2014 outlook: non-ferrous metals and mining · corporates 2014 outlook: non-ferrous metals and...

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www.indiaratings.co.in 3 March 2014

Metal and Mining (Non-ferrous)

2014 Outlook: Non-Ferrous Metals and Mining Over supply and inventory build-up weighs down prices

Outlook Report

Stable Outlook: India Ratings & Research (Ind-Ra) has assigned a Stable to Negative Outlook

to the non-ferrous metals and mining sector and a Stable Outlook to the companies in the

sector for FY15. The agency expects the industry players to maintain stable margins. This is

partly because these companies are able to charge a physical premium, given the oligopolistic

nature of the metals and mining market in India.

Moreover, if the Indian rupee continues to remain at the current INR62/USD level it will likely

provide some cushion to the players; however, if currency levels were to strengthen to

INR60/USD or below, it could negatively impact the margins of large players. Ind-Ra has

already factored such risks into the ratings of its rated industry players.

Aluminium Prices to Remain Low: The global over supply situation is unlikely to correct in

the short term. About 2 million tonnes (mt) of high-cost smelting capacity has closed down

globally in the last 12 months and this is likely to continue for some time. However, 3.2mt-3.8mt

of capacity, more efficiently placed on the cost curve, is likely to come up.

The net incremental capacity addition being more cost efficient may prevent the prices from

exceeding USD1,800/t. Potentially the global aluminium cost curve may be recalibrated

marginally downward.

Aluminium Margins under Pressure: Ind-Ra expects operating profitability to remain

challenged due to cost inflation and lower physical premiums in FY15, though a weak rupee

could offset the decline partly. Cost inflation expectation is backed by inflation in coal and

furnace oil prices. Bauxite availability is likely to be strained and could pressurise the operating

margins of non-integrated players in FY15. The key sectors driving aluminium growth, such as

automobiles, packaging, power and construction, are unlikely to generate robust demand in

FY15.

Limited Upside to Copper Prices: Ind-Ra expects oversupply risk to magnify in the near term.

Reduced demand from China as in 2013 and historically high systemic inventory levels of metal

will keep metal prices down. However, an uptick in demand from the US and Europe may

support the prices above the current level.

Stable Treatment Charges and Refining Charges: Indian metal and mining companies are

likely to benefit from a surplus in concentrates in China and thus stable treatment and refining

charges (TCRC) in FY15. Integrated players such as Hindustan Copper Ltd. are better placed

currently. To the extent currency and global copper prices exhibit limited volatility, even custom

smelters, who are typically non-integrated, are also expected to benefit.

Zinc Potential Upside: Integrated zinc producers will benefit as China is likely to remain a net

importer of the metal along with continuous uptick in demand from the US. Supply surplus

substantially reduced for the 10 months ended October 2013. Domestic producers, being net

exports, will benefit from any supply-side disruptions including a fall in mining output or closure

of smelting capacities resulting in a strong surge in metal prices.

Rating Outlook

STABLE

Sector Outlook

STABLE TO

NEGATIVE

Global Over Supply

US QE Tapering

China Real GDP Growth moderation

Rupee volatility

Related Research

Other Outlooks

www.indiaratings.co.in/outlooks

Other Research

2014 Outlook: Steel Producers

Analysts

Mahaveer Jain S +91 22 4000 1768 [email protected] Sankalp Baid +91 22 4000 1792 [email protected] Deep N Mukherjee +91 22 4000 1721 [email protected]

http://www.indiaratings.co.in/outlooks

http://indiaratings.co.in/upload/research/specialReports/2014/1/17/indra17Steel.pdf

mailto:[email protected]

mailto:[email protected]

Corporates

2014 Outlook: Non-Ferrous Metals and Mining

March 2014 2

Outlook Sensitivities

QE Tapering Uncertainty

The inventory build-up with the major metal trading exchanges touched record levels in 2013.

Carry trades in metals to an extent are facilitated by low interest rates and high levels of

liquidity. If either of these factors changes because of QE tapering, significant long positions in

metals may be unwinded, possibly causing a sharp sustained reduction in metal prices. This

may negatively impact the margins of metal players.

