The metals industry is witnessing a strong global demand growth. Due to limited supply, metal prices are likely to go up. We believe the headwind in the US is unlikely to precipitate a sharp slowdown in demand because of the “decoupling” of the US economy from BRICs and other economies.
Our metal consumption growth expectations result in improved zinc and aluminium fundamentals because we believe the supply surge witnessed in these metals in 2007 is unlikely to be repeated during 2008 and 2009. The prices of aluminium, copper and lead are likely to go up due to sustained momentum in demand growth driven by China, India and other emerging economies.
Strong demand growth underpinned by robust GDP growth, volume growth from recently commissioned capacity, tight control over costs, and leverage to high commodity prices will be the key drivers of profitability over the next one year. Notwithstanding the run-up in stock prices over the past few months, Indian base metal companies under our coverage are currently trading at a 22% discount to global peers on one-year forward EV/EBITDA. We continue to be bullish on zinc, and as the preferred vehicle to play the zinc upcycle, we maintain Sterlite Industries as our top pick.
Sterlite Industries: Sterlite Industries is driven by strong earnings profile. Its volume growth across the zinc, copper and aluminium businesses on the back of recently completed and ongoing expansions, lowering of operating costs from better economies of scale and progress on the Jharsuguda smelter project reflect its strengths. The stock currently trades at 2008-9 EV/EBITDA of 6.2 times, at a discount of 10% to the global base metals average of 6.8 times. Given the company’s strong growth outlook, cost leadership in copper smelting and zinc, and diversified risk profile, we believe this discount is not justified. We maintain our Buy rating on the stock.
HIndustan Zinc: The company had a strong run-up in its share price (up 45%) over the past four months against 28% for the Sensex. Strong volume growth from the ramp up of the 170 kilo-tonnes per annum hydro smelter I, commissioning of the new 170 ktpa hydro smelter II in December 2007 and commissioning of the 80 MW capacity captive power plant reflect its strong earnings profile. The stock trades at a forward EV/EBITDA of 5.7 times, a discount of 16% to the global base metals average of 6.8 times. We maintain Neutral rating on the stock based on a mere 5% free float and limited liquidity.
Nalco: Nalco has underperformed its peers over the past four months (stock is up 20% against 28% for the Sensex). The brownfield expansion to hike its capacity by 30% is likely to be commissioned only by 2009-10 and, until such time, we do not envisage any significant volume growth. The stock currently trades at a forward EV/EBITDA of 5.9 times. Lack of catalysts is a key reason for our Neutral rating on the stock.
