UBS upgrades India’s steel sector; recommends these two stocks for your portfolio

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The metal space has been hogging a significant amount of limelight from brokerages and market watchers, emerging as one of the star performers for quite some time now. The share prices of regional steel companies have rallied 54% on average in the past six months owing to demand recovery and upcycle spreads. JSW’s share price has risen roughly in line with the regional average by 47%, while TATA has outperformed its regional peers, up 79% in past six months.

Most brokerages have re-rated steel sectors and the latest one is UBS that has come out with a report Indian Steel: Going all in; upgrade to Buy.

The India steel sector has rebounded strongly from COVID-19 disruption. The domestic demand recovery is led by the auto sector and the government’s infrastructure pipeline. While prices have slightly corrected from January 2021 peak, current levels are likely to be sustained in the near term because of robust domestic fundamentals. Export orders are strong, driven by robust regional (particularly Chinese) demand and pricing, said UBS in the report.

The brokerage has upgraded JSW Steel & Tata Steel from neutral to buy despite the recent price rise. The firm has increased the price target for JSW Steel to RS 500 giving an upside of 18%. While for Tata Steel the stock has an upside of 24% and the new price target is set at Rs 900.

JSW Steel: timely completion of expansion projects are key triggers

JSW Steel is a pure-play on India exposure, and management expects Dolvi expanded capacity to stabilise in Q1 FY22. While much of the capacity expansion appears to be priced in, we think investors are overlooking JSW’s margin improvement initiatives, including 1) improved raw material sourcing (49% of iron ore receipts in Q3 FY21 from captive sources); 2) production cost-saving initiatives (includes pellet plant and coke ovens); and 3) downstream upgrade projects (includes expansion of cold rolling mill). JSW reported standalone Q3FY21 EBITDA/t (earnings before interest, taxes, depreciation, and amortization/ton) at around Rs 14,500, and we estimate FY22 margins to be at similar levels factoring in high realisations, ongoing cost-savings/raw materials projects, and efficient operations. We expect the stock to rerate if execution continues, noted the report.

Tata Steel: positive outlook with a potential turnaround in Europe and deleveraging

The management’s focus on curtailing capex, project rationalisation, cost management and efficiency improvements in a challenging FY21 have been key positives. TATA reported India Q3 FY21 EBITDA/t of around Rs 20,000, and we estimate FY22 standalone margins to be at c. Rs 19,000/t level, as benefits of price hikes, pass through, and 100% captive iron ore aids margins, which we believe is underappreciated by the market. Also, we believe the benefits of the transformation programme in its Europe business would be evident with the cycle turning positive. With debt concerns gradually easing, we expect TATA to narrow the gap with its historical average multiples, added the report.

(Disclaimer: The recommendations in this story are by the respective research and brokerage firm. Money9 & its management do not bear any responsibility for their investment advice. Please consult your investment advisor before investing.)