Chinese Economic Activity

Metal prices depend substantially on Chinese economic activity. China accounts for 40%-50%

of the global consumption of aluminium, copper and zinc metals. Latest leading economic

indicators are not encouraging with a weak output and low order growth rates. Fitch Ratings Ltd

has reduced the 2014 real GDP growth projection to 7% from sub-7% estimated last year. A

further economic slowdown in China will cause a sustained long-term correction in metal

prices.

Aluminium

Oversupply Situation Unlikely to Correct

Globally, the demand and supply of primary aluminium remained weighted towards a surplus in

2013 to the extent that consumption as a proportion of production was 93% in October 2013.

This is lower than the corresponding number in 2010 and 2012, and marginally better than the

number in 2009 and 2011.

Figure 1

Smelters with a high-cost structure have closed capacities to the tune of 2mt, with most of the

cuts coming from China, Australia, Western Europe and to an extent USA. However, the

agency estimates 3.2mt-3.8mt of capacity (more efficiently placed on the cost curve) is likely to

come on-stream in the medium term. Close to three-fourths of the incremental capacity is likely

to come-up in China alone, already the world’s largest producer with an estimated 24.9mt

nameplate capacity.

Possible Downward Recalibration of Cost Curve

The current price of aluminium in the range of USD1,700/t to USD1,780/t is estimated to be

representative of producers in the range of 75th to 85th percentile in the cost curve. The net

additional capacity coming up in China is likely to have a much lower cost of production than

the facilities that have been closed down. Incremental capacity available at a cheaper cost of

production may potentially push prices further downwards at the current level of demand.

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2009 2010 2011 2012 TTM Oct13

Production (LHS) Consumption (LHS) Percentate surplus to consumption (RHS)

Global Primary Al Production & ConsumptionSupply Surplus status-quo

(000t)

Source: Bloomberg, WBMS

(%)

Corporates


March 2014 3

Historically High Inventory Levels

Metal inventory remained high at an estimated 7.5mt as at end-Nov 2013 (Producer and

London Metal Exchange) keeping metal price at check. The increase in levels of stocks at

exchanges with reduced producers stocks may suggest that a significant portion of the

inventory may be held by financial market participants as opposed to pure producers or

industrial consumers of the metal. Globally, this has caused a significant increase in the

physical premium associated with the metal.

Figure 2

LME has announced a new warehousing policy to release inventory from warehouses and

reduce pressure on consumers. The policy is proposed to be implemented by April 2014, under

which warehouses with higher than 50 days inventory queues will deliver more metal than they

bring in. This may bring down the physical premium. However, long positions on the metal held

by financial market participants may be unwinded, leading to a fall in the price of the metal

around this time.

Impact of QE Tapering

Strong contango continues to suggest that there may be a glut in aluminium supply in near

term. The current low interest rate regime and a surge in global liquidity have created

conditions of carry trade in the metals market. As such the related metal financing structures

are viable only at a low cost of funds.

Figure 3

In the event of sharp unwinding of the unconventional monetary policies (UMP) the cost of

funding may rise, causing many financial trades to unwind, leading to an increase in supplies

from exchange warehouses. In such an event, metal prices may fall to the levels seen during

July 2008 and April 2009, but that is not the base case of the agency for FY15.

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Jan 08 Aug 08 Apr 09 Dec 09 Aug 10 Apr 11 Nov 11 Jul 12 Mar 13 Nov 13

LME stock Producer stocks(000mt)

Primary Aluminium LME & Producer InventoryContinues to be at historical highs

Source: IAI,LME, Ind-Ra estimates

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Dec 07 Aug 08 Apr 09 Dec 09 Aug 10 Apr 11 Dec 11 Aug 12 May 13 Jan 14

Last price (LHS) Spread (RHS)(USD/ton)

Spread Between Three Month Futures and SpotContango Market Indicates Surplus

Source: Bloomberg

(USD)

Corporates


March 2014 4

Domestic Scenario

Favourable Industry Structure

In India, Aluminium metal is an oligopolistic market; as such market players’ pricing ability is

strong. A robust physical premium continued to prevail above USD275/t in 2013 benefiting from

rupee weakening.

