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Despite capex picking up FY22 onwards, ferrous companies will be in a much better shape by FY25 due to enhanced capacities, but lower net debt.

It wouldn’t be wrong to say that metal stocks have been leading the ongoing bull run from the front. As a matter of fact, the Nifty Metal index has galloped 301% since March lows last year, outperforming leading sectors throughout. In fact metal stocks were among the key drivers of the 1Q performance results. “Metals led by strong pricing environment and higher exports to offset the decline in domestic volumes,” stated Motilal Oswal Financial Services in a report. The current fall in metal stocks can be bought into.

Sweeping structural changes

Beyond the illusionary super cycle, Edelweiss Securities see two structural changes in the metals & mining sector that are likely to define the course of the sector in the new decade namely the decarbonisation drive in China; and shifts in global trade. In our view, both are likely to lead to shallower price troughs, reduced cyclicality and improved earnings profile.

However, the brokerage firm cautioned investors that any metamorphosis takes time and has periods of uncertainty and reluctance attached, and this one is no different.

Taking cognizance of the improved demand outlook for ferrous and nonferrous, and the possibility of troughs being higher, Edelweiss Securities has raised its underlying commodity price estimates, particularly for raw materials. While its revised estimates are still lower than the current/Q1FY22 level of prices, they are higher compared to the past.

Repaired balance sheets

“The ongoing balance sheet repair has been comprehensively ignored by the Street so far. Limited correction in prices implies that troughs might be shallower and shorter in duration. For the first time, we are witnessing a scenario where despite capex picking up FY22 onwards, ferrous companies will be in a much better shape by FY25 due to enhanced capacities but lower net debt,” noted Edelweiss Securities in a report.

Rerating beckons

With profit margins settling at higher levels and shallower troughs, Edelweiss Securities expect earnings volatility the traditional bane of multiples to reduce. With better and repaired balance sheets, we see higher EBITDA (earnings before interest tax depreciation and amortization) to PAT (profit after tax) conversion, nudging consideration of P/E (price to earnings) as an alternate valuation methodology.

The brokerage house still sees domestic ferrous companies trading at a premium to peers owing to better RoE (return on equity) profiles. It has raised the valuation multiple of ferrous by companies by 10% each owing to structural change in profitability.

Top picks

Here are Edelweiss Securities top picks from the metals & mining space.

Tata Steel | Rating: Buy | Price target: Rs 2,055 | Upside: 40.6%

Tata Steel is Edelweiss’s preferred pick in the ferrous space. Improving spreads, iron ore security and robust European spreads are likely to propel earnings. The company’s focus on value over volume is likely to improve margin and earnings quality.

The brokerage firm has revised the target price of Rs 2,055 valuing the stock at 5.0x (earlier 4.5x) on Q3FY23E EBITDA.

JSPL | Rating: Buy | Price target: Rs 575| Upside: 35.5%

Edelweiss expects the volume ramp-up at Angul to sustain. Though JSPL will be exposed to high domestic iron ore prices as the benefit from low-cost iron ore fines at Sarda is over now, it sees low capex intensity and increased focus on governance as the key positives.

The brokerage firm has revised the target price to Rs 575, valuing the stock at 5.5x (earlier 5.0x) on Q3FY23E EBITDA.

SAIL | Rating: Buy | Price target: Rs 180 | Upside: 34.4%

According to Edelweiss volume growth and consequent operating leverage to be key stock drivers. Furthermore, the debt reduction through to FY24 would be more pronounced compared to peers. It believes concerns on 10-15mtpa expansion project are exaggerated as we expect far better diligence and fiscal prudence compared to expansion-cum-modernisation project that resulted in the company getting overleveraged. Besides, a favourable steel cycle is also likely to aid.

Citing this the brokerage firm has revised the target price to Rs 180, valuing the stock at 5.0x (earlier 4.5x) Q3FY23E EBITDA.

NMDC | Rating: Buy | Price target: Rs 245 | Upside: 42.6%

Edelweiss is bullish on the near-term profitability amid record-high iron ore prices and volume uptick. Besides, a dividend yield of ~5% is comforting. Further, in view of the favourable steel cycle, we see steel plant getting the value.

The brokerage firm has revised the target price to Rs 245, valuing the stock at an unchanged 4.5x Q3FY23E EBITDA.

Vedanta | Rating: Buy | Price target: Rs 400 | Upside: 21.7%

Edelweiss is of the opinion that Vedanta is the major beneficiary of the current commodity price uptick. Besides, the Aluminum division’s profitability improving further on robust LME
price and ongoing cost efficiency endeavours. The cash allocation concerns are also getting reduced as the intercorporate deposit (ICD) is being repaid.

Besides, the brokerage firm is positive on dividend yield of ~6% and has revised its target price to Rs 400, valuing the stock at a revised 3.8x (earlier 3.5x) Q3FY23E EBITDA.

Jindal Stainless | Rating: Buy | Price target: Rs 220 | Upside: 38.1%

Jindal Stainless is benefitting from the merger with Jindal Stainless-Hisar. Besides, value accretive capex is likely to propel the company to the second-largest stainless steel player (ex-China).

Edelweiss has revised the price target to Rs 220, valuing the stock at an unchanged 5x Q3FY23E EBITDA.

Shyam Metalics | Rating: Buy | Price target: Rs 580 | Upside: 39.8%

Edelweiss is positive on recently listed Shyam Metalics as the company is turning net cash positive in FY23 despite peak capex in FY22. As a result, EBITDA to peak in FY23 at a higher
range of Rs 2,500-3,000 crore. Our thesis on the company is based on capacity ramp-up and
refined product mix.

(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.)