NON FERROUS SECTOR - Fishing in turbulent waters - PINC Research

Despite 20-25% decline in LME prices since Jul'11, we believe it is still early to turn positive on the non-ferrous sector & recommend caution as:

- EU debt uncertainty and growth slowdown concerns in China would continue to exert downward pressure on LME prices

- In India, weak demand for metals on high interest rate and policy inaction

- OPM contraction on sticky cost, mainly energy (23-40% of operating cost)

- Project concerns: cost and time over-run, uncertainty on clearances for captive resources, likely lower utilisation levels and higher cost during stabilisation.

However, owing to 10-50% decline in non-ferrous stocks in India in 2011, we reckon selective pickings have emerged in the sector.

We initiate coverage on Hindalco (REDUCE, TP Rs122) & Sterlite (BUY, TP Rs114). We maintain ACCUMULATE on Hindustan Zinc (TP Rs132) and downgrade NALCO to SELL (TP Rs42).

Hindalco Industries: LME volatility, project concerns
CMP Rs118, TP Rs122 (SOTP-based), REDUCE
We are cautious on Hindalco's prospects and estimate EPS to decline at a 18% CAGR over FY12E-FY14E on lower LME prices, rising energy cost, project concerns with delays in captive bauxite, alumina & coal, and high financial leverage (1.3x FY13E net D/E). Despite 53% decline in 2011, we believe it is still early to turn +ve on Hindalco and initiate coverage with REDUCE.

Sterlite Industries: Concerns on stake increase in associate VAL overdone
CMP Rs94, TP Rs114 (SOTP-based), BUY
We believe the concerns on stake increase in loss-making associate VAL are unfounded and overdone as Sterlite has clarified that equity infusion in VAL would be in proportion to their 29.5% stake. Further, CMP is underplaying 13.8% EPS CAGR over FY12E-FY14E led by highly cost efficient zinc business (50%+ OPM), 107% volume CAGR in energy biz and strong balance sheet (despite excluding Rs89bn of loan given to VAL). Initiate coverage with BUY.

Hindustan Zinc: Defensive amongst metal stocks
CMP Rs124, TP Rs132 (6.0x FY13E EV/EBITDA), ACCUMULATE
Earnings to be supported by volume growth on recently expanded capacity, >30years mine life, rising share of silver profit, highly cost efficient operations, and strong balance sheet despite volatile LME. To factor-in low return on surplus cash, we value surplus cash at 20% disc. to book value & maintain ACCUMULATE.

National Aluminium (NALCO): Multiple headwinds
CMP Rs56, TP Rs42 (5.0x FY13E EV/EBITDA), SELL
We estimate NALCO's EBITDA to decline at 8% CAGR and EPS at 10% CAGR over FY12E-FY14E on lower LME prices and higher energy & labor cost. Further, we are concerned about its foray in unrelated businesses (wind, nuclear power) & geography (Indonesia). We value cash at 20% disc to BV; downgrade to SELL.

Source : Equity Bulls

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