Equity investors remain bullish on metal and mining stocks, shows data

There has been a sharp contraction in the earnings of metal and mining companies in the past two quarters, but equity investors continue to bid for the share price of companies in the sector, expecting a quick turnaround in their earnings trajectory in the next few quarters. This has driven a wedge between companies’ earnings and their market capitalisation (m-cap).

The combined net profit of listed metal and mining companies, such as Tata Steel, JSW Steel, Vedanta, Hindalco Industries, and Coal India, is down 55.9 per cent year-on-year (YoY) in the October-December quarter (third quarter, or Q3) of 2022-23 (FY23), followed by 74.6 per cent YoY contraction in earnings in the second quarter (Q2) of FY23. But their combined m-cap is up 10 per cent since the end of Q3 of 2021-22 (FY22).

These companies had a combined m-cap of Rs 7.52 trillion on Monday, up around 10 per cent from Rs 6.85 trillion at the end of Q3FY22.

The combined quarterly net profit (adjusted for exceptional gains and losses) of 12 metal and mining companies in the Business Standard sample declined to Rs 11,544 crore in Q3FY23, from Rs 26,187 crore a year ago and down 63 per cent from a record high quarterly net profit of Rs 31,195 crore in the fourth quarter (Q4) of FY22.

Similarly, the combined net profit of these companies has shrunk to Rs 7,873 crore in Q2FY23, from Rs 31,051 crore in Q2FY22.

A decline in the quarterly net profit resulted in the contraction of the company’s net profit for the trailing 12 months (TTM) for the second consecutive quarter.

The sector TTM net profit declined to Rs 75,801 crore in Q3FY23, down 29.7 per cent, from around Rs 1.08 trillion a year ago and Rs 90,445 crore in Q2FY23.

Historically, there has been a very high correlation between the m-cap of metal and mining companies and their net profit on a TTM basis. Both numbers move in tandem, albeit with a lag. The m-cap starts moving ahead of changes to earnings.

For example, the post-pandemic boom in the earnings of metal and mining companies was preceded by a sharp rise in their share price and m-cap. Similarly, the m-cap of these companies peaked in Q4FY22 — a quarter before the peak in earnings.

This correlation between earnings and m-cap seems to have now broken. There has been a sharp recovery in the share prices of these companies, notwithstanding a contraction in earnings.

“In the near- to medium-term, the steel sector is likely to emerge from a weak phase in the second half of calendar year 2022 as a result of a substantive reversal of zero-Covid policy in China, government initiatives to ease pain in the real estate sector, and easing of the energy crisis in Europe that could improve industrial activity and steel demand,” write analysts at Emkay Global Services in their report on JSW Steel earnings for Q3FY23.

The brokerage expects a 36.6 per cent upside in JSW Steel’s price from the current levels. By comparison, the company’s net sales were up 3.2 per cent YoY in Q3FY23, while its net profit was down 88.8 per cent YoY in the quarter.

“Tata Steel’s profitability is expected to improve in Q4FY23 amid higher steel prices in the domestic business and losses to reduce at its European business. Further, Neelachal Ispat Nigam is expected to start contributing to overall volumes in 2023-24, while a major contribution from Kalinganagar Phase 2 expansion is expected to reflect in 2024-25,” write analysts at Centrum Institutional Research in their Q3FY23 earnings report on Tata Steel.

Tata Steel reported a surprise adjusted net loss of Rs 1,228 crore in Q3FY23, against a net profit of Rs 9,721 crore a year ago. But analysts at Centrum raised the target price by Rs 4 per share after the earnings.

Likewise, analysts at Motilal Oswal Securities expect a 34 per cent upside in Hindalco stock price, from the current levels of 61 per cent YoY decline in the company’s consolidated net profit in Q3FY23.

It has to be seen how long equity investors will have to wait for a turnaround in the earnings trajectory of metal and mining companies.