Edelweiss Research - December, 22 2010- JSW STEEL

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Acquires 41% stake and management control in Ispat for INR 21.6 bn
JSW Steel (JSW) to acquire 41.3% equity in Ispat Industries (Ispat) by investing
INR 21.57 bn, implying an enterprise value of INR 123 bn (including preference
capital) and equity valuation of INR 52 bn. Ispat has HRC and downstream flats
capacity of 3.3 mtpa and ~0.5 mtpa, respectively. For 12mFY10, Ispat posted
revenue, EBITDA and PBT of USD 1,733 mn, USD 308 mn and USD (-60 mn),
respectively, with sales volume of 2.6 mt.
􀂄 Operational improvement and synergy benefits crucial for turnaround
Ispat achieved EBITDA/t of USD 118 in 12mFY10. We expect a combination of cost
savings, better realisations and cyclical improvement in steel margins to lead to
EBITDA/t and EBITDA of USD 175 and USD 525 mn, respectively, by FY13E. Such
a turnaround would imply EV/EBITDA of 5.2x which is fair but not cheap. Potential
cost savings include those on freight, power, VAT and raw material (leveraging
JSW’s existing supplier base and upcoming pellet capacity).
􀂄 Debt refinancing planned for Ispat; interest cost could be down 200bps
The effective cost of Ispat’s term debt, aggregating INR 67.8 bn, is ~12.5%. JSW
proposes to refinance this by September 2011, which will bring down interest costs
by 200-250bps.
􀂃 Ispat to undertake capex of INR 31.4 bn over next two years
Ispat is planning capex of INR 31.4 bn over the next two years, which includes
setting up a 110 MW CPP, 3 mtpa pellet plant, 1 mtpa coke plant and capacity
expansion to 4.0 mtpa from the existing 3.3 mtpa. So far, it has spent INR 4 bn.
Of the equity infusion of INR 21.57 bn into Ispat, INR 7-8 bn will be the required
equity capital for this capex; the remaining capex is likely to be funded through
fresh debt of ~INR 20 bn over the next two years.
􀂃 Outlook and valuations: Turnaround is key; maintain ‘BUY’
This acquisition will enable JSW to emerge as India’s largest steel player, at 14.3
mtpa, by early FY12. We believe JSW has the financial strength and operational
capabilities to effect the turnaround as mentioned above. However, the issue of
increased debt of INR 94 bn would act as a drag. Hence, we do not see upside to
our fair valuation of INR 1,372/share. We maintain ‘BUY/Sector
Outperformer’ on the stock.