The metal sector had become the darling of the market — be it HNI investors, institutional investors or even retail. But some have been shaken out because of the correction. What are your thoughts on the kind of correction the sector is going through? Have the valuations become attractive?
The commodity cycle normally runs for a few years and we are already one-and-a-half years into this cycle, but I do not think we are at the end of the cycle as yet. Also, there are multiple cycles within the larger cycles. We are just undergoing a little bit of a blip. The larger trend continues. There are two-three things one needs to note.
One is that globally, demand has rebounded quite strongly and this trend is going to continue because the economic recovery is still pretty unstable given that we are seeing the second wave and third wave brought about by the Delta variant in various countries. So both the government and the central banks are going to have a very cautious approach in pulling back any kind of support to the economy. So with that being assured, the demand outlook remains very strong.
Secondly, when it comes to supply, there are two sides to it. One is that globally everything is working to the full capacity. Steel companies are already operating at 90% plus capacity utilisation. Historically, we have not seen this in Europe and the US. But it is happening right now. The second part of the equation is China. China was growing very fast in the first half of CY21, but now they have cut production because they have targets to meet on decarbonisation and that has created little bit of flutter in the market because when China cuts production, the demand for raw material falls and it was iron ore largely which had bore the brunt.
So iron ore prices fell by 40% from the peak but this is transitory because China cannot really cut production forever, if they have to meet their growth targets. Currently they are going through a seasonally weak period.
In this bit of a corrective transitory environment, where do you see the best margin of safety and most attractive risk reward, given the earnings which can pan out versus the prices they have corrected to?
We are most bullish in the ferrous space or steel. Companies like Tata Steel, SAIL which are fully integrated on iron ore and have access to cheaper iron ore. Companies like JSW have bought some mines in the recent auction but their cost of iron ore is very high. So Tata Steel and SAIL are the ones which are best placed in this kind of an environment where the costs are already low and they are benefitting from high steel prices.
Where would you put your bet among these companies or is it a basket approach that you would recommend?
Most of the commodity stocks move in a pack but as I told you, in the ferrous space, integrated steel companies are our best bets. Coming to the non-ferrous space, aluminium is undervalued as compared to steel and copper. It is likely to move up further and we have three plays in aluminium; Nalco is a pure aluminium play and has the highest delta to aluminium prices.
Aluminium prices have not really corrected much. Also, Hindalco is more of a play on recovery in the US given their rolling capacities in Novelis. Vedanta is a highly leveraged company and the percentage change is also pretty high as compared to Hindalco. Plus, there is a potential delisting which can bail out all investors probably in the not so distant future.
So, apart from steel, aluminium looks attractive; Nalco has the most leverage and Vedanta would have more as ready buyers are available.
