming that the capacities are legal and are allowed to commission. According to Rusal, ~6.3mn tonnes of projects under construction have been suspended. Higher ROW deficit driving higher Chinese aluminium exports and supporting prices China s net aluminium exports have grown by 7% yoy from January to July 2017, with a chunk of the growth in recent months, as seen from the chart below. However, higher aluminium exports have not impacted aluminium prices, given a sharp ROW deficit in CY17. This has supported aluminium prices despite higher exports from China. Higher aluminium exports have not impacted aluminium prices, given a sharp ROW deficit in CY17 China aluminium export growth 700 China Aluminium exports % yoy 70% '000 tonnes % 30% 10% 10% 30% 50% Source: Bloomberg, PhillipCapital India Research Growing demand from developed nations along with supply discipline has been the driving force for the ROW deficit since the past four years. While aluminium has been in deficit (ex China) for the past few years, H1CY17 has seen a very sharp increase. Strong consumption growth from countries such as USA and Japan has seen ROW aluminium consumption grow by 3.3% in H1CY17. This compares to only 1.4% jump in production driving the sharp increase in deficit. Page 10 PHILLIPCAPITAL INDIA RESEARCH

11 ROW aluminium surplus / deficit mn tonnes CY13 CY14 CY15 CY16 H1CY17 Source: Bloomberg, PhillipCapital India Research Capacity curbs in China coupled with strong aluminium prices are expected to keep aluminium prices firm ahead. To incorporate this, we increase our aluminium price assumptions for FY18/19 to US$ 1,950 from US$ 1,875/1,900 earlier. Page 11 PHILLIPCAPITAL INDIA RESEARCH

12 Winter curbs: Finally coming Proposed winter curbs in China have had mixed reactions from the industry. While the prices started reflecting the anticipated supply squeeze, many industry participants believed that the rules would be diluted and might not have a major impact. However, the government s intent in implementing the curbs seems quite firm. With winter approaching, China s Ministry of Environment and Protection (MEP) came out with an action plan in August detailing measures that it would take to ensure the implementation. Its action plan highlights China s preparedness to enforce curbs, in our opinion. The plan details measures required for each of the 28 cities individually, with strict timelines for various actions. The curbs span across various industries such as coal, steel, non ferrous metals, fireworks, ceramics, chemicals, pharma, cement, glass, and petrochemicals. Many industry participants believed that the rules would be diluted and might not have a major impact Its action plan highlights China s preparedness to enforce curbs The action plan clearly highlights the production restrictions for steel and aluminium in 28 cities. Supply squeeze for these metals will more than offset the demand slackness (discussed in the next section), if any. Additionally, implementation of the action plan will see costs escalate for producers operating in these 28 cities. This will support higher commodity prices during this period and boost profitability for global producers. Some of the key highlights of the action plan that would impact the metals sector are: 1. To complete the construction of the district and country level monitoring network by the end of October. The monitoring department will upload data from the network on the 5 th of every month. 