Figure 4

Muted Demand Growth

Locally, the agency expects muted demand growth in FY15. The key sectors driving aluminium

growth, such as automobiles, packaging, power and construction, are unlikely to generate

meaningful demand in FY15. Production and consumption declined 5% yoy and 4% yoy in ttm

October 2013, respectively.

Dependence on Imported Inputs

Of the three major entities Hindalco Industries Ltd. (Hindalco) and National Aluminium

Company Ltd. (Nalco) are fully integrated with bauxite/alumina linkages. However Sesa Sterlite

Ltd. (Sterlite) largely depends on the outside purchase of inputs and is thus subject to the price

volatility of key raw materials. Alumina prices continue to increase at higher pace than the

metal prices underpinned by Indonesia’s export ban and rupee weakening.

Incessant cost inflation

Although realisations improved in FY13, the operating profitability of key players was muted

due to an increase in the cost of mining and smelting. All of these three players have captive

power plants, however rising inputs and fuel costs have negated the benefit of increased

realisation. Fitch Ratings (Ind-Ra’s parent company) has muted coal price expectations globally

in 2014. Weakness in international coal prices may provide some comfort to the sector in FY15.

Week Rupee to Benefit

Ind-Ra expects FY15 realisations and operating profits to remain stable at the current levels.

To the extent the rupee remains at the current levels (or depreciates), it will provide a cushion

to the margin of metal players. However, rupee appreciation above INR60/USD may affect

margins negatively.

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Jan 08 Aug 08 Apr 09 Dec 09 Aug 10 Apr 11 Dec 11 Aug 12 Apr 13 Dec 13

Indexed LME price (LHS) Indexed Indian prices (LHS)

USD INR exchange rate (RHS)(Index)

Aluminium Price Trend-LME & IndiaDomestic Prices Split From LME

Source: Bloomberg,LME, Ind-Ra estimates

(INR/USD)

Ind-Ra has the following sectoral outlooks: Auto: Stable to Negative

Auto Ancillary: Stable to Negative

Infrastructure & Project Finance: Negative

Construction: Negative

Power: Stable to Negative

Figure 5

Corporates


March 2014 5

Figure 6 Figure 7

Figure 8 Figure 9

Copper

Supply Surplus Continues

Ind-Ra expects growth in copper supply to continue to surpass demand growth in FY15. Also, a

surplus in copper concentrate would be more pronounced than the refined metal.

According to the International copper study group, expansions and project start-ups during

2013 and 2014 were expected to increase world mine production to around 18.6mt in 2014

from 16.7mt in 2012. Mine production operating rates improved to 83% in the nine months

ended December 2013 from 80% in 9MFY13 while refining operating rate improving only

marginally to 78.7% from 78.2%. Ind-Ra expects more mining capacity to become available

than the refining capacity leading to a higher surplus in the ore/concentrate market than in the

refined metal market.

Demand Prospects Mixed

With better prospects for global economy in 2014, the study group expects the world production

and usage to grow 5.5% yoy and 4.5% yoy, respectively. While the agency expects demand

growth from the US to pick up, it is unsure of China’s high growth rates. In 2013, consumption

growth in North America picked up traction and China’s apparent usage declined. It is

noteworthy that Chinese metal demand growth remained strong at 7% yoy in ttm October 2013

compared with 15% yoy in 2012.

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Q3FY12 Q1FY13 Q3FY13 Q1FY14 Q3FY14

Hindalco Nalco

Sterlite(INRm)

Quarterly Sales of Top Producers

Source: Company results

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Q3FY12 Q1FY13 Q3FY13 Q1FY14 Q3FY14

Hindalco Sterlite(INR)

Quarterly Operating Profit per ton

Source: Company results, Ind-Ra estimates Hindalco EBIT/ton & Sterlite EBITDA/ton

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Jan 07 Jun 08 Nov 09 Apr 11 Sep 12 Jan 14

Al Metal Alumina

India Al Metal and Alumina Price Trends – IndexedAlumina Price Growth over Metal


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Jan 10 Dec 10 Nov 11 Oct 12 Sep 13

Import Bauxite (LHS)

Imports Alumina (RHS)

India Bauxite and Anumina-ImportsTrend Upwards


Operating rates are capacity utilisation levels

Corporates


March 2014 6

Figure 11

High Systemic Inventory

Copper metal inventories, both at producers and exchange, reached an eight-year high at end-

1Q13 and declined to an extent by end-2013. Global consumption is likely to recover in 2014.

