Even as the stimulus by China is yet to take effect, concerns are being raised about its impact and the possible support it can provide to commodities, especially metals.
Some brokers, including CGS-CIMB Securities International Pte. Ltd, are even advising investors to stay away from steel stocks for the next two years. “Falling steel prices in the domestic market, rising steel production in China, depreciating CIS currencies which make exports viable at much lower US$ prices and entry of new players in the Indian steel market are some of the headwinds for Indian steel players. It is not too late to sell steel stocks, in our view,” CGS-CIMB said in a note. CIS is Commonwealth of Independent States.
The impact of the price erosion could reflect in the December quarter earnings. Jefferies India Pvt. Ltd forecasts a significant contraction in earnings of the metal companies on a sequential basis. Worryingly, the earnings contraction is projected to continue through the current quarter (Q4 FY19) as well, as the firms face the full impact of the fall in prices. “Full impact should come through in 4Q. Domestic HRC (hot rolled coil) prices are around ₹2,800 per tonne below 3Q average. With domestic ex-mill prices at a premium to import parity and mill inventories rising, further correction is likely. Aluminium LME is down 5% versus 3Q average,” Jefferies said in a note. LME is London Metal Exchange.
Falling prices should ideally lead to production cuts by high-cost producers, bringing equilibrium to the market. But it can be an arduous process. Things can get worse if demand in China does not see material improvement after the holiday season, some analysts fear.
Lower demand in China will drive exports from the nation, impacting steel prices in the global markets, warns CGS-CIMB. While Chinese policy stimulus can maintain the infra spends, slowdown in real estate and automotive sectors—high users of metals—can weigh on demand, points out Kotak Institutional Equities Research.
The scenario is peculiar in the aluminium sector. Markets outside China are in a deficit mode (gap between production and demand). But softening demand and sizeable inventories mean the prices can remain soft, warns Kotak.
So much so, the broking firm fears return on invested capital from the aluminium operations of Hindalco Industries Ltd, one of the low-cost producers globally, can fall to low-single digits at the assumed prices. “We cut our consolidated EBITDA estimate by 9% to ₹161 billion, ₹165 billion for FY2020E, FY2021E,” Kotak said in a note, referring to Hindalco. Ebitda is earnings before interest, tax, depreciation and amortization.
The concerns are weighing on stocks. The Nifty metal index is down 13% in the last three months. While the losses in the individual stocks are more pronounced—JSW Steel Ltd lost a fifth of its value—demand recovery in China and global markets, and stabilization in prices will be crucial for the stocks.