Materials – Positive : Daiwa

Visit http://indiaer.blogspot.com/ for complete details �� ��


Sector thesis: sales growth/backward integration should drive
margins
We have a Positive rating on the India Materials Sector, as we expect productionvolume
growth to mitigate rising cost pressure over the next two-to-three years. India
still has a steel deficit, and companies with strong production-volume growth and
backward integration should continue to expand their EBITDA margins. We expect
companies like JSW Steel (JSWL), Tata Steel and Steel Authority of India (SAIL) to
add meaningful capacities over the next two years, which should result in strong
growth in production volume. Tata Steel and SAIL, which have captive iron-ore mines
to meet their respective requirements for their incremental production, and JSWL,
which has a plant for iron-ore beneficiation (the process of improving the quality of
iron content in iron ore to enable it to be used in steel making), should continue to
expand their EBITDA margins even in an environment of rising raw-material costs.



Under India’s 11th Five Year Plan (for the FY08-12 period, with March year-ends)
spending on infrastructure is projected at Rs10,750bn in total for FY11 and FY12,
representing a CAGR of 24% for FY10-12. We believe the India Materials Sector
is well-placed to benefit from strong spending on infrastructure. We expect India to
be a net importer of steel to the tune of 4m tonnes for 2010. The country’s net steel
imports have surged over the past three years as domestic supply has been unable
to keep up with domestic demand. However, given the new capacities due to come
on stream over the next two-to-three years, we believe imports are likely to slow as
demand should be met largely through domestic production.

Structural outlook: three-year view
Our Positive sector rating also reflects the materials industry’s strong capex cycle
under way, which we expect to result in significant growth in production volume
over the next three years. We forecast India’s steel production to increase at a
CAGR of 15% for 2010-13 (the highest rated worldwide), aided by significant
brownfield expansion by the top-three steel producers in the country. In addition,
we expect many small producers to add capacities and open captive mines in the
next few years, which we think will drive valuation re-ratings. We believe the key
long-term issues in the sector remain the availability of land, and regulatory
approvals to set up greenfield steel plants to drive capacity expansion. If these
issues are not addressed over the next one-to-two years, we believe India would
remain a net importer of steel. We do not expect significant greenfield capacity to
come on stream over the next three years, except at three companies which have
acquired land and have received all the clearances required or are in the final stages
of receiving regulatory approval.

Along with capacity expansion, we note that India’s steel industry is undergoing a
transformation with an improvement in its overall product mix of the companies. A
new trend has emerged in the industry in 2010, with many companies forming joint
ventures or collaborations with world leaders in steel manufacturing to bring newer
technologies in steel making. JSW Steel-JFE Holdings, Tata Steel-Nippon Steel,
Uttam Galva-Arcelor Mittal and SAIL-POSCO are some of the key joint ventures
announced over the past 12 months which we believe highlight the market’s
recognition of the strong potential of India’s steel industry. In our view, these steel
heavyweights find India an attractive destination due to: 1) the availability of iron
ore, 2) low-cost skilled labour, and 3) an expanding domestic steel market, making
India one of the most attractive countries globally in which to produce steel. We
believe that India is likely to become a net exporter of steel by 2014 due to strong
expansion of greenfield projects.