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Big Story | How Covid-19 deepened the pain for metal and mining players

Satya Sontanam | Updated on May 31, 2020

Two years of unfavourable market conditions were already weighing on metal, mining players when Covid-19 struck a heavy blow. We examine demand-supply dynamics and prospects of firms in the sector

The Covid-19 pandemic has delivered a severe blow to the metal and mining sector.

LME (London Metal Exchange) prices of three non-ferrous metals — zinc aluminium and copper — have corrected 13.6 per cent, 14.1 per cent and 13.2 per cent in 2020, respectively. Steel prices are down about 10 per cent.

The weak show follows two years of unfavourable market conditions due to slowing economic activity and prolonged trade wars.

With global economic growth set to contract severely by 3 per cent in 2020, according to the International Monetary Fund (IMF), and world’s merchandise trade set to plummet 13-32 per cent, according to the World Trade Organization (WTO), the prospects of metal companies in the near future are clearly challenging.

Recent forecasts by leading research houses including CRISIL, UBS and SBI Research, that India’s GDP growth is set to contract by more than 5 per cent in FY21, also do not bode well for the domestic demand for metals.

The silver lining is that the GDP of China — world’s largest producer and consumer of most metals — is expected to grow at 1.2 per cent in 2020, according to the IMF. If China continues importing metals, it could help India’s metal producers to some extent.

We examine the demand-supply dynamics of each of the metals and the extent to which the pandemic has impacted them, to gauge the medium-term prospects for the companies in the sector.

Steel: Exports to the rescue for now

The Indian steel sector has been facing headwinds since the beginning of 2019 due to general elections, intensified trade tensions, slump in auto sales and the slowdown in domestic economy. The Covid-19 pandemic has only added to the sector’s woes.

By mid-March 2020, the demand for most of the steel companies had almost dried up, as indicated in the orders cancelled or postponed by customers. ICRA Ratings estimates domestic steel demand in March and April 2020 would have contracted 22 per cent and 91 per cent, respectively, compared with the corresponding months in the previous year.

As shutting down the steel plants could have led to technical problems and higher cost, most integrated steel players have not shut their factories during the lockdown and have operated at minimum capacity.

Continued production and non-existent demand in the past few months have led to piling up of inventory at the plants. With no demand in the domestic market, steel players have turned towards exports, despite it being less remunerative than domestic sales.

For instance, JSW Steel, which exported 21 per cent of its total sales in FY20, has increased the share of its exports to more than 50 per cent in Q1FY21 (so far), while guiding for a flat sales growth in FY21.



Steel companies are likely to continue depending on exports in the first half of FY21, as domestic demand from user industries is unlikely to revive in this period. CRISIL predicts 2020 to be another year of double-digit sales decline for the automobile sector.

Further, domestic demand is also likely to be curtailed by lower government capital expenditure due to the reallocation of expenses towards healthcare spends and other revenue expenditure. Another rating agency, ICRA, says that the Budget cuts in FY21 by some States will curtail the allocations to infrastructure spend and stretch the receivable cycle for construction contractors.

Given the liquidity crunch and higher working capital requirement, many secondary and small steel players may take time to restart operations. Meanwhile, integrated steel players holding large inventories can cater to the incipient demand — once it revives.



Integrated steel players such as Tata Steel, JSW Steel and SAIL can, therefore, witness a revival in sales sooner than their smaller counterparts. On the realisations front, improvement in Indian steel prices is expected to be muted going ahead.

With profitability of steel companies likely to be under stress in FY21, companies with better margins, superior product mix and higher diversification can withstand this difficult phase better than others. The operating profit margins of Tata Steel, JSW Steel and SAIL from their Indian operations were 24 per cent, 18.8 per cent and 9.5 per cent, respectively, for the first nine months of FY20.

Tata Steel seems to be in a better position, supported by its captive iron-ore mines and with a good share of value-added products in sales. JSW Steel, which bagged captive iron-ore mines last year, is also expected to fare better.

SAIL, with weak realisations and higher costs, will be under further pressure until demand revives.

Zinc: Prospects intertwined with steel

The Indian zinc industry has been suffering from loss of production since the beginning of FY19. The industry has also witnessed a sharp drop in exports, on account of a fall in domestic production.

Lower production at Hindustan Zinc, which accounts for 80 per cent of India’s zinc output, due to the company’s transitional issues (from open-pit mining to underground mining) since April 2019, has contributed to the drop in zinc output in India.



Also, due to geopolitical tensions, zinc prices fell from about $3,284 per tonne towards the end of March 2018 to about $2,292 per tonne by the end of December 2019.

About 50 per cent of the zinc produced is used for galvanising steel. And with weak steel demand in the past one year, India’s consumption of zinc, too, fell by about one per cent (y-o-y) to 510 kilo tonnes during April 2019-January 2020, as per CARE Ratings.

Now, the pandemic may pose further hardship to the industry. During the lockdown, the mines are being operated at minimal utilisation rates. The operational performance of Hindustan Zinc may not improve drastically in FY21, given the bleak demand outlook for the end-user — the steel sector.

Also, zinc prices, too, may take time to recover due to lower demand and if production continues in zinc mines in 2020.

However, while Hindustan Zinc is likely to be impacted in the short run, it can do well over the long term, given the government’s production target of 300 million tonnes of steel by 2030. Hindustan Zinc’s strong operating profit margins at above 35 per cent, near-monopoly in the domestic zinc market, minimal debt and strong cash balance are factors in favour of the company.

Aluminium: Losing sheen

Covid-19 is set to deliver a severe blow to domestic aluminium producers who were already struggling with weak commodity prices and subdued demand.