2. Strengthen the monitoring of data quality management. Any data monitoring fraud will be investigated seriously and relevant personnel will be held responsible. 3. Accelerate the process of disposing the scattered pollution sources by clearing raw materials and finished products. 4. Measures to prevent pollution from coal: o Prevent scattered coal burns in different regions o Strengthen supervision and management of coal quality. Crack down on o poor quality coal sales and ensure national and regional coal standards. Comprehensive investigation of coal fired boilers upgrading the boiler quality. Coal fired boilers that do not meet discharge requirements to be stopped by November Complete the task of resolving excess capacity in coal and steel ahead of schedule. 6. Strengthen restructuring of unorganised emissions: All easy to produce dust powder and granular materials such as coal ash, sand, gypsum, and cement, should be sealed, stored, and transported with a closed belt. Other comprehensive measures to be taken for dust suppression. Cars, trains, conveyors that are used for transportation should have closed covers, etc. 7. Promote full coverage of automatic monitoring of flue gas emissions by the end of October Exhaust port height of more than 45 metres to be built from the elevated source for various industries like steel, coke ovens, cement, and glass. 8. Steel sector: Classification of iron and steel enterprises based on levels of pollution emission by September 2017; limit peak production of these enterprises based on emission standards. Limit steel production to 50% of capacity (steel/blast furnace) in certain regions. 9. Alumina/Aluminium: To curb production by 30% for electrolytic cells. If special emission norms are not achieved, production will be discontinued until they are. Page 12 PHILLIPCAPITAL INDIA RESEARCH

13 10. Accelerate the issuance of emission permits for key industries by October Key industries include power, steel, cement, copper/zinc/lead smelting, electrolytic aluminium, API manufacturing, and pesticides. 11. Thoroughly investigate and deal with excessive discharge of goods vehicles / high emission construction equipment machines. 12. To develop unified warning / grading standards and implement an alert response mechanism. Colour scheme to be devised based on emission reduction after an emergency situation arises. Blue/yellow/orange/red warnings once emission reduction achieved is 5/10/15/20% from the emergency situation. Production will be ordered to stop once an emergency situation arises. This will be monitored daily. Page 13 PHILLIPCAPITAL INDIA RESEARCH

14 Strong Chinese demand surprises the street Strong Chinese demand has played a major role in the recent commodity price rally. It supported various supply side reforms in China, which had triggered the rally in commodities in CY16. H1CY17 saw China's steel/aluminium consumption grow by 9.8%/10.2%. China s commodity consumption surprised the street, especially as it was expecting a fall in demand after restrictions on the real estate sector due to the sharp rise in prices in the early part of CY17. China: Steel and aluminium consumption growth 35% Steel Aluminium 30% 25% 20% 15% 10% 5% 0% 5% 10% 15% Jan 15 May 15 Sep 15 Jan 16 May 16 Sep 16 Jan 17 May 17 Source: Bloomberg, PhillipCapital India Research We expect momentum to continue through the year; the quantum of growth can moderate because of base