Kotak Sec recommends: Sell JSW -target Rs 1,150

Use the recent stock rally to sell. JSW stock has outperformed the benchmark over
the past few months on the back of balance sheet deleveraging (JFE deal), uptrend in
steel prices, decline in steel imports and prospects for a strong 2HFY11E. However, all
these factors are discounted in the stock price; the stock trades at expensive valuation
of 9.7X FY2011E and 6.6X FY2012E EBITDA. Weak performance for 2QFY11 and likely
negative surprises on volumes will likely remain an overhang. REDUCE.


Stock trades at expensive valuation; REDUCE
JSW Steel stock has increased by 19% in the past month and 24% over the past three months on
the back of positive corporate developments and increase in steel prices. In our view, the stock
captures all the positive developments and now trades at expensive 9.7X FY2011E and 6.6X
FY2012E EBITDA, even after generous assumptions on pricing. The stock also trades at a
significant premium to regional players. We have tweaked our estimates marginally and base our
revised target price of Rs1,150 (Rs1,075) on FY2012E financials.
Weak 2QFY11 likely; expect EBITDA/ ton of US$140
JSW’s 2QFY11 performance will likely be impacted by decline in realization (approx US$60/ ton)
and increase in coking coal costs (US$20/ ton impact). The negative impact from the above factors
will be somewhat offset by positive contribution from lower iron ore prices after the Karnataka
Government banned iron ore exports. We expect flat absolute EBITDA on a sequential basis and
EBITDA of US$140/ton in 2QFY11E versus US$190 reported in 1QFY11 and steel deliveries of 1.6
mn tons (+34% qoq, +10% yoy). However, 2HFY11 will be significantly better on higher
realizations and a likely decline in raw material costs.
Volumes could fall short of expectations
We lower steel delivery estimates to 6.28 mn tons from 6.4 mn tons earlier (lower than the
company guidance of 6.75 mn tons) for FY2011E. We did expect volumes to be lower than guided
after a surge of imports from China at the beginning of FY2011, however, the downward revision
in volumes reflects more damage than our earlier assessment. On the positive side, the company
will likely unwind close to 100kt of the 270kt inventory added in 1QFY11.
JSW Steel management’s volumes guidance of 9.5mn tons for FY2012E appears aggressive in our
view. Note that the industry capacity addition in flats of 18 mn tons (81% of end-FY2010E
capacity) from FY2010-12E may be significantly higher than the domestic markets can absorb in a
short span. This may pressure pricing in the flats segment in FY2012E and FY2013E. We model
steel deliveries of 8.5 mn tons for FY2012E for JSW Steel.