However, the liquidation of built-up copper inventories, scheduled capacity expansion and

possible moderation in Chinese consumption would weigh on metal prices in FY15.

Figure 12

Signals from Financial Markets

Copper has entered into a backwardation since beginning of December 2013. In theory, this

indicates a scarcity of the commodity. Empirically, a backwardation in copper markets in the

past has generally not been followed by a sharp increase in the metal price. However, if the

current levels of global interest rate and liquidity persist, there may be limited upside to the

price of copper.

Figure 13

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2009 2010 2011 2012 TTM Oct13

Production (LHS) Consumption (LHS) Percentage surplus to consumption (RHS)

Cu Metal Production & ConsumptionSurplus Trend Upwards

(000mt)

Source: Bloomberg

(%)

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Jan 08 Aug 08 Apr 09 Dec 09 Jul 10 Mar 11 Nov 11 Jun 12 Feb 13 Oct 13

Producers and other inventory (LHS) Stock exchange inventory (LHS)

Average monthly LME prices (RHS)(000MT)

Cu Inventory and LME Price Trend


(USD/Mt)

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Last price (LHS) Spreads 3M Futures-Spot (RHS)

Spot Trend 3M LME Futures – SpotPredominantly a Contango Market

Source: Bloomberg/LME

(USD/Mt) (USD)

Figure 10

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March 2014 7

Domestic Scenario

Muted Demand Growth

Ind-Ra expects muted domestic demand growth for the metal in FY15. The key sectors driving

demand growth, such as electricals, power and construction, are unlikely to generate

meaningful demand in FY15. Domestic production and usage declined by an estimated 12%

yoy and 1% yoy, respectively, for ttm October 2013. Production disruption at Sesa Sterlite’s

Tuticorn smelting unit during 1QFY13 also contributed to the production decline.

TCRC Margins Supported by Surplus Concentrates

The expected surplus in global copper concentrates along with additional mining capacity is

favourable for TCRC. Figure below # shows the agency’s observation that copper ore prices

softened in 2H13 when rupee weakened substantially. India is among the top 10 counties by

smelting capacity. Smelters generally pass through increases in copper prices and earn TCRC

margin. India depends on imported concentrates to a large extent and is a net exporter of the

primary metal.

Figure 14

Integrated Producer to Sustain Margins

A weak rupee is favourable for integrated copper miners but not so much for custom smelters

who depend on imported ore/concentrates. Thus, integrated producers are in a better position

to sustain operating margins in the event of volatility in input prices and/or forex rates.

Hindustan Copper is the only integrated producer in India and Sesa Sterlite and Hindalco

predominantly are custom smelters.

Figure 15

Cost Pressure

In FY15, Ind-Ra expects cost inflation to continue to offset the benefit of a weak rupee and

favourable TCRC margins. Hence, operating profitability is likely to remain stable. Low prices of

key by-products, such as sulphuric acid and precious metals, have also offset the benefit of

currency weakness.

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WS copper price index (LHS) Copper ore WS price index (RHS)

India Cu Metal and Cu Ore Price Trends – IndexedOre Price Growth Slows


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Jan 08 Sep 08 May 09 Dec 09 Aug 10 Mar 11 Nov 11 Jun 12 Feb 13 Sep 13

Total metal exports (LHS) Ore imports (RHS)

India Cu Ore Imports and Metal Exports


(tons) (tons)

Corporates


March 2014 8

Figure 17

Figure 18

Zinc

Price Upside Restricted

Ind-Ra expects zinc prices to remain stable in FY15. Although global demand of the metal is

likely to recover from the FY14 levels, the supply surplus in the China concentrate market,

metal inventory build-up, with producers and exchange alike and risk of China growth

moderation will continue to restrict the upside for the price.