effect, as seen in the chart above. However, upcoming winter curbs will restrict overall supply and cushion a possibility of lower growth. A change in the policy stance after the Chinese presidential elections towards the end of the year is a big risk. METALS SECTOR UPDATE Infrastructure spending spurred growth... While we were positive about overall consumption, the extent of growth has surprised us as well. Infrastructure stimulus announced last year continued to have a positive impact on overall consumption. FAI in railways has grown 3% till July 2017; FAI in highways has surged with 24% growth until July The charts below highlight the growth in FAI under railways and highways segments, which has been the major driver for consumption of steel and aluminium. Infrastructure stimulus announced last year continued to have a positive impact on overall consumption China FAI growth in railways and highways 40% Railways Highways 30% 20% 10% 0% 10% 20% Feb 14 Jun 14 Oct 14 Feb 15 Jun 15 Oct 15 Feb 16 Jun 16 Oct 16 Feb 17 Jun 17 Source: Bloomberg, PhillipCapital India Research Page 14 PHILLIPCAPITAL INDIA RESEARCH

15 Real estate stable and not a spoiler, as anticipated by the street Real estate segment continued with stable growth; considering expectations of a slowdown after government imposed restrictions to curb a sharp rise in real estate prices, it has not disappointed. Floor space under construction for both residential and commercial segments has grown by 3% until July China floor space under construction 60% 50% 40% 30% 20% 10% 0% Commercial Residential Stayed positive against consensus estimate of declines 10% Feb 07 Jul 07 Dec 07 May 08 Oct 08 Mar 09 Aug 09 Jan 10 Jun 10 Nov 10 Apr 11 Sep 11 Feb 12 Jul 12 Dec 12 May 13 Oct 13 Mar 14 Aug 14 Jan 15 Jun 15 Nov 15 Apr 16 Sep 16 Feb 17 Jul 17 Source: Bloomberg, PhillipCapital India Research As mentioned in our April 2017 note, we expected construction momentum to continue despite a price surge in Tier 1 cities. As seen from the chart below, the price surge in Tier 1 cities softened while it was stable in Tier 2 and 3 cities, thereby supporting demand. China real estate price growth Feb 07 Jul 07 Dec 07 May cities first tier second tier third tier Oct 08 Mar 09 Aug 09 Jan 10 Jun 10 Nov 10 Apr 11 Sep 11 Feb 12 Jul 12 Dec 12 May 13 Oct 13 Mar 14 Aug 14 Jan 15 Jun 15 Nov 15 Apr 16 Sep 16 Feb 17 Jul 17 Source: Bloomberg, PhillipCapital India Research Other segments also contributed positively Other segments added to positive growth momentum from infrastructure and real estate. Commercial vehicle sales and machinery segments were major contributors with positive growth. Passenger vehicles didn t contribute much but were not a drag. Consumer appliances, although small contributors, saw positive growth. Page 15 PHILLIPCAPITAL INDIA RESEARCH

16 China s commercial vehicle growth 60% 50% 40% 30% 20% 10% 0% 10% 20% 30% 40% 50% Jan 11 May 11 Sep 11 Jan 12 May 12 Sep 12 Jan 13 May 13 Sep 13 Jan 14 May 14 Sep 14 Jan 15 May 15 Sep 15 Jan 16 May 16 Sep 16 Jan 17 May 17 Source: Bloomberg, PhillipCapital India Research China s passenger vehicle growth 60% 50% 40% 30% 20% 10% 0% 10% 20% 30% Jan 11 May 11 Sep 11 Jan 12 May 12 Sep 12 Jan 13 May 13 Sep 13 Jan 14 May 14 Sep 14 Jan 15 May 15 Sep 15 Jan 16 May 16 Sep 16 Jan 17 May 17 Source: Bloomberg, PhillipCapital India Research China s machinery volume growth 60% 50% 40% 30% 20% 10% 0% 10% 20% 30% 40% Feb 11 Jun 11 Oct 11 Feb 12 Jun 12 Oct 12 Feb 13 Jun 13 Oct 13 Feb 14 Jun 14 Oct 14 Feb 15 Jun 15 Oct 15 Feb 16 Jun 16 Oct 16 Feb 17 Jun 17 Source: Bloomberg, PhillipCapital India Research Page 16 PHILLIPCAPITAL INDIA RESEARCH

