Metal Stocks Rally: What Next?

Metal stocks have rebounded. Here's what investors need to know.

<div class="paragraphs"><p>(Photo: Christophe Dion/Unsplash)</p></div>
(Photo: Christophe Dion/Unsplash)

Metal stocks have rebounded from their October lows even as sector constituents saw margins contract on lower sales realisation and higher operating expenses in the second quarter. Will the rally sustain?

Shares of metal companies have rallied in the range of 7-17% in the last one month. That was aided by a fall in Dollar Index and China relaxing post-Covid restrictions.

China is also trying to rescue its property sector. Financial regulators issued a 16-point plan to boost the real estate market, triggering a rally in Chinese developer stocks on Monday. A recovery in real estate demand in China will potentially aid metal companies in India due to an increase in demand.

The Dollar Index is down 3% in the last five sessions and has fallen 5% in the last one month. As DXY and commodities have an inverse correlation, softening of DXY has triggered an upward movement across base metal prices globally and in turn a rally in metal companies. 

"Metals have seen a major rally in last two trading sessions. Markets are already pricing in a cool-off in Dollar index and positive news from China,” said Kunal Shah, head of commodities research at Nirmal Bang. “In spite of the rally, we could potentially see another 5% upside across metals like aluminium, copper and zinc.” 

However, managements BQ Prime spoke with after the earnings have mixed views. Hindalco Industries Ltd., Jindal Steel and Power Ltd. and JSW Steel Ltd. signal caution in global markets but are positive on domestic demand.

Management Take

The next couple of quarters are going to be "extremely difficult to navigate", especially for companies involved in the commodity side of business, according to Satish Pai, managing director at Hindalco Industries. “Certain amount of high-cost inventory that got produced during Q2 will see a spill over in Q3FY23. Input cost on upstream business will have a positive impact on the cost of production going ahead, he said, adding that the business environment is "very uncertain".

Seshagiri Rao, joint managing director, JSW Steel, said the global situation is not very good but select Middle East and Asian countries are in a better place. He expects margins to recover in the second half of the year, underpinned by strong domestic demand and stabilising prices, after it posted a loss last quarter.

“Costs of key input materials have started easing, which will be reflected in earnings for the current quarter,” he said.

Bimlendra Jha, managing director at JSPL, is also betting on domestic demand. “Globally we are seeing contraction in demand, however India growth story is very different. There is positivity with regards to domestic d\emand.”

Analyst View

"Globally, we are seeing pressure in realizations and demand. Expect to see a sharp recovery in margins due to lower raw material costs in Q3FY23," Jatin Damania, vice president at Kotak Securities, told BQPrime.

Coking coal price is down by nearly $100 from its peak, he said, adding that some companies might see some benefit of operating leverage. While he remains cautious on the metal sector from long-term perspective, Hindalco is the brokerage's the top pick.

CarEdge Research expects a 50-55% decline in steel exports in FY23 because of the export duty imposed in May on a range of finished steel products. But the research firm expects domestic demand for the alloy to rise given the government’s focus on infrastructure.

Fundamentals of metal firms still look weak and the sector is sometime away from a complete turnaround. And the stocks are still trading at a 25-35% premium to long-term multiples.

While prices of metals have stabilised after a correction, there concerns persist about global slowdown and supply-chain issues, besides the export duty on domestic steel. A key trigger for steelmakers could be India revoking the export duty on steel.

Here's what analysts recommend:

Watch key highlights from BQ Prime's conversations with top executives of metal companies: