Rise in input cost offsets rev. growth; OPM contracts For Q3FY11, while revenue for metal companies in PINC coverage universe grew by a healthy 14% YoY, benefiting from both improved realisation and higher volume, EBITDA growth at 2% YoY was subdued due to sharper rise in raw material and power cost. Blended OPM contracted by 216bps to 18.2%. However, PAT grew 13% YoY on lower interest and tax outgo.

Sectoral trends: Although metal realisations have improved YoY, the hike in the input cost (mainly raw materials and power) has been sharper, resulting in a contraction of the operating profit margin for non-integrated metal producers. Backward integration helped Tata Steel India, JSPL, Nalco, Sterlite in expanding margin.

Result surprises: While results of Tata Steel, Godawari Power, Hindustan Zinc, and Nalco surprised positively, we were disappointed by poor performance of SAIL, JSW Steel and Usha Martin as contraction in margin for these companies was much severe than expected due to higher raw material and power cost. Sesa Goa’s result benefited from higher realisation despite volume concerns.

OUTLOOK Despite inflation concerns, metal prices in the ongoing quarter have continued to strengthen, driven by robust growth in emerging economies, signs of sustainable recovery in the US and supply constraints worsened by adverse weather in producing countries. Most of the global metals and mining companies have given encouraging outlook for 2011 (pls ref pg5). However, we believe that stronger resource prices could squeeze processing margin in 2011, thereby further enhancing competitive edge of integrated producers. Demand for resource suppliers to move to monthly contract system and likely tax on mining profit are additional concerns. Although we have revised our estimates to factor in the margin squeeze (pls ref pg3 for changes in PINC estimates), we believe that recent correction in metal equities adequately factors in the concerns. We maintain our positive stance on metal stocks.

RECOMMENDATION We upgrade SAIL, Sesa Goa and Monnet Ispat to 'BUY' on raised target price. We maintain ‘BUY’ on JSW Steel and Usha Martin, albeit with reduced target price. Top BUY: Tata Steel, Godawari Power and Usha Martin Top SELL: Bhushan Steel, Nalco