News & Analysis » India

Lower sales realization have pulled down profits of Indian metal companies

Contributed by Nirmal Bang

By Nirmal Bang

The September ’09 quarter marks the end of a declining growth trend, seen in case of metal companies for the last four quarters. This also represents the worst quarter among the last eight quarters, at least in terms of growth figures. The metal companies, however, have managed to deliver an impressive result when compared sequentially.

Rising sales realization, reduced operating expenses and lower raw material cost are some of the factors that have helped companies to report better profitability numbers on a sequential basis.

The market was smart enough to know all these facts before the quarterly results of most metal companies were out. The 30% rise in the BSE Metal index as against 15% rise in the Sensex during the June-September period confirms this fact.

The metal and mining sector should be categorized into three broader segments - steel, non-ferrous metals and mining - while analyzing the quarterly results. This is important since each of these segments gets impacted by different factors and hence varies from each other in terms of industry structure.

The steel segment is driven by domestic prices whereas non-ferrous metal segment gets affected by the London Metal Exchange (LME) prices and the rupee-dollar movement among others. Hence we have analyzed the performance of these three segments differently. On a sequential basis, the steel sector has done extremely well mainly due to higher sales volume and lower raw material cost.

However, the performance looks subdued when compared to the same period last year. The aggregate net sales of 43 steel companies declined by close to 13% on a y-o-y basis.

This could have been even worse had the companies not managed to sell more steel than what they did last year. For instance, top steel companies such as SAIL, Tata Steel and JSW Steel reported a y-o-y growth in sales volume of at least 14% in the September quarter. The domestic steel demand is in line with the recovery in Indian economy and this is expected to continue in the coming quarters as well.

Knowing very well that they have little control over external factors, steel companies tried to increase their operating profit through internal cost control measures, not to forget reduced raw material cost. As a result, the y-o-y decline in aggregate operating profit is the lowest in the last four quarters.

In fact, the operating profit margin expanded by close to 300 basis points sequentially. A lot of steel companies signed the new long-term contracts with their raw material suppliers in the beginning of the last quarter. The suppliers have settled down to supplying raw materials, mainly iron ore and coking coal, at comparitively much lower prices.

For instance, most of primary steel producers have signed a contract to source coking coal at $110 per tonne to $130 per tonne, which is less than half of what it was last year. The impact of these lower raw materials was clearly visible in the financials of the steel companies. The aggregate raw material cost declined by more than 15% on a y-o-y basis. And this is for the first time in the last eight quarters, that the raw material cost witnessed quite a fall.

Considering the recent slowdown, most steel companies either reduced their company’s headcounts or cut-down on employees’ benefits. As a result, the aggregate employee expense for the September ’09 quarter almost got halved. Such a decline in employee expense is highest in the last four quarters.

However, the gain made in operating profit was partly wiped off by a lesser fall in interest cost and rise in depreciation. Both interest expense and depreciation are fixed expense items and it is very difficult for companies to change them within a short period of time.

As a result, the net profit fell at a faster pace than operating profit. The aggregate net profit of most steel companies declined by one-fifth from what it was in the September ’08 quarter.

The performance of some top steel companies is mentioned below.

TATA STEEL LTD
Low steel prices continue to weigh high on Tata Steel’s profitability for the second consecutive quarter. The good news, however, is that it reported a 20% y-o-y growth in its sales volume.

Tata Steel’s sales realization became two-third from what it was last year and this reduced the quarterly revenue by one-fifth.

Though the company did well to reduce its operating expenses, its adjusted net profit got almost halved. Moreover, Rs 903 crore of net profit came slightly below market expectations.

STEEL AUTHORITY OF INDIA LTD
Steel Authority of India Ltd (SAIL) managed to sail through the September ’09 quarter very well. A sharp fall in sales realization was partially offset by low operating expenses, volume growth and higher interest income among others.

The 17% y-o-y fall in its adjusted net profit is much lower than almost a 55% drop seen in case of its nearest rival Tata Steel. Its quarterly net sales at Rs 9,943 crore, is slightly below the market expectation.

The story of non-ferrous metal producers is, however, slightly different than their steel peers. While their topline performance is not so bad, the bottomline growth was not impressive either.

During the period from June-September time period, the LME prices, the benchmark for base metals, surged significantly upwards.

Aluminium prices rose by 16% while copper and zinc prices increased by around 25% each. Also, the rupee remains weak in the September ’09 quarter when compared to the same period last year. This has a 2.5% positive impact on rupee sales realization of base metals. The recovery in the economy and subsequently in industrial production led to higher demand for base metal prices. As a result, the company could sell more than what they did last year.

Top non-ferrous metal producers like Sterlite Industries and Hindalco reported at least 10% sales volume growth across different business segments. In spite of all these positive factors, the aggregate net sales of around 20 companies declined by 10% on a y-o-y basis, mainly on account of lower sales realization.

Unlike steel companies, non-ferrous metal companies could not lower their operating expenses significantly. Though the decline in topline for non-ferrous metal companies is lesser than that of steel companies, the bottomline fell at a faster rate. The aggregate operating profit of these non-ferrous metal companies became two-third of what it was last year.

The performance of some non-ferrous companies which are a part of the Sensex is as follows.

STERLITE INDUSTRIES INDIA LTD
The company’s copper and zinc business performed very well. Copper and zinc contributed close to 90% of the total operating profit (profit before interest and tax). The profit numbers would have been better had the realization from by-products not fallen so sharply.

For instance, the realization from sulphuric acid, a by-product of copper operation, fell by close to 96%. As a result, the company’s overall operating margin remained at the same level as it was in the previous quarter. In spite of a 25% year-on-year decline in net profit, the result beat street estimates, both in terms of revenue and net profit.

HINDALCO INDUSTRIES LTD
Lower sales realization and higher operating expenses hurt the profitability numbers of the aluminium and copper major, Hindalco Industries, during the September ’09 quarter. In spite of strong volume growth and lower cost of production, the quarterly net profit of Hindalco Industries got more than halved, reckoned on a year-onyear basis.

The company’s aluminium business performed badly, the copper business did well though. The net profit at Rs 344 crore came below the street estimates.

The performance of the mining sector is more or less similar to the non-ferrous metal segment. The downturn in commodity cycle lowered the demand for mining products like iron ore and coal among others.

This in turn significantly reduced the prices of iron ore, the main raw material of Indian miners like National Mineral Development Corporation (NMDC), SesaGoa and Gujarat Mining Development Corporation (GMDC) among others. As a result, the aggregate revenue reduced by one-fifth, reckoned on a y-o-y basis.

Since most of the operating expenses of these miners are fixed, the aggregate operating profit fell at a faster rate. The aggregate operating profit and net profit was almost two-third of what it was last year.

Overall, the poor performance of metal and mining sector was driven mainly by lower sales realization. The base effect of higher prices seen last year will not be there from the next quarter. As a result, most companies are expected to report better growth numbers. However, the absolute profit numbers will depend on an individual company’s ability to manage its operation.