The white metal is known to be very volatile, and during the current crisis, aluminium prices on LME declined about 14 per cent (year to date), currently trading at $1,530 per tonne.



With weak demand, domestic aluminium companies have also got piled-up inventories in March and April. To compensate the loss of sales in the domestic market, most players have increased their share of exports, some as much as 70 per cent of total sales.

Despite the lockdown, China’s aluminium production rose 2.8 per cent y-o-y during the first two months of 2020, as per CARE, while demand from user industries such as power transmission, automobiles, construction and white goods was poor. As a result, the inventory of the metal stocks held in Shanghai Futures Exchange (SHFE) warehouses surged to over 528 kilo tonnes in March 2020 from 185 tonnes at the end of December 2019.

Even if the demand improves going ahead, inventories will be drawn down, allowing prices to recover gradually. According to a report by the Commodity Research Unit (CRU), the aluminium price is expected to return to 2019 levels ($1,700-1,800 per tonne) only in 2023. This makes the outlook for aluminium players quite unattractive.

The three major aluminium players in India — NALCO, Hindalco, Vedanta — have been reporting weak financial numbers for the past 2-3 years from this segment.

Their prospects will improve only when demand and realisations improve.

Of the three, Hindalco seems better-placed to ride out the crisis since it is a low-cost aluminium producer. The operating profit margin of the company for the first nine months in FY20 stood at 16.33 per cent. NALCO’s and Vedanata’s aluminium segments posted operating profit margins of 6.6 per cent and 4.2 per cent, respectively, during the same period.

Hindalco’s US subsidiary, Novelis (producer of beverage cans and rolled aluminium) has not seen much impact from Covid-19 due to strong at-home consumption trend.

NALCO, a Central PSU engaged in making and selling alumina (raw material for aluminium) and aluminium, seem to be losing its sheen. The company, which had been surviving on sale of high-margin alumina, may take considerable time to recover, as prices of alumina, too, have been on the downtrend for some time now.

Copper: Realisations to be under pressure

Over the past two years, domestic copper players have been facing the dual problem of competition from cheap imports, including from Japan, and lower LME prices.

Due to the pandemic, LME prices of the metal have fallen by about 13 per cent this year, and currently trade at about $5,350 per tonne.

Most of the domestic copper players such as Hindalco and Vedanta import copper concentrate and convert it to the metal. The price of copper concentrate is fixed by deducting the global treatment and refinery charges (Tc/Rc), on a particular day, from the LME prices.



Movement of Tc/Rc charges is based on the global production of copper ore. If production is high, demand for smelting increases and the Tc/Rc charges also rise.

Despite reduced or complete shutting of operations in the top copper-producing nations such as Chile and Peru, supplies are expected to improve in 2020 on the back of recovery in output from Indonesia and ramp-up in output from Africa, as per Kotak Securities. This may rein in the fall in Tc/Rc charges going forward.

Tc/Rc charges are also dependant on the demand for copper, which in turn depends on segments such as electrical and telecommunications, building and construction, automobiles, and consumer durables. As per the CRU, copper demand is set to decline by over 5 per cent this year, which represents the strongest downturn since the mid-1970s. The CRU also expects copper to face considerable market surpluses over the next five years.

The future benchmark Tc/Rc charge for CY20 was pegged at 15.9 cents/lb, a drop of 23 per cent from the CY19 levels, as per Hindalco’s investor presentation in February 2020.

Among the three copper players — Hindalco, Vedanta and Hindustan Copper — Hindalco is likely to face more challenges going ahead.

While half of Hindalco’s revenue from its copper unit is derived from the Tc/Rc segment, the rest is from value-added products such as CC (continuous cast) rods and from its DAP (diammonium phosphate) unit.

Revenue from all these segments could contract in the near term. One, due to lower Tc/Rc charges; two, due to expected low demand for high-margin products during the Covid crisis; and three, due to closing of the DAP unit for some time in FY21 for inspection. The current operating profit margins from the copper segment of the company is just about 6 per cent and is likely to see further pressure.

Vedanta’s copper plant in Tamil Nadu remains shut due to environmental issues.

Hindustan Copper’s prospects may revive once refined metal prices rise, as the company is an integrated copper producer and does not depend on external sources for its raw material.

The operating profit margin in the first nine months of FY20 was almost 30 per cent.

However, higher fixed costs of the company would be a deterrent.

Mining: Contingent on revival of metals

As the output of mining companies is the input of metal companies, the sales growth of the former depends on the production growth of the latter.

For instance, the performance of both iron-ore and manganese-ore industries is directly linked to the performance of the steel industry. While iron ore is a key raw material in primary steel-making, manganese ore is utilised for making steel alloys.

As steel companies have been operating at lower utilisation rates, inventories would have piled up at iron-ore and manganese mining companies such as NMDC and MOIL since April.

This is despite the shutting of mining operations for some period during the lockdown or operating at reduced utilisation rates.

Till the demand for steel revives, sales volumes of these companies could be under pressure.

In terms of pricing, both the mining companies revised its prices in the beginning of May 2020. While NMDC reduced its iron-ore prices by 15 per cent (month-on-month) on lumps, MOIL, surprisingly, increased the prices on all grades by 45 per cent (month-on-month).

Prices for both iron ore and manganese ore remain elevated in the international markets due to supply constraints. NMDC bucked the trend and revised its prices downwards as it is more linked to the fundamentals in the domestic market.

Both NMDC and MOIL, with good operating profit margins of above 50 per cent, can revive once the demand for steel improves.

Being PSUs, the dividend yield of these companies in the past few years was 2-4 per cent and 4-6 per cent, respectively.

Published on May 30, 2020

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