Portfolio

Indian miners measure up to the global best

ADARSH GOPALAKRISHNAN | Updated on November 15, 2017

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We assess how investors can unearth value, after recent declines in commodity prices.

Commodities have borne the brunt of the Chinese slowdown and European politico-economic crisis. Prices of manganese, iron ore, zinc and aluminium have dropped 10-25 per cent over the last one year, impacting companies that process or mine these metals.

But Indian metals and mining companies may weather this phase better, with their low-cost structure. Here's an assessment of their prospects.

IRON ORE

The prices of high-grade iron ore imported by China from Australia are down by 20 per cent over the last one year. This dip is attributed to the slowdown in steel production growth in China and drop in European consumption.

For India, global iron ore prices serve only as a directional cue. India's largest iron ore miner, NMDC, sells ore at a discount of 35-45 per cent to international ore of similar grade. Despite this, NMDC's 75 per cent margins exceed those of higher realisation earning peers such as BHP Billiton, Rio Tinto and Vale.

NMDC's other advantages include control over 40 per cent of domestic iron ore output, which is an edge in terms of ability to hold prices steadier than volatile international prices. NMDC still remains among the best placed iron miners globally as its cost of production is low and imports too expensive to threaten prices.

DANGER ZONE

But Indian mining has been a regulatory death-trap for some producers. Take Sesa Goa. Its operating margins of 53-60 per cent were not in the realm of NMDC, but still handy enough to beat miners of similar size elsewhere.

Then came the mining ban in Karnataka, shutdown of an expensive mine in Orissa and an export duty hike. The company's core operations in Goa have come under the scanner, casting a shadow over the stock. Margins in the fiscal ended March 2012 slid to 41 per cent. As a result, Sesa Goa's profits are under pressure.

ZINC

Vedanta-controlled Hindustan Zinc controls over 90 per cent of the Indian market. Hindustan Zinc enjoys operating margins of 50-55 per cent. This is over double that of peers such as Teck Resources and XStrata.

Zinc inventories are growing and stand at high levels of 8-10 per cent of global annual production. The International Lead and Zinc Study Group reports that zinc metal supply during the first three months of 2012 has outpaced demand (as it has for five years now). The fear is, this could result in pressure on zinc prices.

In such a scenario, Hindustan Zinc is well-placed to ride out the storm. The company's growing silver and lead output has helped stem profit declines from lower realisations.

At current prices of around $2,000 per tonne of zinc, several global producers barely break even. Prices moving south could spell shutdown time for these producers, sparking support for zinc prices. Hindustan Zinc's profits and volumes will grow with an expanding home market.

MANGANESE

Manganese consumption tracks that of steel. Major sector producers include MOIL and Tata Steel. Unlike in the iron ore space, domestic manganese producers get to sell their ore at international prices. This puts players such as MOIL in a sweet spot. They get to enjoy the realisations of international players while operating on low cost structures.

MOIL's operating margins of 55-70 per cent trounce global peers such as Eramet and BHP Billiton's manganese division whose margins have ranged 25-55 per cent. Newer mines in Indonesia and South Africa tend to be even less profitable.

Global production of manganese ore in 2011 shot up by 10 per cent, far outpacing the 7 per cent increase in steel production. Manganese prices collapsed over the last year owing to a sharp rise in inventories and a huge spike in supply from South Africa and Indonesia.

MOIL's advantage in this context is a simple one.

If manganese prices continue to slide, the first set of producers to drop out are new mines in Indonesia and South Africa, the second set are relatively more expensive and low grade ore projects. Being in the lowest quartile in terms of cost of production and being rich in cash leaves MOIL with wiggle room and a chance to snap up assets for cheap.

ALUMINIUM

India has two major aluminium producers, NALCO and Hindalco. The latter is an integrated producer with captive bauxite and coal mines. This allows it to produce alumina and power at a low cost.

Aluminium producers globally have suffered from a glut of aluminium smelting capacity. In addition, competing for coal has become increasingly expensive, hurting margins.

Power is a key input for production of aluminium metal, accounting for over 30 per cent of the cost of making aluminium. Producing alumina, which accounts for over 15 per cent of the cost, has been no walk in the park either.

NALCO's ageing equipment and reliance on imported coal has cost the company dearly over the last few months. Slipping aluminium prices have strained the company's profits.

As for Hindalco, the company has been profitable so far. But its exposure to Europe and US through Novelis remains a worry. The slow pace of expansion domestically has also been an overhang on the stock.

Published on May 19, 2012

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