Sector review | Metals

November 25, 2011 Bhavesh Chauhan

Tel: 022- 39357800 Ext: 6821 bhaveshu.chauhan@angelbroking.com

2QFY2012 Result review

Margins succumb to cost pressures
Robust top line, but high input costs dent operating profit growth: Most metal
companies witnessed robust top-line growth (average growth of 15.4% yoy) during 2QFY2012 mainly due to higher realization. However, most steel and aluminium players reported a decrease in profitability on account of higher input costs. Nevertheless, Coal India, Hindustan Zinc, Sterlite Industries and NMDC reported robust profit growth, as these companies are highly leveraged to any increase in commodity prices. Average EBITDA for our sample universe grew by only 4.7% yoy despite top-line growth of 15.4% yoy. EBITDA of steel and aluminium players decreased by 26.1% on account of higher prices of key inputs. Despite modest growth in operating profit, other income recorded strong growth of 80.6% yoy during the quarter. Hence, average adjusted PAT for our sample companies grew by 16.5% yoy. However, some companies reported massive forex losses on account of a sharp depreciation of INR against the USD. Hence, reported PAT decreased by 38.2% yoy during the quarter. Some players delay expansion plans: On account of subdued demand, slowdown in capex cycle, higher interest rates and weak financial markets, some of the companies have delayed their expansion plans. Specifically, SAIL has reported delays in some of its brownfield projects, while Hindalco has delayed its Mahan smelter by a quarter. Near-term outlook remains gloomy, although INR depreciation mutes price declines: Steel consumption in India grew by only 1.8% in 1HFY2012 on account of subdued demand. Looking ahead, we expect steel consumption to pick up in 2HFY2012. However, there are some concerns owing to slowdown in capex cycle, higher interest rates and slowdown in construction and auto demand, among others. Globally, steel prices declined by 12-20% during June-November 2011. However, domestic steel prices have remained flat on account of INR depreciation against the USD. Similarly, although internationally base metal prices have fallen sharply over the past three months, the decline in domestic prices has been muted due to INR depreciation against the USD. Valuations inexpensive, but sentiment remains weak: Metal stocks have been battered over the last one year on account of escalating debt crisis, subdued domestic demand and rising input costs without the corresponding increase in finished product prices. Nevertheless, we believe the recent decline has left some of the stocks undervalued. We like companies with captive assets, strong visibility over expansion plans, low leverage levels and compelling valuations. Hence, our top picks are Tata Steel, Hindalco, Hindustan Zinc and NMDC.

Please refer to important disclosures at the end of this report

Sector review | Metals

Robust top-line growth on the back of higher realization: Most metal companies
witnessed robust top-line growth (average 15.4% yoy for 11 companies chosen for this analysis) during 2QFY2012 mainly due to higher realization. Average steel, copper, aluminium and zinc prices rose by 12.9%, 23.9%, 16.3% and 10.2% yoy, respectively. Only MOIL and Sesa Goa reported a yoy decline in their top lines during the quarter.

Exhibit 1: 2QFY2012 Top-line growth

80.0 60.0 40.0 20.0

Exhibit 2: Top line Variance from expectation

50 40 30 20 10 (10) (20) (30) (40)

(%)

(20.0) (40.0) (60.0) (80.0)

MOIL

(%)

Tata Steel

Hind. Zinc

Coal India

Sterlite Inds

yoy growth

qoq growth

Source: Company, Angel Research

Source: Company, Angel Research

Higher input costs dent operating profit: Despite robust top-line growth, most
steel and aluminium players reported a decrease in profitability on account of higher input costs. While steel players margins were hit by rise in coking coal prices, aluminium players margins were hit due to rise in thermal coal prices. Nevertheless, Coal India, Hindustan Zinc, Sterlite Industries and NMDC reported robust profit growth, as these companies are highly leveraged to any rise in commodity prices as they are backed by low-cost captive mines. Average EBITDA for our sample universe grew by only 4.7% yoy despite top-line growth of 15.4% yoy. EBITDA of steel and aluminium players decreased by 26.1% on account of higher prices of key inputs.

