Steel Authority of India- Captive iron ore advantage?:: Macquarie

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Steel Authority of India
Captive iron ore advantage?
Event
 2QFY11 results – below expectation: SAIL reported 2Q FY11 results which
were 18% below estimates. SAIL reported EBITDA margin at $106/t, even
lower than its non-integrated peer JSW Steel, which had reported $126/t
margin, negating any advantage of captive iron ore. We have reduced
earnings and cut our target price of SAIL to Rs168 from earlier Rs186.
Maintain Underperform on SAIL and recommend a switch to Tata Steel.
Impact
 Weak Q2 results: Net Sales at Rs106bn were up 7%YoY driven by 7%
increase in realisation, as volumes remained flat. EBITDA at Rs14.9bn is
down 35% YoY, as coking coal cost increased sharply. PAT at Rs10.9bn was
down 34% YoY, as interest expense increased while other income shrunk.
 Reducing estimates: We have reduced earnings for SAIL by 8-10%
respectively for FY11-13 driven by lower than expected profits in the first half.
We are building in substantial recovery from current EBITDA/ton of US$101 to
US$203/t in 2HFY11 and is a stretched target to meet.
 Clarity on expansion to drive consensus earning downgrades: SAIL has
given the tentative schedule of completion of each of its expansions. It
appears that the full ramp-up can now happen only by FY14. This should lead
to sharp reduction in consensus estimates for FY12 and FY13. We are 22%
and 31% below consensus on FY12-13.
 Capex amount now balloons to US$15.5bn:.SAIL has now added US$2bn
for the expansion of its iron mines in line with steel capacity. We believe that
everyone on the street was assuming 100% captive iron ore without assuming
this extra capex. This puts capex at US$1500/t of steel capacity almost 50%
higher than its peers.
Earnings and target price revision
 We are reducing our estimates by 10%, 12% and 8% in FY11, FY12 and
FY13, respectively.
Price catalyst
 12-month price target: Rs168.00 based on a PER methodology.
 Catalyst: Announcement of FPO timeline
Action and recommendation
 Maintain Underperform: SAIL currently looks expensive at 12x PER on
FY12E, with no earnings growth. The stock also has an overhang of the
upcoming equity issuance which will increase the free float by 66%. We
believe it is a bit too early to play the volume expansion story here and
recommend to switch to Tata Steel (TATA IN, OP, Rs608, TP: Rs887), where
consensus is severely underestimating the earnings.