>METAL SECTOR (EMKAY)

Visibility Rising

The macro business environment for all the domestic metal companies seems to be improving, with the increased thrust on infrastructure spending by both India and China. This seems to have provided better visibility to the targeted volume growth by the domestic companies. Moreover, to shield from the meltdown, all the companies have embarked upon huge cost reduction programs, which will provide the much needed cushion to the falling margins due to steep fall in realizations. Most of the companies have shown the actual reduction in cost of production in their earnings. The steel prices seem to have bottomed out and with the improvement in demand, they may catch the northward trend. Considering all these factors, we are giving higher multiples and upgrading all the metal stocks under our coverage

Improving business environment
The macro business environment for all the metal companies seems to be improving with the increasing willingness of the government to spend more on infrastructure development. The same is visible even in China. This is expected to give more visibility to the targeted volume growth by the companies. This may also improve the valuation multiples of the companies leading to higher valuations

Prices seem to have bottomed out
The steel prices seem to have bottomed out giving strong indications that prices may not fall from current levels and with improvement in overall demand scenario, prices may start increasing. Prices in China have increased to around USD440/t from USD400/t FOB. Considering freight and insurance of USD20/t and import duty of 5% in India, the landed cost comes to around USD480/t. The Indian prices are currently around USD500/t. If the domestic steel producers are not allowed to increase prices by the Government, then the imposition of anti dumping duty seems to be less likely as there will not be any significant disparity in the domestic prices and landed cost.

Cost reduction programs to improve margins
Taking cue from the contracting margins, most of the players have embarked on cost reduction programs to maintain their margins. Corus announced 40% production cuts, job cut of around 3,500 employees and other performance improvement programs to reduce cost and increase efficiency. JSW has announced various measures to increase efficiency, optimizing input blends and lower raw material prices (basically undoing the wrong dones during peak times). Sterlite is also targeting to reduce cost of production across divisions, especially aluminum – to reduce cost from as high as USD1,400-1,500/t to around USD900/t and zinc from USD680/t to around USD600/t. Sesa Goa is planning to reduce its mining cost by improving logistics and increasing productivity.

Revision in Target Price
We are revising upgrading Tata Steel from REDUCE to HOLD, with revised target price of Rs489 (1.3x FY11E book value and 4.7x FY11E EPS of Rs103), upgrading JSW Steel from REDUCE to HOLD with revised target price of Rs673 (1.2x FY11E book value and at 11.3x FY11E EPS of Rs59.8), upgrading Sesa Goa from REDUCE to BUY with revised target price of Rs243 (2.2x FY11E book value and at 7.6x FY11E EPS of Rs31.8), upgrading Godawari Power from HOLD to BUY with revised target price of Rs166 (0.7x FY11E book value and at 3.6x FY11E EPS of Rs46.3), downgrading Sterlite Inds from BUY to HOLD with revised target price of Rs738 (1.3x FY11E book value and at 12.9x FY11E EPS of Rs56.9) and revising target price of Monnet Ispat to Rs274 (0.85x FY11E book value and at6.2x FY11E EPS of Rs44.4).

To see full report: METAL SECTOR