Exhibit 3: 2QFY2012 Operating profit growth

80.0 60.0 40.0 20.0 (20.0) (40.0) (60.0) (80.0) (100.0)

Exhibit 4: Operating profit Variance from expectation

20 10 (10)

(%)

(%)

(20) (30) (40) (50) (60)

SAIL

Tata Steel

SAIL

Sterlite Inds Sterlite Inds

Coal India

Hind. Zinc

JSW Steel

JSW Steel

Sterlite Inds

Sesa Goa

Hind. Zinc

Coal India

Coal India

JSW Steel

Hind. Zinc

yoy growth

qoq growth

Source: Company, Angel Research

Source: Company, Angel Research

November 25, 2011

JSW Steel

Sesa Goa

Tata Steel

NMDC

Hindalco

Hindalco

NMDC

Nalco

Nalco

MOIL

MOIL

Tata Steel

SAIL

Sesa Goa

NMDC

Hindalco

Hindalco

NMDC

Nalco

Nalco

MOIL

SAIL

Sesa Goa

Sector review | Metals

Other income boosts adjusted PAT growth: Despite modest growth in operating profit, average other income recorded strong growth of 80.6% yoy during the quarter. Hence, average adjusted PAT for our sample companies grew by 16.5% yoy. However, some companies reported massive forex losses on account of a sharp depreciation of INR against the USD. Hence, reported PAT decreased by 38.2% yoy during the quarter. Exhibit 5: Other income growth remained strong
2,000 1,800 1,600 1,400 1,200 1,000 800 600 400 200 -

Exhibit 6: Some companies reported forex losses

200 100 (100) (200) (300) (400) (500) (600)

(` cr)

(` cr)

MOIL

SAIL

Tata Steel

NMDC

Nalco

Hindalco (S)

Tata Steel

Coal India

NMDC

Nalco

SAIL

HZL

HZL Sterlite Inds

Coal India

2QFY12

2QFY11

JSW Steel

2QFY12

2QFY11

Source: Company, Angel Research

Source: Company, Angel Research

Exhibit 7: 2QFY2012 Adjusted PAT growth

100.0 80.0 60.0 40.0 20.0 (20.0) (40.0) (60.0) (80.0) (100.0)

Exhibit 8: Adjusted PAT Variance from expectation

60 40 20 -

(%)

(%)

(20) (40) (60) (80)

MOIL

SAIL

Tata Steel

SAIL

Hind. Zinc

Sterlite Inds

Coal India

Hind. Zinc

Coal India

Sesa Goa

yoy growth

JSW Steel

qoq growth

Source: Company, Angel Research

Source: Company, Angel Research

November 25, 2011

JSW Steel

Tata Steel

NMDC

Sesa Goa

Hindalco

Hindalco

NMDC

Nalco

Nalco

MOIL

JSW Steel

Hindalco (S)

MOIL

Sesa

Sterlite

Sterlite

Sesa

Sector review | Metals

Exhibit 9: Reported PAT declined for steel players

3,000 2,500 2,000 1,500 1,000 500 (500) (1,000)

(`cr)

NMDC

Nalco

MOIL

SAIL

Tata Steel

Hindalco (S)

Coal India

Sterlite

Sesa

HZL
Hindalco (S)

2QFY12
Source: Company, Angel Research

2QFY11

Some players delay expansion plans: Some of the companies have delayed their expansion plans on account of subdued demand, slowdown in capex cycle, higher interest rates and weak financial markets. Specifically, SAIL has reported delays in some of its brownfield projects and Hindalco has delayed its Mahan smelter by a quarter. Debt levels remain stable broadly: Most mining companies remained cash rich as of September 30, 2011; hence, they had zero or insignificant debt levels. However, Hindalco, Sesa Goa, Sterlite and SAIL have higher debt on a yoy basis (in order to fund their expansion plans). Interest cost as a percentage of sales remained at low levels for all our sample companies.

Exhibit 10: Debt levels broadly comfortable

70,000 60,000 50,000 40,000 30,000 20,000 10,000 329.8 400 350 300 250 200 150 100 50 (50) (100) (150)

Exhibit 11: Interest costs as a % of net sales

800 700 600 500 400 300 200 100 (100)

(` cr)

62.0

7.7 (24.7)

(8.0) (98.3)

SAIL

Tata Steel

NMDC

Nalco

Hindalco (S)

MOIL

Coal India

Sesa

HZL

JSW Steel

(%)

75.3

66.3

(` cr)

SAIL

Tata Steel

NMDC

Sterlite

Nalco

MOIL

Coal India

Sesa

HZL

JSW Steel
JSW Steel

2QFY12

FY11

2QFY11

% change over 2QFY11

2QFY12

2QFY11

Source: Company, Angel Research

Source: Company, Angel Research; Note: Capitalized portion of interest on debt has not been captured

November 25, 2011

Sterlite

Sector review | Metals

Near-term outlook remains gloomy, although INR depreciation mutes price declines: Steel consumption in India grew by only 1.8% in 1HFY2012 on account of subdued demand. Looking ahead, we expect steel consumption to pick up in 2HFY2012. However, there are some concerns owing to slowdown in capex cycle, higher interest rates and slowdown in construction and auto demand, among others. Globally, steel prices declined by 12-20% during June-November 2011. However, domestic steel prices remained flat on account of INR depreciation against the USD. Similarly, although internationally base metal prices have fallen sharply over the past three months, the decline in domestic prices was muted due to INR depreciation against the USD.