Global demand growth turned positive in the 11 months ended November 2013, contributed

mainly by key markets including the USA and China. This has resulted in better balance in

global metal demand supply situation. However, in the context of limited capacity expansion in

the near term, closure or disruption of any major project could trigger a deficit in supplies,

pushing metal prices up.

Chinese mine production is likely to have remained well above consumption in 2013, creating a

surplus. This could keep regional metal prices in check in 2014.

Figure 19

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Jan 08 Jun 08 Nov 08 Apr 09 Sep 09 Feb 10 Jul 10 Dec 10 May 11 Oct 11 Mar 12 Aug 12 Jan 13 Jun 13 Nov 13


USD INR exchange rate (RHS)

Copper Price Trend-LME & IndiaWeak Rupee Split Domestic Price From LME


(Index) (USD INR)

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Dec 11 Mar 12 Jun 12 Sep 12 Dec 12 Mar 13 Jun 13 Sep 13 Dec 13

Hindalco Hindustan copper Sterlite(INRbn)

Revenue Trend

Source: Company Results

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2009 2010 2011 2012 TTM Oct 13

Production (LHS) Consumption (LHS) Percent surplus to consumption (RHS)

Zn Metal Slab Production & ConsumptionDegree of surplus continue to ompress

('000 mt)


(%)

Figure 16

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March 2014 9

The global inventory build-up in metal exceeded 2mt at end-September 2013 from around

1.85mt at end-September 2012 (source: International Lead and Zinc Study Group). The

inventory is an estimated 17% of the global annual consumption in 2013.

Figure 20

Zinc futures market moved from being predominantly in contango to backwardation by end-

2013 indicating supply tightness. The agency expects a decline in mining supplies in the

medium term with certain large and low-cost mines scheduled to close. This would lead the

inventory levels to moderate from the current levels and support potential upward movement in

metal price.

Figure 21

Domestic Scenario

Ind-Ra expects domestic realisation and operating profitability in FY15 to remain stable, despite

a likely increase in demand, due to global high inventory levels and pressure on metal prices.

Strong Industry Structure

India’s zinc industry is marked by a duopoly with Hindustan Zinc Ltd (HZL) and Binani Zinc Ltd.

being the only two meaningful metal producers. Hindustan Zinc is among the top three

integrated players globally (in terms of metal capacity) with cash cost in the lower quadrant.

Muted Demand Growth

Ind-Ra expects a moderate uptick in domestic metal demand on back of modest growth in steel

production in FY15. The agency has a negative outlook for the steel sector in FY15.

Galvanisation of steel is the key end-industry, consuming an estimated three-fourths of the

domestic production. The agency expects the domestic supply situation to remain comfortable

in the medium term. HZL plans to increase its mining capacity to 1mtpa (metal) in FY14-FY15.

The company’s Zinc sales grew 27% yoy in ttm December 2013.

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Jan 08 Jul 08 Jan 09 Jul 09 Jan 10 Jul 10 Jan 11 Jul 11 Jan 12 Jul 12 Jan 13 Jul 13 Jan 14

LME inventory (LHS) LME price (RHS)(MT)

Zinc Inventory & Price MovementInventory Levels Recede From Peak of Jan 13

Source: Bloomberg/LME

(USD/Mt)

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LME price/mt (LHS) Spread (futures 3M-spot) (RHS)(USD/Mt)

Spread Between Three MonthFutures and SpotBackwardation May Mean Supply Tightness

Source: Bloomberg, LME

(USD/Mt)

Corporates


March 2014 10

Figure 22

Cost of Production Offsets Rupee Benefit

HZL‘s average realisations increased by 13% yoy in 2013 on back of a weakening rupee.

However, operating profitability improved only marginally due to higher cost of production and

lower by-product realisation.

