Metal Stocks: Why you need to be cautious before Investing

Can we build an investment case?

The sharp correction in the price of metal stocks has once again raised the subject of cheap valuations. The theorists may have a valid point from a valuation standpoint. Most stocks like Hindalco, Tata Steel, SAIL and Vedanta have corrected by 50-60% from their peak prices. This has probably made these stocks attractive in dividend yield terms too. But any investor needs to be cautious about 4 factors before jumping into metal stocks. Here is why…

Demand is contracting…

That is the biggest problem. Since the crisis of 2008, China emerged as the biggest consumer of all kinds of metals and alloys. That is changing with the distinct slowdown in China. Official figures have projected growth rates at around 6.5% next year but unofficial estimates put Chinese growth closer to US levels at 4%. That is not great news for metals and alloys demand. Currently, there is no other economy in the world that can match Chinese demand.

Yuan devaluation story…

The devaluation of the Yuan may have just begun. Over the last one year, the People’s Bank of China (PBOC) has sunk almost $640 billion trying to defend the Yuan. They may not find it worthwhile any longer. A cheaper Yuan will mean that Chinese exports will become more competitive. That will only add to the low cost advantage that Chinese manufacturers already possess. If anything, this can only worsen matters for Indian metal companies as they may find their products become increasingly uncompetitive.

End of the super-cycle…

Most metals and alloys move in long term super-cycles. The metal super-cycle that began in the early 2000s, has finally been dragged into a downturn. The upturn was led by Chinese demand and the downturn will be no different. Normally, such super-cycles never exhibit a V-shaped recovery; and this time it is unlikely to be any exception.

Don’t forget the debt burden…

In fact, the Finance Secretary had virtually sent an SOS to the Steel Secretary a couple of months ago about the unsustainable levels of debt that steel companies are running. Even companies like Hindalco have heavily leveraged themselves for the acquisition of Novelis. Tata Steel and Vedanta have also heavily leveraged to finance acquisitions of Corus and Cairn respectively.

The problem with such a heavy debt burden is that there may be only one of the two choices available. First is to sell off assets to pare debt. Second is to wait until debt comes under control before value emerges. Neither seems to be a very attractive alternative! ©

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