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Metals: Better safe than sorry...

Jun 9, 2004

After the huge bull run witnessed on the bourses during 2003, markets have not only come to a screeching halt during 2004 but have also shifted into the reverse gear. It must be noted that it is not just politics that has soured Indian investors sentiments. Though it has played a key role in spoiling the stock market party, various global issues pertaining to strong oil prices, rising US interest rates, terrorism and the China slowdown have all taken its toll on investor sentiments, not just in India, but across the globe. In this article, we look at how investor sentiments have been affected on the back of fears of a slowing Chinese economy and what has been its effect on the stock prices of companies, which are likely to be affected by the Chinese slowdown.

  2003 gains/losses (%) 2004 gains/losses (%) PAT growth FY04 (%)
France CAC-40 Index 16.1% 4.6% -
Arcelor (Paris) 25.6% -9.0% Turned profitable
Dow Jones 25.3% -0.6% -
Alcoa (US) 66.8% -17.6% 123%
Nifty 71.9% -17.9% -
Tisco (India) 193.1% -30.5% 73%
SAIL (India) 398.5% -41.7% Turned profitable
Hindalco (India) 140.2% -31.0% 44%
Nalco (India) 111.3% -34.8% 41%
Note: Arcelor and Alcoa year ending December 2003. 2004 gains/losses as on June 7, 2004

As is evident from the above table, while the metal stocks in India and all across the globe outperformed their respective indices, 2004 has seen a reversal in this trend. While stock markets have adhered to a trading range over the last few months, global aluminium (Alcoa, Hindalco) and steel (Arcelor, Tisco, SAIL) stocks have under performed the indices substantially. Despite eye-catching financial performances managed by these companies during FY04, markets seemed to have ignored these stocks. This sudden change in attitude could be attributed to the cautious outlook arrived at towards these sectors in wake of the planned Chinese slowdown.

It must be noted that the biggest beneficiary of the Chinese growth over the last couple of years have been commodity sectors like aluminium, steel, copper, nickel, zinc, etc. and their allied industries like scrap, iron ore, coal, coke and alumina. Insatiable Chinese demand for all these commodities (and many more) led to a huge spurt in their prices, pushing them to multi-year highs, the benefit of which was reflected in the improving profitability of the players in the industry. While many players from these industries, across the world, which were bleeding, managed to achieve a financial turnaround, many others managed to record spectacular growth rates, as reflected in their stock prices (see table above).

However, now, with Chinese authorities making a concerted effort at reigning in the Chinese growth rates, the effect of this is already being reflected on commodity prices. The table below indicates the fall in spot prices of certain commodities from their peak over the last couple of months.

Approx. % fall in prices
Aluminium 9%-10%
Steel 10%-15%
Copper 10%-12%
Iron Ore 35%-40%
Scrap 30%-35%

This is not likely to immediately affect most of these companies.This is owing to the fact that they generally tend to enter into long-term contracts (semi-annual and annual) with much of their sales being bound at contracted prices. But, it is at the time of renewal of the same that the pricing pressure comes to the forefront for these companies.

Just to put things in perspective, Tisco's approximately 25%-30% of volume sales are sold via quarterly, semi-annual and annual contracts, while the rest is primarily on the basis of monthly contracts. Thus, when the monthly contracts are up for renewal, falling prices have a significant negative impact on the bargaining power of the supplying companies. However, while companies like Tisco are better equipped to survive cyclical downturns, it is others like SAIL that tend to get the worst affected. The same principle can be applied to companies in other commodity sectors also wherein some are better placed relative to their peers. However, the bottomline is that none are spared from the cyclicality of the sector as their profitability gets severely affected.

While all the above companies have given a positive outlook post their March quarter results on the basis of a strong recovery in the US and the Euro zone economies, the catch is that the outlook provided is largely focused on the next 3-6 months. Further, with input prices showing signs of easing off, it is only time that this gets reflected in the end-product prices, as their latter price rise had been very much on this pretext.

Therefore, we believe that investors need to look beyond the near-term horizon and arrive at a decision. Already, the valuations of many of these stocks have largely factored in the likely growth of these companies for FY05, which is likely to be tepid compared to FY04. Thus, we feel that investors need to adopt a cautious approach towards commodity stocks and not get carried away with the effect of market momentum on these sectors. You don't want to get stuck with a SAIL at Rs 60, do you? Conclusion, it is better to be safe than sorry!

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