17 China s consumer appliances growth 80% Air Conditioners Washing Machines Refrigerators 60% 40% 20% 0% 20% 40% 60% Feb 10 Jun 10 Oct 10 Feb 11 Jun 11 Oct 11 Feb 12 Jun 12 Oct 12 Feb 13 Jun 13 Oct 13 Feb 14 Jun 14 Oct 14 Feb 15 Jun 15 Oct 15 Feb 16 Jun 16 Oct 16 Feb 17 Jun 17 Source: Bloomberg, PhillipCapital India Research Page 17 PHILLIPCAPITAL INDIA RESEARCH

18 Companies Section Page 18 PHILLIPCAPITAL INDIA RESEARCH

19 INSTITUTIONAL EQUITY RESEARCH Hindalco (HNDL IN) Driver aluminium price; hedging to limit FY18 upgrades INDIA METALS Company Update Strong pricing outlook Expected supply squeeze in China and strong global demand will drive aluminium prices ahead. We upgrade our aluminium price assumption for FY18/19 to US$ 1,950 from US$ 1,875/1,900 earlier. However, we do not expect Hindalco to gain materially in FY18 from the sharp rally in aluminium prices, given hedges at lower prices for 77% of its FY18 volumes. Hedges: Limits near term gains Hedges for 77% of FY18 estimated aluminium sales will limit its earnings upgrade potential. The company has taken hedges for 0.98mn tonnes of aluminium at US$ 1,796 while our current aluminium price assumption for peers is US$ 1,950. However, this will not impact Hindalco s profitability for FY19. USD/INR hedges for US$ 1,375mn at 72, and benefit of higher aluminium prices on the unhedged portion, will offset negative impact in FY18. Inorganic acquisitions: next growth engine Media reports indicate Novelis is evaluating bids to acquire Constellium and Aleris. These acquisitions will help Novelis consolidate its already strong position in developed markets, in addition to giving it exposure to segments such as aerospace. While this is a positive operationally, deal valuations will determine the direction for Hindalco. Deleveraging focus continues While Hindalco is looking at inorganic growth opportunities for Novelis, its deleveraging focus in India continues. It has prepaid Rs 64.3bn since September 2016 and plans to pre pay another Rs 23bn in Q2FY18. Strong profitability and focus on low ticket capex projects would help with deleveraging. Valuations We marginally increase our estimates to factor in higher aluminium prices, partly offset by lower exchange rate assumptions. We have raised our FY19 operating profit / net profit estimates by 2% / 5%. At CMP, the stock trades at an FY19 P/E of 13.5x and EV/EBIDTA of 6.2x. We reiterate our Buy rating with a revised target of Rs 295 (from Rs 280 earlier) valuing Hindalco at 6.5x FY19 EBIDTA. Valuation summary Y/E Mar, Rs mn FY16 FY17 FY18E FY19E Net Sales 994 1,002 1,026 1,092 EBIDTA Net Profit EPS, Rs PER, x EV/EBIDTA, x P/BV, x ROE, % Total debt/equity (%) Source: Company, PhillipCapital India Research Estimates 12 September 2017 BUY (Maintain) CMP RS 251 TARGET RS 295 (+18%) COMPANY DATA O/S SHARES (MN) : 2243 MARKET CAP (RSBN) : 563 MARKET CAP (USDBN) : WK HI/LO (RS) : 255 / 139 LIQUIDITY 3M (USDMN) : 36.4 PAR VALUE (RS) : 1 SHARE HOLDING PATTERN, % Jun 17 Mar 17 Dec 16 PROMOTERS : FII / NRI : FI / MF : NON PRO : PUBLIC & OTHERS : PRICE PERFORMANCE, % 1MTH 3MTH 1YR ABS REL TO BSE PRICE VS. SENSEX Apr 16 Sep 16 Feb 17 Jul 17 Hindlaco Source: Phillip Capital India Research BSE Sensex Page 19 PHILLIPCAPITAL INDIA RESEARCH

