Metal stocks rallied over 20% in August; time to book profits?

NEW DELHI: Metal stocks have made a smart bounce-back since August. The BSE Metal index has rallied over 20 per cent as compared to the 2 per cent rally in the BSE Sensex.

Metals & mining stocks have rallied by 5-35 per cent over the past one month on the back of positive news flows from across the globe, especially China, alongside weak INR which has plunged nearly 15 per cent so far in 2013 against the USD.

“For steel companies, these factors make a case for an increase in realizations and better volumes growth (due to higher export prospects and also import substitution due to INR depreciation),”Angel Broking said in a note authored by Bhavesh Chauhan & Vinay Rachh.

“However, domestic steel demand remains weak in the near term. Steel consumption growth declined to multi-year lows to 3.3 per cent YoY during FY13,” added the report.

Metal stocks are high-beta and the sector has tended to underperform the wider market during falling markets.

In the past, metals stocks have been among the worst performers among the large-caps in the last one year.

Apart from a drop in metal prices following the slowdown in China, shares of metal firms have been hurt by regulatory headwinds across projects. Slowdown in the Indian economy has also weighed on the sector.

However, analysts at top brokerage firms are of the view that the underperformance of the sector is over and most of them have upgraded their target price and rating on the sector.

The stocks, which had underperformed the market over the last one and half years, have rallied in anticipation of a pick-up in demand from China and rupee's depreciation.

There are expectations of better earnings from metal companies. The rupee depreciation has made exports much more lucrative for these companies as well.

Angel Broking says it likes companies with captive assets, strong visibility on earnings growth over the coming few years, low leverage levels and inexpensive valuations. Tata Steel, Hindustan Zinc and NMDC still remain their preferred bets.

Nomura and JPMorgan expect metal stocks to give sharp returns over the long term on the back of a pick-up in demand and currency fluctuation.

"We are changing our underweight stance and turning overweight on the Indian metals sector as we believe that falling rupee's benefits for the sector can be substantial going forward. The improvement in the global economy alongside a much weaker rupee makes for a powerful tailwind for metal companies' earnings, in our view," said a Nomura report.

According to JPMorgan report, Indian firms are likely to give strong returns as they turn into 'cash generators' from cash 'guzzlers'.

According to analysts, metal stocks are likely to continue with their upward move after today's breather, as fundamentally things are looking strong for the sector.

Real steel consumption in India rose by just 0.3 per cent YoY during April-August 2013 due to low demand from construction and automotive sectors. Nevertheless, we expect a 3-4 per cent improvement in realizations for domestic steel companies during 2HFY14, compared to announced price hikes of 6-7 per cent, added the Angel Broking report.

According to the report, for steel makers, a weakening rupee raises landed cost of steel imports, thus giving higher pricing power to domestic steel players.