However, in the past three months, favourable macros seem to be helping the sector to revive. On the earnings front, as expected, the cuts have been sharp for most companies. Going ahead, we expect CY20 to be better for domestic stocks as:
In the near term, we see potential iron ore disruption in market to affect ferrous stocks—most positive for NMDC and most negative for JSW Steel. We continue to prefer JSPL, Hindalco and NMDC (all ‘BUY’) due to volume uptick, stable earnings and benefits from iron ore disruption, respectively.
A year dominated by demand woes, price dips and earnings cuts
A major part of CY19 was tough for the sector, characterised by:
1) an unprecedented 21 successive weeks of HRC price decline in the domestic market;
2) demand growth grinding to the slowest since FY15 even in ferrous; and
3) FY20 earnings cuts of up to 43% for major companies.
As a result, spreads dipped to the lowest in the past two years. In base metals as well, aluminium and zinc prices have dropped further 3% and 7% in CY19 following a fall of 18% and 25%, respectively in CY18, impacting margins of non-ferrous companies.
Favourable macros have changed narrative in past three months
Since October 2019, we find easing macros:
1) progress on China-US trade discussion;
2) initial deal reached between EU & UK on Brexit;
3) stabilising economic & downstream indicators in China; and
4) dollar index peaking out.
This has resulted in stocks recouping most of the losses in the year with impressive returns of more than 20% for most stocks under coverage in past three months. We also find earnings likely to have bottomed out as a result of ~15-20% uptick in global steel prices since October 2019 and base metal prices also remaining range-bound. The lower prices of bulk materials—iron ore and coal—are expected to improve earnings further going ahead.
Watch out for potential iron ore disruption in domestic market
In the domestic market, we continue to keenly follow the bidding process in Odisha as it has potential to disrupt ~45-50mt that could lead to higher iron ore prices and disrupt the longs value chain. While NMDC is likely to benefit, JSW Steel owing to dependence on third party iron ore is likely to be impacted the most.
Outlook: Prefer JSPL, Hindalco and NMDC
Overall, we expect CY20 to be better for the sector. We believe JSPL (owing to operating leverage benefits and focus on longs), Hindalco (largely LME delinked operating model) and NMDC (key beneficiary of potential iron ore supply disruption) are likely to benefit the most. We maintain ‘BUY/SO’ on JSPL, Hindalco and NMDC.