>INDIA BASIC MATERIALS (MACQUARIE RESEARCH)

Rallied hard – What next?

Event
■ Strong re-rating and further upgrades: Strong demand growth from China and now the restocking cycle gaining momentum in the developed world have provided visibility on the sustainability of metal prices; thus, our commodities team has upgraded its metal price forecasts. However, none of our forecasts is above current metal prices, as we expect a supply response to kick in. The key themes to play are restructuring and domestic growth, in our view.

Impact
■ Our preferred metals: Based on supply-demand fundamentals, we prefer exposure to copper, iron ore, coking coal and zinc. Aluminium remains our least preferred metal.

■ Themes to play: While we believe that most of the commodity price increases have been factored into stock prices, we focus on the following
themes:

• Restructuring: It is a new world order, and many companies are restructuring to emerge as lean and mean. Tata Steel is our top pick, and we stand 19% ahead of consensus on FY11.
• Domestic growth: India is one of the fastest-growing economies and is supply-constrained. Sterlite is our top pick, followed by Jindal and Grasim.

■ Consensus earnings estimates – Earnings upgrades to continue: After our upgrades, our FY10 estimates for most companies are now 7–29% ahead of consensus, except for Nalco and Sail, where we lag by 8–10%. We expect maximum earnings upgrades for Hindalco, Sterlite and Hindustan Zinc, and we expect Jindal to have the maximum upside risk even on our estimates.

■ Valuations – Looking beyond FY10: The market is already looking at FY11 earnings as companies move towards sustainable operations and the predictability of earnings improves. In addition, the preferred valuation metric is moving from defensive PBV to earnings multiples such as PER.

Outlook
■ Steel – Selective Outperforms: With our expectation of a cap on steel prices, we believe that the focus is back to basics. Tata Steel is restructuring to emerge better, while JSW is growing fast; they remain our top picks. Sail remains Underperform, due to its high cost structure and possible negative surprises.

■ Base metals – Looking for better entry: Our top pick here is Sterlite Industries, as we expect its numerous catalysts to play out. Hindalco is the most improved company; however, given our negative stance on aluminium and the lack of growth in the next two years, we await a better entry point.

■ Diversified – Maintain Outperform: JSP and Grasim are our top picks in this space. Both are benefiting from domestic growth and their leadership positions in their space.

■ Top picks: Sterlite, Tata Steel, JSP and Grasim remain our top picks.

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