20 HINDALCO COMPANY UPDATE Financials Consolidated Income Statement Net sales 994,195 1,001,838 1,026,346 1,092,311 Growth, % Other income 6, ,668 6,908 Total income 1,000,422 1,001,838 1,033,013 1,099,219 Other Operating expenses 912, , , ,134 EBITDA (Core) 87, , , ,085 Growth, % (1.7) Margin, % Depreciation 42,872 44,572 44,942 45,980 EBIT 45,044 79,902 97, ,105 Growth, % (15.9) Margin, % Interest paid 50,489 57,424 46,956 44,314 Other Non Operating Income 12,153 11,110 10,102 10,102 Pre tax profit ,395 77,559 65,892 Tax provided 5,148 15,567 23,425 24,401 Profit after tax 4,205 17,829 54,135 41,491 Others (Minorities, Associates) 6, Net Profit 2,034 17,752 54,054 41,406 Growth, % (72.1) Net Profit (adjusted) 7,799 17,943 37,284 41,406 Unadj. shares (m) 2,065 2,227 2,227 2,227 Wtd avg shares (m) 2,065 2,227 2,227 2,227 Balance Sheet Cash & bank 43,120 82,612 55,373 92,052 Debtors 79,414 82,748 81,671 88,496 Inventory 167, , , ,541 Loans & advances 63,533 3,358 4,971 5,016 Other current assets 40,391 88,211 88,211 83,800 Total current assets 393, , , ,906 Investments 143, , , ,960 Gross fixed assets 1,160,241 1,260,039 1,286,164 1,309,064 Less: Depreciation 352, , , ,701 Add: Capital WIP 40,576 17,409 16,032 16,032 Net fixed assets 848, , , ,395 Total assets 1,385,617 1,456,423 1,420,090 1,448,261 Current liabilities 305, , , ,130 Total current liabilities 305, , , ,130 Non current liabilities 691, , , ,074 Total liabilities 997, , , ,205 Paid up capital 2,065 2,227 2,227 2,227 Reserves & surplus 382, , , ,990 Shareholders equity 388, , , ,056 Total equity & liabilities 1,385,617 1,456,423 1,420,090 1,448,261 Source: Company, PhillipCapital India Research Estimates Cash Flow Pre tax profit ,395 77,559 65,892 Depreciation 42,872 44,572 44,942 45,980 Chg in working capital 20,319 19,904 25,469 3,717 Total tax paid 9,126 14,326 19,750 20,605 Other operating activities 12,795 38, Cash flow from operating activities 67, ,989 77,036 94,984 Capital expenditure 40,301 76,631 24,748 22,900 Chg in investments 19,775 7,327 2,481 2,567 Cash flow from investing activities 60,076 69,305 27,229 25,467 Free cash flow 7,726 52,684 49,807 69,517 Equity raised/(repaid) 0 33, Debt raised/(repaid) 9,537 40,001 72,971 29,837 Dividend (incl. tax) 2,485 2,866 2,915 2,915 Cash flow from financing activities 17,695 13,193 77,110 32,838 Net chg in cash 9,970 39,492 27,303 36,679 Valuation Ratios FY16 FY17 FY18e FY19e Per Share data EPS (INR) Growth, % (72.1) Book NAV/share (INR) FDEPS (INR) CEPS (INR) CFPS (INR) DPS (INR) Return ratios Return on assets (%) Return on equity (%) Return on capital employed (%) Turnover ratios Asset turnover (x) Sales/Total assets (x) Sales/Net FA (x) Working capital/sales (x) Working capital days Liquidity ratios Current ratio (x) Quick ratio (x) Interest cover (x) Dividend cover (x) Total debt/equity (%) Net debt/equity (%) Valuation PER (x) Price/Book (x) EV/Net sales (x) EV/EBITDA (x) EV/EBIT (x) Page 20 PHILLIPCAPITAL INDIA RESEARCH

