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A Classic Asian Growth Story


Whether you're talking about coal, titanium, aluminum, iron, copper, lead or zinc, the base elements have been elevated to the top of the heap amid ravenous demand by emerging markets for the raw materials that fuel factories, power grids and highways...

When it's time to name this decade with an arch moniker, like the "Swingin' '60s" or the "Roarin' '20s", investors will probably vote for something like the "Ore '00s". For the most salient feature of this ten-year span so far has been the unprecedented rise in the value of natural resources and the companies and countries that produce and refine them.

Whether you're talking about coal, titanium, aluminum, iron, copper, lead or zinc, the base elements have been elevated to the top of the heap amid ravenous demand by emerging markets for the sort of raw materials that fuel factories, power grids and highways.

While China is the poster child for this phenomenon, we should absolutely not forget about India. It too has a massive population and is determined to enjoy rapid industrialization and urbanization throughout the country. India is growing a whopping 9% per year, and I have been recommending one of its leading lights to clients lately: the little-known copper, zinc and aluminum powerhouse Sterlite Industries (SLT). The company's corporate structure is a little arcane, but basically it is a separately traded unit of the United Kingdom-based mining conglomerate Vedanta, which also has major operations in Australia and Zambia.

Click here to enlarge.

Sterlite is primarily known in India as a leading copper refiner and smelter, but after a recent deal it has also absorbed 91% of the country's leading zinc miner and refiner, Hindustan Zinc. You may know of zinc as primarily a dietary supplement or sunblock, but a much heavier version of the resource now accounts for a third of Sterlite's revenue and 70% of its earnings.

The zinc that Sterlite produces is primarily used to coat steel for protection against corrosion, a process called galvanization. Galvanized steel is used in structures that range from automobile bodies to skyscrapers, all of which are in great demand now in the region as the Chinese and Indian economies grow at a rapid pace. On the commodities futures market, zinc prices have more than tripled over the last three years while inventories have dwindled, though they've stalled a bit lately.

Worldwide, zinc consumption grew 5% last year, and it is set to grow another 4.5% in 2007 and 2008. With marginal higher-cost mines being restarted, it will be difficult for supply to catch up with the shortages of skilled labor and equipment plaguing the entire mining industry. So, as demand grows, zinc prices are going to continue to rise, which is great news for producers like Sterlite. The company's Hindustan Zinc unit operates a mine and three smelters in northwestern India and is currently exploring a 6,000 square mile area, which could boost its reserves by as much as 25%.

Total zinc capacity currently stands at approximately 400,000 tons annually, but the company has a number of expansion projects underway that will help boost production. Goldman Sachs analysts expect Hindustan's zinc volume to grow 21% next year, while Macquarie analysts see volume up as much as 50% by 2009. Macquarie also sees substantial increase in the company's copper and aluminum smelting capacity and production volume as well. Since its facilities are very efficient, considered among the top 10% in the world in terms of cost effectiveness, the company should have little problem meeting expectations.

Last month, Sterlite sold $2 bln worth of shares in the United States to finance its buyout of the Indian government's stake in Hindustan Zinc. That opened the door for me to buy into this classic Asian growth story. If you cock your head a bit and squint your eyes, you can envision how it could turn out to be a mini version of India-born steel titan Arcelor Mittal (MT), which has done very well for my portfolios in the past year, rising 100%. Other comparable global base metals plays include BHP Billiton (BHP), Freeport McMoRan (FCX), Teck Cominco (TCK) and Century Aluminum (CENX).

I will have more to say about Sterlite in the future, including details about its large copper business. For now, the stock continues to look like a solid play on global metal demand for my 2008 target of $22. Set stop at around $16.25 in case of trouble.
Position in MT.

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