We believe that metal companies in India would benefit from sequential upswing in prices. However, cost pressure, mainly increasing raw material and higher energy cost would impact margins. We expect Q3FY11 performance for metal companies to be a mixed bag, depending upon the varying level of integration.

Ferrous: Although steel prices rebounded sharply in Dec'10,

European debt crisis and rate hike in China on renewed inflation concerns kept prices low in Oct'10 and Nov'10. On the raw material side, while contract prices for Q3FY11 had declined sequentially, those for Q4FY11 increased 8-15% QoQ as spot prices gained strength on higher imports from China and supply concerns.

.. SAIL: Sequential improvement on lower usage of high cost coking coal

.. Tata Steel: Lower profitability at TSE to drag down consolidated performance despite strong Indian operation.

.. Sesa Goa: To benefit from higher spot price despite decline in volume. However, volume growth concerns remain

.. Usha Martin: Failure of blade in captive power plant and unavailability of trucks for coal transportation to result in lower output and contraction in margin.

Non-ferrous: Infusion of USD600bn as part of renewal of quantitative easing (QE2) by US Fed resulted in increased demand for base metals as inflation-hedge. While LME copper was the biggest beneficiary (up 19% QoQ), Alu, zinc and lead also strengthened.

.. HZL: Performance expected to marginally decline YoY due to muted volume growth and increase in operating cost.

.. Nalco: Despite slight decline in sales volume and rise in energy cost, we expect Nalco's performance to improve on higher realization.

Recommendation

Top BUY: Tata Steel, Godawari Power and Usha Martin

Top SELL: Bhushan Steel, Nalco