21 INSTITUTIONAL EQUITY RESEARCH Hindustan Zinc (HZ IN) Play on zinc price and high dividend INDIA METALS Company Update 12 September 2017 Strong pricing outlook Strong supply deficit continues to support zinc prices with a 21% gain from the start of CY17. Mine closures have also boosted lead prices by 15% YTD CY17 (although these are lagging zinc price gains). This is expected to boost Hindustan Zinc s profitability. Winter curbs to aid Upcoming winter curbs in China are likely to impact production at some Chinese miners / smelters, disrupting zinc and lead production. While the impact may not be as significant as aluminium and steel, it adds to the bullish outlook for zinc prices due to a global deficit. Expansion on track: to boost volumes from FY20 With expansion plan on track, volumes are likely to bounce from FY20 with major gains from silver. HZ expects silver volumes to ramp up to 700 tonnes by FY20 from 452 tonnes in FY17. Valuations We upgrade our zinc price assumption for FY18/19 to US$ 2,950/3,100 from US$ 2,800/3,000 earlier. This leads to a 5%/3% increase in our operating profit / net profit estimates for FY18/19. At CMP, the stock trades at an FY19 P/E of 11x and EV/EBIDTA of 6.8x. With strong dividend payout, we expect FY19 dividend yield to be 3%. However given a sharp rally, downgrade to Neutral with a revised target of Rs 330 (Rs 320 earlier), valuing the company at 7x FY19 EBIDTA. Valuation summary Y/E Mar, Rs mn FY16 FY17 FY18E FY19E Net Sales 139, , , ,417 EBIDTA 66,406 97, , ,298 Net Profit 81,967 83, , ,124 EPS, Rs PER, x EV/EBIDTA, x P/BV, x ROE, % Total debt/equity (%) 25.7 Source: Company, PhillipCapital India Research Estimates Neutral (Downgrade) CMP RS 313 TARGET RS 330 (+5%) COMPANY DATA O/S SHARES (MN) : 4225 MARKET CAP (RSBN) : 1321 MARKET CAP (USDBN) : WK HI/LO (RS) : 314 / 193 LIQUIDITY 3M (USDMN) : 9.7 PAR VALUE (RS) : 2 SHARE HOLDING PATTERN, % Jun 17 Mar 17 Dec 16 PROMOTERS : FII / NRI : FI / MF : NON PRO : PUBLIC & OTHERS : PRICE PERFORMANCE, % 1MTH 3MTH 1YR ABS REL TO BSE PRICE VS. SENSEX Apr 16 Sep 16 Feb 17 Jul 17 Hind. Zinc BSE Sensex Source: Phillip Capital India Research Page 21 PHILLIPCAPITAL INDIA RESEARCH

22 HINDUSTAN ZINC COMPANY UPDATE Financials Income Statement Net sales 139, , , ,417 Growth, % Other income 2,675 1,560 1,638 1,720 Total income 142, , , ,137 Raw material expenses 2,348 3, ,330 Employee expenses 7,862 7,220 7,942 8,141 Other Operating expenses 65,649 71,262 79,461 85,028 EBITDA (Core) 66,406 97, , ,298 Growth, % (10.8) Margin, % Depreciation 7,126 18,112 17,644 16,484 EBIT 59,280 79, , ,814 Growth, % (12.9) Margin, % Interest paid 169 2,017 3,954 0 Other Non Operating Income 27,294 24,737 19,298 15,408 Non recurring Items Pre tax profit 86, , , ,223 Tax provided 4,438 18,837 28,204 29,098 Profit after tax 81,666 83, , ,124 Net Profit 81,666 83, , ,124 Growth, % (0.1) Net Profit (adjusted) 81,967 83, , ,124 Unadj. shares (m) 4,225 4,225 4,225 4,225 Wtd avg shares (m) 4,225 4,225 4,225 4,225 Balance Sheet Cash & bank ,804 13,345 74,759 Debtors 2,441 1,360 1,741 1,894 Inventory 10,582 19,358 24,781 26,964 Loans & advances 62, Other current assets 1,104 17,236 17,236 17,236 Total current assets 77, ,005 57, ,088 Investments 351, , , ,368 Gross fixed assets 157, , , ,048 Less: Depreciation 58,006 76,119 93, ,247 Add: Capital WIP 23,628 30,713 33,288 39,413 Net fixed assets 123, , , ,215 Total assets 552, , , ,671 Current liabilities 151, ,625 42,022 45,724 Provisions 1,138 1,284 1,477 1,698 Total current liabilities 152, ,909 43,499 47,422 Non current liabilities 25,713 27,480 22,232 19,248 Total liabilities 178, ,429 21,267 28,174 Paid up capital 8,451 8,451 8,451 8,451 Reserves & surplus 365, , , ,046 Shareholders equity 373, , , ,497 Total equity & liabilities 552, , , ,671 Cash Flow Pre tax profit 86, , , ,223 Depreciation 7,126 18,112 17,644 16,484 Chg in working capital 