Foreign brokerage firm Jefferies India has indicated that the best days for the steel sector may have ended in 2021.
The steel sector that was one of the most in-demand sectors in 2021 with many stocks in the space rallying 14-2000 percent in the space of 12 months, is now being questioned whether it can carry on its red-hot streak in the New Year.
“We lower our optimism on India metals as we enter 2022. Weak macro and demand concerns in China are weighing on metal prices,” Jefferies India said in a note. The brokerage has downgraded shares of Tata Steel and JSW Steel on the premise that the steel sector’s earnings are “inflecting down” due to weak demand and pricing environment.
It is important to note that even as the demand environment was muted in the domestic market throughout 2020 and the majority of 2021, it was the strong exports and ever-expanding margins that drove the re-rating in steel stocks after October 2020.
JSPL output grows 9% to 5.9 MT in April-December FY22
The brokerage firm’s downgrade of the sector may not come entirely as a surprise to investors who have seen many steel stocks give up substantial gains in the past four months ever since concerns rose over the economic slowdown in China and as the domestic steel price rally lost steam. In the past three months, the Nifty Metal index has risen merely 0.7 per cent in line with the gains of the Nifty50 index.
Jefferies has slashed its 2022-23 earnings estimates for Tata Steel and JSW Steel by 18 percent and 26 percent, respectively – the biggest such downgrade in more than a year. The primary driver of the earnings downgrade is a concern of a sharp contraction in margins of steel producers, which has been aided in recent quarters by a spectacular rise in global steel prices during the pandemic.
High input cost of steel forces MSMEs to sell at loss
Jefferies India argued that unlike in the early months of 2021, the case for a “big rally” in metal prices is weak largely due to the slowdown in the Chinese economy and, in particular, its property market – the biggest consumer of steel in the country.
“We find risk-reward for India steel far inferior to a year ago. We believe Indian steel margins have peaked in 1HFY22 and will fall sharply by FY23, albeit settle above historical levels,” Jefferies India said in a note.
Considering the weak earnings set-up for steel companies, Jefferies has downgraded its rating for Tata Steel to ‘hold’ from ‘buy’ earlier and for Jindal Steel to ‘underperform’ from ‘buy’. The brokerage has further cut its price target for Tata Steel by 22.5 percent and for Jindal Steel by 25 percent.
Is it time to shift to aluminium stocks?
Where it is less optimistic about the steel space, it is equally enthusiastic about aluminium producers. Jefferies believes that increased focus on transitional metals in new capital expenditure in China bodes well for companies like Novelis Corp, a subsidiary of Hindalco Industries.
Reinventing steelmaking for a green revolution
“We find Novelis also well-placed for the global shift to aluminum from steel in autos, and from plastics & glass in beverage cans,” Jefferies India said. In addition to the bright fundamental outlook, Jefferies also believes Hindalco’s 1.2 times one-year forward price-to-book value is attractive for a company pegged to give a 16 percent return on equity in 2022-23.
Given the attractive valuations and the low risk to earnings for aluminium producers, Jefferies India retained its ‘buy’ rating on Hindalco and raised its price target for the stock by 8 percent to Rs. 660.
Disclaimer: The views and investment tips expressed by investment experts on Moneycontrol.com are their own and not those of the website or its management. Moneycontrol.com advises users to check with certified experts before taking any investment decisions.