Figure 23

Figure 24

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Slab consumption Slabs exports

India Zinc Slab Domestic and Exports Monthly SalesDomestic Sales remain robust

(tons)


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Ore production (LHS) Zinc ore price (RHS)(tons)

India Zinc Ore Production and Price Trends Ore Prices Trends Up

Source: Bloomberg 2004-2005 =100

(Index)

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Jan 08 Aug 08 Mar 09 Oct 09 May 10 Dec 10 Jul 11 Feb 12 Sep 12 Apr 13 Nov 13


USD INR exchange rate (RHS)(Index)

Zinc Price Trend-LME & IndiaWeak Rupee Split Domestic Prices from LME


(USD INR)

Corporates


March 2014 11

Figure 25

2013 Review

Sesa Sterlite Ltd.

Sesa Sterlite, erstwhile Sesa Goa Limited, is a subsidiary of Vedanta Resource Plc (Fitch

Ratings Issuer Default Rating ‘BB+’/Stable). As part of a reorganisation completed in August

2013. Sesa Sterlite was formed by merging Sterlite Industries India Limited, Madras Aluminium

Company Limited, Vedanta Aluminium Limited and Sterlite Energy Limited with Sesa Goa

Limited.

Ind-Ra has assigned Sesa Sterlite a Long-Term Issuer Rating of ‘IND AA+’. The Outlook is

Stable. The ratings reflect its strong and diversified business profile with significant presence in

multiple business segments including zinc, oil & gas, copper, aluminium, iron ore and power.

Sesa Sterlite’s most business operations entail low cost, especially in oil & gas and integrated

Indian zinc operations where the company’s cost of production lies in the first cost quartile. The

cost of production in the company’s other businesses also, especially aluminium, continues to

be in the lower half of the cost curve despite lack of raw material linkages.

Ind-Ra expects Sesa Sterlite’s consolidated revenue to decline in FY14 due to softening of

commodity prices, although the impact would be partially offset by a depreciated rupee. The

decline will also be due to the temporary suspension of Indian copper operation. EBITDA is

also expected to fall in FY14 despite higher production from the company’s Rajasthan oil fields

due to lower profitability from the oil & gas segment (higher exploaration cost) and higher profit

petroleum paid to the government. Profitability will also be impacted from lower copper

production in India, although the impact will to some extent be offset by higher profits from Zinc

India due to higher volumes.

Sesa Sterlite’s net leverage is likely to increase in FY14 due to the lower profitability and

tproposed buyback of Cairn’s shares. However, the increase will remain within the negative

rating guidelines.

Century Aluminium Manufacturing Co.

Century Aluminium Manufacturing Co (CAMCO) is a closely held company. It manufactures

aluminium alloys ingots for the domestic automobile engineering industry and de-oxidants for

the steel industry. CAMCO’s manufacturing facilities are located at Khardah in West Bengal

and Faridabad and Hodal in Haryana.

Ind-Ra downgraded CAMCO’s Long-Term Issuer Rating to IND BB in 2013 from INDBB+. The

Outlook Is Stable. The downgrade reflects the material deterioration in CAMCO’s credit metrics

and financial profile in FY12 (year end March). Margin declined because of high input costs

which it could not pass through to its customers and debt increased due to debt-funded capex

and increased working capital requirements.

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Dec 11 Mar 12 Jun 12 Sep 12 Dec 12 Mar 13 Jun 13 Sep 13 Dec 13

Realisation per ton (LHS) Sales qty (RHS)(INR)

Hindustan Zinc Sales Vol. & Realisation TrendVol. & Realisations Improved in 2013

Source: Company Results, Zinc, Lead and Silver

(tons)

Corporates


March 2014 12

The rating is supported by CAMCO’s established track record of over 30 years in aluminium

recycling coupled with its long-standing relationships with a reputed clientele. The rating is

further underpinned by CAMCO’s presence in National Capital Region which gives it proximity

to various original equipment manufacturers.

Corporates


March 2014 13

Appendix

Figure 26 Issuer Ratings

Issuer Rating/Outlook/RW

(Current) Rating/Outlook/RW

(End-2012)

Sesa Sterlite Ltd. IND AA+/Stable IND AA+/Stable* Century Aluminium Manufacturing Co. Limited IND BB/Stable IND BB/Stable

Source: Ind-Ra, * Sterlite Industries India Ltd

Corporates


March 2014 14

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