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Metals: ‘Steel’y 2004 - Views on News from Equitymaster
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  • Dec 30, 2004

    Metals: ‘Steel’y 2004

    It was yet another year of gains for investors in the stock markets with the benchmark index – Sensex – having notched gains of about 14% during 2004. Similar to last year, practically all the sectors (barring FMCG this time) ended the year with significant gains, as reflected by their respective indices. The metals index (steel & aluminium) has also ended the year in the positive by registering gains of about 27% (calculated on a simple average basis of the stocks in the tables below, as the BSE Metals index was launched only in 2HCY04). We take a look at what led the continued optimism amongst investors towards the sector after the spectacular performance in 2004 and what is in store for 2005.

    As mentioned above, the metals index has risen by about 27% during the year. However, if we consider the steel and aluminium sectors in isolation, the steel index has registered an impressive growth of about 40% while the aluminium sector has closed the year on a negative note with about 2% fall, consequently affecting the overall performance of the metals index.

    2004 vs. 2003:
    While China continued to be the dominant force even in 2004, driving metal prices through the roof, there were significant apprehensions during the first half of 2004 with respect to the Chinese economy slowing down. It must be noted that Chinese authorities have adopted concerted efforts to reign in their galloping economy so as to prevent a hard landing in the event of a slowdown. However, their efforts have not yielded much result as yet, which has led to the extension of the steel cycle and further strengthening the aluminium cycle.

    Steel - The prolonged steel cycle, contrary to our expectations, continued to immensely benefit steel sector companies in terms of higher realisations - average steel prices surged approximately 30% YoY. Continued high levels of capacity utilisation on the back of strong domestic and international (led by China) demand helped steel companies register strong bottomline growth during the year. Apart from the financial performance, the sector continued to hog the limelight all through 2004.

    Aluminium: The underperformers
    Company Price on Dec 26, 2003 (Rs) Price on Dec 27, 2004 (Rs) % change
    BSE-SENSEX 5,699 6,513 14.3%
    HINDALCO 1,366 1,322 -3.2%
    MALCO 210 205 -2.2%
    NALCO 196 194 -1.3%

    The primary reason for the steel sector to hit the headlines time and again in 2004 revolved around rising steel prices. While steel manufacturers cited helplessness in the face of surging raw material prices like that of coke, iron ore and melting scrap, which forced them to pass on the same to consumers, there was significant opposition by steel user industries including auto and construction citing significant pressure on their margins.

    Further, with India passing through an inflationary phase (more than 8% in August 2004), the sector came under government scrutiny time and again, with a view to control the spiraling steel prices. This included measures like suspending the DEPB scheme so as to discourage exports to increase domestic availability, forcing players to withhold price hikes (during election months) and announcing custom duty cuts on various forms of iron and steel products to repel steel companies’ intentions of hiking prices.

    Steel: The outperformers
    Company Price on Dec 26, 2003 (Rs) Price on Dec 27, 2004 (Rs) % change
    BSE-SENSEX 5,699 6,513 14.3%
    SESA GOA 592 1,006 69.8%
    JINDAL STEEL & POWER 550 887 61.4%
    ESSAR STEEL 26 39 49.4%
    ISPAT INDUSTRIES 16 21 33.8%
    TISCO 283 374 32.3%
    SAIL 52 61 17.2%
    JINDAL IRON & STEEL 284 327 15.1%

    Aluminium - Aluminium sector players also benefited from the surge in alumina and aluminum prices. While aluminium prices ended 2004 higher by over 20%, alumina prices witnessed significant volatility during the year. This is evident from the fact that alumina prices strengthened from about US$ 400 per tonne in December 2003 to US$ 470 during March 2004, consequently collapsing to about US$ 300 per tonne within a couple of months. This was on fears of China slowing down, which would affect commodity prices. However, as soon as these receded, prices shot back again and are currently near last year December levels.

    Outperformers of the year:
    While all steel stocks have been outperformers with respect to the Sensex in 2004, the biggest gainer (up 70%) was Sesa Goa, India’s largest private sector exporter of iron ore. The stock continued to have a handsome run on the bourses on the back of strengthening iron ore prices. While international contracted prices for iron ore sales witnessed a hike of near 19% for 2004 (9% in 2003), there are expectations that the negotiations due in early 2005 are likely to see benchmark international iron ore prices settle at 20%-25% higher levels over that of 2004.

    Laggards of the year:
    Aluminium stocks have been the underperformers in 2004. Alumina players like Nalco, registered improved financial performance on the back of higher average contracted prices during 2004, which was reflected in the company’s quarterly results. Further, while Hindalco’s aluminium segment performed well during 2004, a steep duty reduction of 10% and depressed TC/RC margins continued to bog down the performance of its copper business, affecting the overall performance. However, the positive performance of the sector players was not reflected in the stock price of companies (in line with our expectation) as much of this growth was already factored in the stock valuations at the end of last year.

    What to expect?
    We continue to maintain our positive stance towards the aluminium sector for 2005. This is on the back of a global economic recovery and strong domestic economic growth. The aluminium sector will benefit from impressive growth in transport and construction sectors. The global recovery in aluminium demand, led by major economies like the US, Europe and China, is intact. Aluminium prices therefore, are unlikely to weaken much in the medium-term. Further, the added advantage for Hindalco would be the improvement in performance of its copper business in wake of higher TC/RC margins.

    As far as the steel sector is concerned, we must admit that the steel cycle has extended beyond our expectation as China continues to register strong growth rates despite efforts by its authorities to cool down the economy. However, we continue to remain apprehensive on the steel sector for the medium-term owing to various reasons. We believe that the steel cycle has peaked and the various domestic and global capacity expansion plans that are taking shape would put pressure on steel prices. Indian steel majors have already announced aggressive capacity expansion plans in India. This means that any shortfall in the demand/imports from China will lead to overcapacity in the domestic market. It must be noted that in the first 10 months of 2004, Chinese steel imports have fallen by 18%. At the current juncture, the risk-reward ratio in the sector is against the investor.



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