Steel on, Mining gone...!!!

The dynamics of metals and mining sector has undergone a considerable change over the past year, largely led by the slowdown in China. The change in the Chinese growth structure from an investment led growth to consumption led growth in 2014 has reduced its resource consumption to a large extent. China’s huge appetite for resources and growth rate of over 10% for building massive infrastructure led to a global commodities boom a decade back from the year 2004.

We believe that boom is history now, and will not be witnessed again as the Chinese growth is cooling down along with its characteristics from over 10% to around to 7% With the new “normal” price range of all minerals coming into play, considerable price declines have been witnessed. The price range prevailing currently, is more than 60% lower from the top prices prevailing during the boom period for all metals. Though the prices have bottomed out however the upside will be limited to 25-30% . We believe there will be further consolidation and small players would be either closing down or selling off to larger players as survival becomes difficult in the new “normal” metals prices regime.

Volume growth back on forefront

We believe that growth in the sector would come from volumes and operational efficiency rather than captive mining benefits as low prices and high royalty rates and differentcesses take away the benefits of captive resources. Against this backdrop we likeJSW Steel, Tata Steel, GPIL, IMFA. We are negative on Coal India, Sail, NMDC and MOIL as we believe that the valuations are expensive and earnings will be disappointing despite volume growth because of low mineral prices and sticky cost.

High Royalty Rates: Key Overhang

Mining in India suffers from the highest royalty rates among the world. Royalty rates for iron ore and bauxite is 15%. Besides, poor logistics and years of unscientific mining have been responsible for high freight and mining cost as ore body goes deeper.

The logistical problems and overburdened railways have resulted in high freight cost. This makes mining unattractive and uncompetitive in India as compared to global mining companies at current mineral prices. Margins get squeezed further when minerals prices are weak. This is making it difficult to attract investment in mining in India.

Product Prices near bottom, upside potential of 25-30%

We believe that we are close to a bottom as far as steel prices are concerned, however we are not building the case for another bull run in the price given structural demand slowdown in China.

China continues to remain the biggest consumer and producer of metals and a slowdown in its consumption without proportionate decline in production and capacities is leading to an oversupply situation which will continue to keep a lid on any sharp bull run in prices. However we believe that over the next 2-3 years, unviable capacities will close down giving support to the prices, therefore we expect upside of about 25-30% from the current level.