Metals & Mining: Q3FY21 Preview- Margins likely to rise to new highs

Strong commodity prices coupled with muted costs will drive record margins for metal companies in Q3FY21e. Strong steel prices (+20% q-o-q) and subdued coking coal costs will likely raise steel margins to record high levels in Q3FY21e. With 13% q-o-q higher aluminum/zinc prices, base metal companies, too, should see a sharp improvement in margins. Companies remain cautious on capex spends and strong earnings should accelerate deleveraging. Higher exit prices in Q3FY21 suggest margin uptrend and earnings upgrade in metals will continue.

Steel: Strong prices and muted costs to drive margins to record levels
Regional steel prices hit decadal high in Q3FY21 led by strong sequential recovery in demand. China export HRC price increased 14% q-o-q to $569/ton. Domestic steel prices witnessed a sharper improvement (+20% q-o-q). Further, stronger demand resulted in lower exports which would further boost realisations in Q3FY21e.

Coking coal prices corrected by 1% q-o-q in Q3FY21 but given the inventory lag, we estimate a $5-7/ton cost reduction for steel companies. Domestic iron ore prices increased 46% q-o-q on the back of strong demand and higher regional prices which would hit non-integrated players like JSW/JSPL.

We estimate 3% y-o-y volume decline for JSW and TATA and 12% y-o-y volume growth in JSPL. We estimate Ebitda/ton to increase by 29-47% q-o-q for TATA, JSW and JSPL, factoring in sharp price increases. We estimate NMDC to witness 63% y-o-y and 152% q-o-q increase in Q3FY21e Ebitda.

Non-ferrous: Commodity price tailwinds to raise margins
Base metal prices saw sequential improvement in Q3FY21e led by strong sequential demand recovery across regions, stronger than expected demand in China and weaker $. Zinc and Aluminum prices increased by 13% qoq whereas Alumina remained stagnant (+2% q-o-q) during the quarter.

(i) HNDL: We estimate India Ebitda (standalone + Utkal) at Rs 15.4 bn (+23% y-o-y, +18% q-o-q); (ii) For HZ, we estimate its Ebitda to increase by 5% q-o-q to Rs 31 bn (+35% y-o-y); (iii) We expect Vedanta Ltd’s Ebitda to increase by 18% q-o-q to Rs 76 bn (+61% y-o-y); (iv) We estimate Nalco’s Ebitda at Rs 4.3 bn (+1153% y-o-y, +56% q-o-q).

Strong FCF to accelerate deleveraging
We note that exit commodity prices in Q3FY21 are 5-23% higher than Q3FY21 average and uptrend in earnings/upgrades should continue in Q4FY21e. Despite the recent rally, metal stocks are trading below their historic mean valuations. With stronger balance sheets and upside risk on earnings, we see further re-rating potential. TATA, HNDL and JSP are our preferred stocks to play the current buoyancy.