Bhushan Steel – 2QFY2011 Result Update Angel Broking

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Bhushan Steel – 2QFY2011 Result Update

Angel Broking recommends a Neutral on Bhushan Steel.

Topline growth led by higher sales volume: Bhushan Steel’s (BSL) sales volume

grew by 21.6% yoy and 33.5% qoq to 413kt. While flat product sales increased

by 33.9% yoy and 52.7% qoq to 329kt, long products sales were down 10.7% yoy

to 83kt. In addition, average gross realisations increased by 11.3% yoy (down 6%

qoq) to `45,015/tonne. Consequently, net revenue increased by 32.4% yoy and

25.2% qoq to `1,719cr. The 1.9mn tonne hot strip mill is under trial runs and BSL

produced 221kt of hot rolled coils (HRC) during 2QFY2011. The mill is expected to

be capitalised in 4QFY2011.

Strong operating performance: While other steel companies like SAIL and JSW

reported margin contraction of 800-900bp yoy, BSL’s EBITDA margin expanded

by 207bp to 28.5%. Consequently, EBITDA increased by 42.7% yoy to `489cr.

This was mainly due to captive consumption of HR coils which led to raw material

cost (as percentage of net sales) declining to 54.0% from 63.1% in 2QFY2010.

However, other expenses increased by 132.6% yoy to `269cr. EBITDA/tonne

increased to US $255 from US $209 in 2QFY2010. Interest expenses grew by

86.6% yoy and 27.6% qoq to `101cr. Thus, net profit grew by 36.9% yoy and

25.9% qoq to `259cr.

Outlook and valuation: At the CMP, the stock is trading at 10.3x FY2011E and

8.2x FY2012E EV/EBITDA, a significant premium of ~30% over its peers. While

BSL is expected to benefit significantly through its backward integration initiatives,

we believe that the recent outperformance (gain of 57.3% over last 3 months vs.

11.5% for Sensex and 10.9% for BSE Metal Index), provides limited upside from

the current levels. Hence, we recommend a Neutral on the stock.

Other key highlights

􀂄 In 1HFY2011, BSL has incurred a capex of~ `2,059cr and has raised debt of

~ `1,779cr during the same period. Total debt at the end of the quarter was

`13,183cr.

􀂄 Inventory during 1HFY2011 increased by `1,570cr to `3,068cr.

􀂄 Depreciation expense during the quarter was flat at `53cr as the new hot strip

mill is yet to be capitalised. In October 2011, the company has produced

~90,000 tonnes of HRC. For FY2011E, the management reiterated its

guidance of 0.9-1.0mn tonnes of HRC production

􀂄 Sponge iron production was lower by 20.9% yoy and 45.9% qoq at 61,952

tonnes on accounts of technical problems associated with the sponge kiln.

However, sponge iron production is expected to increase in 3QFY2011.

Investment rationale

Entering a new orbit

BSL has undertaken an expansion plan in Orissa to increase its foothold in the

industry. The project is being executed in three phases, with Phase-I already

commissioned in FY2007 and Phase-II being commissioned recently. Post the

completion of Phase-II, the company's primary steel-making capacity will increase

to 2.2mn tonnes. Moreover, with the current ramping up of its new HR plant, BSL is

moving from being a steel converter to a leading primary producer of steel,

extending its presence in the steel value chain. Phase-III is currently under

execution and is expected to come on stream by 3QFY2013E. On completion of

Phase-III, BSL's primary steel capacity will increase to 4.7mn tonnes, making it one

of the leading steel producers.

Volume growth sweetened by increasing EBITDA/tonne

With the commissioning of BSL's Phase-III expansion plan, we expect sales volume

to grow at a 26.7% CAGR over FY2010–15E, much higher than its peers. Despite

BSL not being integrated, cost of production is expected to be low due to a)

combination of BF-EAF technology to produce steel and b) lower conversion costs.

The usage of BF-EAF technology will result in lower coal costs. Hence, we expect

EBITDA to register a 39.5% CAGR over FY2010–12E through a combination of BFEAF

technology and low conversion cost. Thus, BSL is expected to earn

EBITDA/tonne of US $309 in FY2011E and US $333 in FY2012E.

Outlook and Valuation

At the CMP, the stock is trading at 10.3x FY2011E and 8.2x FY2012E EV/EBITDA,

a significant premium of 30% over its peers. While BSL is expected to benefit

significantly through its backward integration initiatives, we believe that the recent

outperformance (gain of 57.3% over last 3 months vs. 11.5% for Sensex and

10.9% for BSE Metal Index) provides limited upside from the current levels. Hence,

we recommend a Neutral on the stock

We revise our estimates to factor in a) higher prices, b) higher power and fuel

expenses, c) delay in the capitalisation of 1.9mn tonnes HR mill resulting in a

change in depreciation and interest expense and other book keeping changes.