112,185 95, ,201 1,587 Total tax paid 3,911 72,029 22,957 26,114 Other operating activities Cash flow from operating activities 201, ,682 46, ,179 Capital expenditure 15,659 25,713 22,575 16,125 Chg in investments 79, ,997 35,674 20,215 Cash flow from investing activities 94,947 88,284 13,099 36,340 Free cash flow 106, ,966 33, ,839 Dividend (incl. tax) 141, ,690 37,227 43,425 Cash flow from financing activities 141, ,690 37,227 43,425 Net chg in cash 34,788 83,276 70,459 61,414 Valuation Ratios FY16 FY17 FY18e FY19e Per Share data EPS (INR) Growth, % (0.1) Book NAV/share (INR) FDEPS (INR) CEPS (INR) CFPS (INR) DPS (INR) Return ratios Return on assets (%) Return on equity (%) Return on capital employed (%) Turnover ratios Asset turnover (x) Sales/Total assets (x) Sales/Net FA (x) Working capital/sales (x) (0.5) (1.0) Working capital days (195.3) (363.4) Liquidity ratios Current ratio (x) Quick ratio (x) Interest cover (x) Dividend cover (x) Net debt/equity (%) (94.2) (78.7) (57.7) (66.0) Valuation PER (x) Price/Book (x) Yield (%) EV/Net sales (x) EV/EBITDA (x) EV/EBIT (x) Source: Company, PhillipCapital India Research Estimates Page 22 PHILLIPCAPITAL INDIA RESEARCH

23 INSTITUTIONAL EQUITY RESEARCH JSW Steel (JSTL IN) Play on inorganic opportunities INDIA METALS Company Update 12 September 2017 Global steel spreads hint at upside risk to estimates Global steel spreads are at near decade highs, driving steel stocks up in anticipation of higher profitability. Current spreads sustaining is critical for further upgrades. While we believe this is likely, it may not be linear. We would wait and watch if the recent increase in spreads sustains before factoring it into our estimates. Higher exports relative to peers provides incremental delta Domestic steel prices have lagged global prices in the recent upswing. However, because exports account for 20 25% of JSW Steel s total volumes, the profit delta due to the global steel price rally is likely to be higher for the company. India steel industry consolidation JSW to be the biggest beneficiary The recent IBC proceedings against five steel companies should benefit major steelmakers like JSW Steel and Tata Steel as it gives them an opportunity to acquire operating assets at a reasonable cost. In the interim, production disruptions at the companies under IBC are benefiting other steel producers in the country too. JSW Steel acquiring either Essar Steel or Bhushan Steel at a big haircut would be a great valuations driver. Inorganic growth While JSW Steel is evaluating various inorganic growth opportunities in India through the IBC process, as discussed above, it also continues to evaluate various inorganic opportunities globally. As per media reports, it is considering bidding for a 2.5mn tonne steel company in Italy (after its failed bid for Ilva an Italian steeworks company). However, we believe that JSW Steel will acquire any company only if it has the potential to turnaround the asset (thereby adding value) and if the acquisition cost fits within its overall leverage targets. Integration process started; to pick up pace once norms are eased The company has won five iron ore mines and one coking coal mine in the auctions conducted so far. While these may not materially benefit it yet, we expect JSW Steel to win more mines as and when they are auctioned. The government is currently in the process of reviewing auction terms in the light of poor response so far. The