Nomura research: SAIL preview: Favoured play on operating leverage

Steel Authority of India Ltd
Favoured play on operating leverage
SAIL reported sales volume of 3.17mn tonnes in 2QFY11, up 37.8% q-q and 5% y-y.
Since SAIL has the highest operating leverage among Indian companies, we expect it
to benefit the most from the volume surprise. We expect EBITDA per tonne to increase
from INR8,012 in 1QFY11 to INR8,638 in 2QFY11 despite lower steel prices and
higher raw material costs.
Strong volumes after disappointing 1QFY11
SAIL reported sales of 3.17mn tonnes in 2QFY11 up from 2.3mn tonnes in 1QFY11,
which saw a sharp fall on account of higher imports. Please note that the company has
reported the highest-ever second quarter sales volume.
Realization fall in line with industry
We expect SAIL’s blended realization to fall by INR2,000/t to INR37,710/t from
1QFY11 levels.
Higher raw material costs compensated by lower other costs
We expect raw material costs to increase by close to INR2,200/t primarily on account
of higher coking coal costs. SAIL will continue to use some coal from earlier contracts
of US$300/t vs. current prices of US$225/t. Please note that this was also presented in
the last quarter. At the same time, raw material costs will be slightly higher on account
of sale from inventory (which will also result in slightly lower ex raw material costs).
However, we expect its staff costs to come down in 2QFY11, as the last quarter had
extraordinary item to account for an increase in gratuity. At the same time, we expect
per tonne costs to come down because of leverage from higher sales volume. We
expect ex raw material costs per tonne to come down from INR19,375/t in 1QFY11 to
INR14,500 in 2QFY11.
Operating leverage results in higher EBITDA/t …
We expect EBITDA/t to improve on a q-q basis, primarily because of leverage from
higher volumes despite lower realizations and higher raw material costs. We expect
total EBITDA of INR27.4bn in 2QFY11, up from INR18.4bn in 1QFY11.
… and boost in net profits
Higher EBITDA should translate into net profit of INR17.7bn, up from INR11.8bn in
1QFY11.