When the outlook for a particular commodity improves, it throws up an equal – if not bigger – corresponding opportunity in the equity market too.
Equity investors having exposure to commodity-based businesses constantly look at the market for the underlying for clues.
Some data shows equity bets on a commodity-based business often deliver better returns than the commodity itself. But how!
Analysts attribute this equation to major margin boost in a business when the prices of the underlying commodity rise, which in turn inflates operating profit, as cost of the production remains constant.
By the same logic, commodity-linked stocks fall faster than the prices of the underlying in a commodity downturn.
“A rise in commodity prices boosts top lines of companies selling those products, because of higher realisations. There is a huge expansion in margin and that is how these companies make lots of money in an upcycle and vice-versa,” said Hitesh Agrawal, EVP & Head – Retail Research, Religare Securities.
Take the case of aluminium. Prices of the base metal have surged over 25 per cent since January 2016. But its equity market counterpart Hindalco and Nalco have seen their share prices soar 141 per cent and 80 per cent in the same period to trade at Rs 204 and Rs 73, respectively, as of July 14.
Prathamesh Mallya, Chief Analyst, Non Agri-Commodities and Currencies, Angel Commodities Broking, is bullish aluminium and expects the prices to hit Rs 130-135 a kg level in the near term. Aluminium prices were hovering at Rs 124 a kg on July 13.
In the case of steel, prices of the non-ferrous metal have advanced nearly 15 per cent in last year-and-a-half, whereas its equity equivalents Tata Steel, JSW Steel, Jindal Steel and SAIL have seen their shares gain 118 per cent, 107 per cent, 47 per cent and 108 per cent, respectively, during this period.
Steel stocks have bounced sharply ever since the government first introduced import restrictions at the end of FY16. Analysts say a major rerating could be on the cards for the industry, as the government has since extended the minimum import price and anti-dumping duties on major steel products till 2021, thus providing a floor price and making steel more of a domestic commodity like cement.
Margins of crude oil exploration and production companies are directly linked to the prices of the black gold. Earnings per share of upstream oil companies tend to improve with rising crude prices. Crude oil prices recently hit their seven-month low levels.
On a year-to-date basis, shares of upstream oil companies such as Oil India and ONGC have slipped 22 per cent and 17 per cent to Rs 265 and Rs 159, respectively, as of July 13. Crude oil prices are down 15 per cent in the ongoing calendar year so far.
“Crude can move to $48 on the on the higher side and $43 on the lower side,” said Mallya.
Sanjeev Jain, Senior Manager for Equity Research at AUM Capital Market, says companies that are directly related to the price of the respective commodities benefits mostly as prise rise improves their margins.