Metals melt on Evergrande group crisis; what should investors do now?
Evergrande’s debt crisis has the potential to severely weaken global steel demand and induce a sharp correction in steel prices.
Metal stocks were on the receiving end as weakening Chinese demand and Evergrande group crisis dented the investor sentiment. In the last three trading sessions the Nifty Metal index has tanked over 7.5% from 5,822 on September 16, 2021, to 5,380.60 in today’s session.
Risk to metals
Evergrande’s debt crisis has the potential to severely weaken global steel demand and induce a sharp correction in steel prices and, in turn, margins for India’s steel industry. This event could have a significant impact on close to 60% of steel demand in China, which equates to ~30% of global steel demand in CY20. The concern is visible in the sharp correction in iron ore price to ~US$ 90/t from a peak of US$ 239/t in May’21.
Averting contagion
“The risk of widespread defaults can possibly be avoided by managing consumer confidence, property prices and investor trust. This could involve protecting consumer deposits for incomplete properties, avoiding fire sale of properties and working out debt resolution plans. For Evergrande, a breakup or buyout solution would be perceived as a better route over bankruptcy or bailout,” said Kirtan Mehta of BOBCAPS.
Stock play
BOBCAPS is of the opinion that the margins of steel companies will be softening margins over the next 6-12 months with steel prices easing to US$ 650/t by FY23. With the steel cycle at a peak, the brokerage firm prioritises capital discipline over expansion projects and is therefore positive on Tata Steel and Jindal Steel & Power (JSP) who are now focusing on responsible growth.
Tata Steel | Rating: Buy | Price target: Rs 1,755
Better integration all the way to iron ore, its Indian operations are resilient through the cycle and generate leading margins in the domestic steel sector. Tata Steel is working on improving the viability of its European operations via better cost control and production optimisation.
Meaningful debt reduction through FY22, adherence to disciplined capital allocation, demonstration of sustainability of European operations, timely delivery on the pellet plant and CRM expansion at Kalinganagar, completion of realignment across four identified verticals to simplify group structure.
Jindal Steel & Power | Rating: Buy | Price target: Rs 555
Armed with an improved balance sheet, Jindal Steel & Power aims to restart growth investments in its core steel operations at a measured pace while keeping net debt/EBITDA (earnings before interest tax depreciation and amortization) below 1.5x at all times. Though divestment of non-core capacity has aided a stock rerating, the company continues to trade at a discount to peers. Jindal Steel & Power stands to benefit the most from the ongoing ramp-up in infrastructure investments in India, given its focus on long and structured products.
(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.)