High Costs Drive Down Profits of Metals Companies

The metal sector reported good topline numbers for the quarter ended September ’08. But higher input costs pulled down the operating profit margins (OPM) of companies. In line with past records, the growth in ferrous companies was higher than that seen in non-ferrous companies. The ferrous segment recorded net sales growth of 43.8% compared to the same period last year.

This is the highest growth rate in the past four quarters. The main reason for this is higher sales realisation compared to the same period last year. Steel prices started falling rapidly only in end-September; hence, the impact of this slowdown will be visible only in the December quarter. Despite high growth in topline, the segment failed to maintain its OPM, which fell by around 245 basis points.

For instance, the consolidated net sales of JSW Steel grew by around 70%, while its operating profit grew by only half that figure. Rising costs of raw materials, mainly iron ore and coking coal, were the main culprits. Another reason for the fall in OPM was higher salary expenses. For instance, Steel Authority of India (SAIL), which is a public sector company, increased the salary of its employees in line with the Sixth Pay Commission recommendations. SAIL’s salary expenses more than doubled compared to the same period last year.

In the past two months, coking coal prices have not fallen as much as iron ore and steel prices. Coking coal prices have come down by one-third, while steel and iron ore prices have almost halved. Further, many big steel companies have signed long-term contracts and the recent fall may not come as a relief to them if they sell their end products in the spot market.

Hence, many steel companies, which are not integrated, are anticipating a further pressure on operating margins in the December quarter. Non-ferrous companies also posted good numbers for the September quarter. Net sales grew by around 9% compared to the same period last year.

Though base metal prices have fallen, the average quarterly London Metal Exchange (LME) price for copper in the September ’08 quarter was higher compared to the same period in ’07. Similarly, aluminium prices were almost flat compared to the year-ago period. The rupee, which depreciated by around 9% during the September quarter, also turned out to be a saviour for topline growth of nonferrous companies which export their products to a large extent.

However, zinc prices for the September quarter were down by 44% compared to the year-ago period. The end result was that even net sales of companies like Hindustan Zinc declined by 12%. Though topline of the non-ferrous segment grew at a decent pace, the rise in power cost (by 40%), which accounts for 35-40% of the operating cost in the aluminium business, pulled down operating profit growth.

Operating profit of the nonferrous segment declined by a marginal 3.7% for the quarter ended September. Hindustan Zinc contributed the maximum (34% decline) towards this fall in operating growth. Since the beginning of October, the prices of base metals have fallen sharply. In fact, for zinc and aluminium, the prices are below the marginal cost of production for some global players. Industry experts believe the prices may not fall much from here onwards. But the current fall will be enough for non-ferrous metal companies to report a decline in profitability for the quarter ended December ’08.

Author: Jo Amey