auctioning process should pick up pace once the government eases norms, benefiting JSW Steel, Tata Steel, and others. Valuations At CMP, the stock trades at an FY19 P/E of 10x and EV/EBIDTA of 6.5x. We marginally tweak our estimates, but we are yet to factor in the current steel spread expansion. However, we increase our target multiple to 6.5x EBIDTA from 6x earlier to factor in a potential earnings upgrade and upcoming consolidation opportunity. We retain our Neutral rating on the stock with a revised target price of Rs 275 (Rs 240 earlier). Neutral (Maintain) CMP RS 269 TARGET RS 275 (+2%) COMPANY DATA O/S SHARES (MN) : 2417 MARKET CAP (RSBN) : 651 MARKET CAP (USDBN) : WK HI/LO (RS) : 272 / 151 LIQUIDITY 3M (USDMN) : 17.2 PAR VALUE (RS) : 10 SHARE HOLDING PATTERN, % Jun 17 Mar 17 Dec 16 PROMOTERS : FII / NRI : FI / MF : NON PRO : PUBLIC & OTHERS : PRICE PERFORMANCE, % 1MTH 3MTH 1YR ABS REL TO BSE PRICE VS. SENSEX Apr 16 Oct 16 Apr 17 JSW Steel BSE Sensex Source: Phillip Capital India Research Valuation summary Y/E Mar, Rs mn FY16 FY17 FY18E FY19E Net Sales 418, , , ,463 EBIDTA 60, , , ,445 Net Profit 13,835 47,395 50,998 63,432 EPS, Rs PER, x EV/EBIDTA, x P/BV, x ROE, % Source: Company, PhillipCapital India Research Estimates Page 23 PHILLIPCAPITAL INDIA RESEARCH

24 JSW STEEL COMPANY UPDATE Financials Consolidated Income Statement Net sales 418, , , ,463 Growth, % Total income 418, , , ,463 Other Operating expenses 358, , , ,018 EBITDA (Core) 60, , , ,445 Growth, % (35.4) Margin, % Depreciation 31,879 34,299 35,730 37,123 EBIT 28, , , ,321 Growth, % (51.7) Margin, % Interest paid 33,027 37,681 35,758 35,464 Other Non Operating Income 1,682 1,521 1,559 1,598 Non recurring Items 21, Pre tax profit 23,610 63,917 72,581 90,347 Tax provided 15,241 16,743 21,804 27,137 Profit after tax 8,370 47,174 50,777 63,211 Others (Minorities, Associates) Net Profit 7,419 47,395 50,998 63,432 Growth, % (25.0) Net Profit (adjusted) 13,835 47,395 50,998 63,432 Unadj. shares (m) 2,417 2,417 2,417 2,417 Wtd avg shares (m) 2,417 2,417 2,417 2,417 Balance Sheet Cash & bank 7,340 14,851 27,488 42,438 Debtors 28,016 41,494 41,753 45,521 Inventory 84, , , ,541 Loans & advances 79,047 5,462 5,872 6,018 Other current assets 7,990 59,203 62,961 67,095 Total current assets 206, , , ,613 Investments 6,184 13,671 13,671 13,671 Gross fixed assets 767, , , ,968 Less: Depreciation 226, , , ,391 Add: Capital WIP 66,652 38,652 88, ,652 Net fixed assets 607, , , ,229 Total assets 820, , ,747 1,030,513 Current liabilities 192, , , ,866 Provisions 5,333 2,994 3,144 3,301 Total current liabilities 197, , , ,167 Non current liabilities 413, , , ,463 Total liabilities 611, , , ,630 Paid up capital 2,417 3,013 2,417 2,417 Reserves & surplus 206, , , ,175 Shareholders equity 208, , , ,883 Total equity & liabilities 820, , ,747 1,030,513 Valuation Ratios Per Share data EPS (INR) Growth, % (25.0) Book NAV/share (INR) FDEPS (INR) CEPS (INR) CFPS (INR) DPS (INR) Return ratios Return on assets (%) Return on equity (%) Return on capital employed (%) Turnover ratios Asset turnover (x) Sales/Total assets (x) Sales/Net FA (x) Working capital days Liquidity ratios Current ratio (x) Quick ratio (x) Interest cover (x) Dividend cover (x) Total debt/equity (%) Net debt/equity (%) Valuation PER (x) Price/Book (x) Yield (%) EV/Net sales (x) EV/EBITDA (x) EV/EBIT (x) Source: Company, PhillipCapital India Research Estimates Page 24 PHILLIPCAPITAL INDIA RESEARCH