Exhibit 12: Domestic vs. international steel prices

20.0 10.0

Exhibit 13: Domestic vs. LME base metal prices

20.0 15.0 10.0 5.0 0.0

(%)

0.0

(10.0) (20.0) (30.0)

(%) India Rupee depreciation Chinese export UK US Chinese domestic CIS export Iron ore

(5.0) (10.0) (15.0) (20.0) (25.0) MCX aluminium Rupee depreciation LME aluminium MCX zinc LME zinc

June - Nov

Sep-Nov

June - Nov

Sep-Nov

Source: Company, Angel Research

Source: Company, Angel Research

Valuations inexpensive, but sentiment remains weak: Metal stocks have been battered over the past one year on account of escalating debt crisis, subdued domestic demand and rising input costs without any corresponding rise in finished product prices. Nevertheless, we believe the recent decline has left some of the stocks undervalued. We like companies with captive assets, strong visibility over expansion plans, low leverage levels and compelling valuations. Hence, our top picks are Tata Steel, Hindalco, Hindustan Zinc and NMDC.

November 25, 2011

Sector review | Metals

Exhibit 14: One-year stock price performance

JSW SAIL Sesa Nalco Hindalco Sterlite Tata Steel BSE Metal Index NMDC HZL MOIL Coal (60) (50) (40) (%)
Source: Company, Angel Research

(30)

(20)

(10)

Exhibit 15: Some stocks attractive on P/BV vs. RoE screening (FY2013)
35.0 30.0 25.0
Tata Steel JSW Sesa MOIL Sterlite HZL Coal NMDC

(ROE) (%)

20.0 15.0 10.0 5.0 0.0 0.0

Hindalco

Nalco SAIL

0.5

1.0

1.5

2.0

2.5

3.0

3.5

(P/BV) (x)
Source: Company, Angel Research

November 25, 2011

Sector review | Metals

Exhibit 16: Recommendation summary

Companies CMP Target Reco. Mcap Upside (` cr) (%) P/E (x) FY12E P/BV (x) FY13E EV/EBITDA (x) FY12E RoE (%) RoCE (%) (`) price (`) FY13E FY12E FY13E FY12E FY13E FY12E FY13E

MOIL Nalco NMDC SAIL Sesa Sterlite Tata Steel Coal India Hindalco HZL JSW Steel

226 52 187 82 171 100 374 309 114 113 557

- Neutral - Neutral 240 208 121 510 151 142 699 Buy Buy Buy Buy Buy Buy Buy 88 Accum.

3,788 13,337 74,259 33,952 14,892 33,623 35,884 21,795 47,598 12,422

28 8 21 21 36 33 26 26

8.5 13.4 8.7 8.9 5.8 7.0 6.3 13.2 6.5 8.0 8.2

7.8 11.0 7.9 6.7 5.2 5.5 4.8 12.6 5.7 7.4 4.8

1.5 1.1 2.9 0.8 1.0 0.7 0.8 4.3 0.7 1.7 0.7

1.4 1.1 2.2 0.7 0.9 0.6 0.7 3.4 0.6 1.4 0.6

3.2 5.8 4.7 7.3 3.7 2.6 5.7 8.3 4.7 4.4 4.5

2.5 3.4 3.7 5.2 3.7 2.0 4.4 7.5 4.4 3.2 3.3

19.4 8.6 37.9 9.7 18.7 11.0 24.0 37.8 11.0 23.7 10.0

18.4 9.9 31.5 11.7 17.7 12.5 15.5 30.5 11.3 20.9 15.3

21.1 6.5 47.4 7.2 21.1 9.7 10.5 35.2 7.6 22.7 10.1

19.7 9.5 39.6 9.4 19.4 11.4 12.1 28.0 7.9 20.0 14.6

- Neutral 195,049

Source: Company, Angel Research

November 25, 2011

Sector review | Metals

Research Team Tel: 022 - 3935 7800

E-mail: research@angelbroking.com

Website: www.angelbroking.com

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Disclosure of Interest Statement

Analyst ownership of the stock Coal India Hindalco Hind. Zinc JSW Steel
MOIL

Angel and its Group companies ownership of the stock No No No No No No No No No No No

Angel and its Group companies' Directors ownership of the stock No No No No No No No No No No No

Broking relationship with company covered No No No No No No No No No No No

No No No No No No No No No No No

Nalco NMDC SAIL Sesa Goa Sterlite Inds Tata Steel

Note: We have not considered any Exposure below `1 lakh for Angel, its Group companies and Directors.

Ratings (Returns):

Buy (> 15%) Reduce (-5% to 15%)

Accumulate (5% to 15%) Sell (< -15%)

Neutral (-5 to 5%)

November 25, 2011

Sector review | Metals

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November 25, 2011