Stay cautious! Metal stocks rally may take 'U'-turn hereon
Many stocks in the sector are trading at their lifetime highs with valuations touching 2x of book value
Over the past one-year metal stocks have shining bright on Dalal Street. The Nifty Metal index has surged around 193% compared to 59% returns generated by Nifty since May 6, 2020. This outperformance is driven by rising prices, strong global demand and supply-side constraints from China.
Many stocks in the sector are trading at their lifetime highs with valuations touching 2x of book value. While most analysts suggest that are multiple tailwinds in the sector, but some see this as irrational exuberance.
A note by CGS-CIMB Securities says the increase in steel prices has been underpinned by a decline in productivity. “Due to the COVID-19 situation in CY20, steel production declined by 78 MT (million tonnes) in ROW (rest of the world) ex-China leading to supply chain shortages of 30-40 MT in the ROW,” it said.
A similar situation happened after the Lehman Brothers crisis when production declined by ~240 MT, leading to supply chain shortages of 60-80 MT that were fulfilled only in May-Jun 2010. Steel stocks peaked in Apr 2010, retested the peak 12 months later and then fell sharply by 50%, add the note.
“Production growth has ramped up since March, but sustained production growth of 15-16% in next 2-3 months in the RoW is needed to balance the global supply chain. If steel production growth continues, prices are likely to decline in 2-3 months. This makes the risk-reward is unfavourable,” said Satish Kumar of CGS-CIMB.
The note further states that JSW is trading at 4.7x FY22F P/B and Tata Steel at 1.7x. JSW Steel. Valuation, like that of JSW steel, is normally assigned to growth companies, not commodity makers. But such is the flow of liquidity and paucity of ideas that any stock approaching near-term earnings growth is getting high valuations.
CGS-CIMB believe stocks will correct only if steel prices fall but that is two to three months away and contingent on production growth in RoW (ex-China).
The firm has assigned reduce rating for SAIL (Steel Authority of India) and has set a price of Rs 54. SAIL did CAPEX of Rs 63,000 crore in last 10 years but capacity remains un-commissioned (4-5 MT); efficiency did not increase, leading to FY21F net debt/ EBITDA 7.33x.
Similarly, for Tata Steel it has assigned reduce rating with a price target of Rs 575 as the company looks overvalued on all parameters. European asset sales are factored into its price.
A much widespread second wave of COVID-19 and localised lockdowns has resulted in FPIs snapping their six-month buying spree, and turning into net sellers in April 2021 and pulled out $1.29 billion which is highest since March 2020.
“The top three sectors which saw maximum outflow were Banking & Financial (USD 1.12bn), Oil & Gas (USD 466mn) and Metals & Mining (USD 242mn). While the current sectoral weightage in Banking & Fin now stands at 6 months low at 32.7%. The weightages in Oil & Gas is at 11.3% and Metals & Mining is at 2.4%,” said Edelweiss Alternative Research in its Foreign Sectoral Flow Insight report.
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