India Will See A Commodity Upcycle Even If Growth Is Below Trend, Says JPMorgan

Weak demand, weak global prices and judicial intervention has resulted in weak earnings and stretched balance sheets, Pinakin Parekh, analyst at the research firm, wrote in an October report. That has left very little appetite for resources companies to spend on capex. As a result, according to the report, imports of coal, liquefied natural gas, oil, steel and aluminium will rise in the next 10 years.

This, according to JPMorgan, will create a foundation for the next commodity upcycle in India. Indian steelmakers including Tata Steel Ltd. and JSW Steel, largest aluminium producer Hindalco Industries Ltd. and state-owned oil and gas companies will benefit, the report said.

India’s demand growth is structural, underpinned by rising urbanisation, the report said. The share of urbanisation in India one of the lowest among large economies.

In addition to stretched balance sheets, a combination of factors including capital availability, land issues, policy uncertainty on environment and fear of cheap imports will keep even the handful of companies who can usually undertake large capex on the sidelines, the report said.

While companies will operate at peak utilisations, Parekh said it will take time for balance sheets to be ready for firms to start looking at projects. Time taken, especially for greenfield projects, can be between five and eight years depending on land acquisition and approvals, making required internal rate of return very high and difficult, he said.

As a result, it said, all the key commodities won’t see fresh greenfield supply as companies have no incentive to go for large projects.

Top Picks

All said, JP Morgan sees a multi-year road ahead of higher
utilisations, steady demand, limited supply, increasing local premiums, higher earnings and improving balance sheets. This should drive earnings and valuation multiples higher in the metals sector, particularly steel, and select energy segments like regasification terminals, the report said.

One reason why JP Morgan sees limited capacity addition by steelmakers is low profitability on that capex. According to the report, the total yearly capex of the industry would be $4.5 billion—or $45 billion over the next 10 years. With the combined profit lower than $5 billion a year at this point, JPMorgan said, even 22 million tonnes of capacity addition is an optimistic assumption.

• JPMorgan report sees Tata Steel Ltd., JSW Steel Ltd. and the Steel Authority of India best placed.
• Hindalco should also benefit from rising aluminium premiums, the report said.
• In energy, top picks include Petronet LNG Ltd., Indian Oil Corp., Bharat Petroleum Corp, and Hindustan Petroleum Corp.