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JSW Steel
Attractive deal, maybe a bit too early
Event
ƒ JSW to acquire 45.5% Ispat Industries: JSW Steel announced today that
it will be acquiring a 45.5% stake in Ispat Industries for a consideration of
US$480m. This deal values Ispat Industries at close to US$2.5bn, or US$712/t,
which is a 30% discount to the replacement cost. While we have doubts about
the timing of the deal, given that JSW recently reduced its leverage and
needed to consolidate, we find the deal valuations are attractive.
Impact
ƒ The assets – near the consumer and high on potential: Ispat Industries
owns a 3.3mtpa steel plant near Mumbai, close to consumers (autos and
re-roller). It includes a 1.6mt gas-based DRI, a 2mt blast furnace and a 3.3mt
hot strip mill. It also owns a 12mtpa captive port. With additional investment of
US$500m in CPP, coke oven and pellets, we estimate the EBITDA margins
can be improved from the current US$70–80/t to US$110–120/t.
ƒ Deal attractively valued and can be easily funded: On a replacement cost
basis, the deal does look attractive to us at just US$712/t of steel capacity.
JSW is sitting on cash of US$680m and won’t need to raise further debt to
fund this purchase. However, the debt on Ispat Industries will have to be
refinanced and would increase JSW’s debt/equity to 1.37x from 0.8x, by our
estimates.
ƒ EPS dilutive at first glance: Based on our assumptions (EBITDA for Ispat at
US$80/t), the deal would lead to 10% EPS dilution in FY12E. It needs
US$150/t of EBITDA for an EPS breakeven, which looks difficult to us as JSW
itself is doing close to a US$125/t EBITDA margin currently.
ƒ Open offer for a further 20% stake: As per the SEBI’s guidelines, JSW will
have to make an open offer for an additional 20% stake on expanded equity
at Rs20.7/sh. The acceptance ratio will need to be 78% of the free float,
assuming existing promoters do not subscribe. However, given the current
stock price is higher than the open offer price, and considering that Ispat
Industries actually will be in much better shape, many investors may not
subscribe to this offer. Hence, we consider JSW might limit its holding to 51%.
Earnings and target price revision
ƒ No changes.
Price catalyst
ƒ 12-month price target: Rs1,492.00 based on a sum-of-the-parts methodology.
ƒ Catalyst: Increasing steel prices in India and synergies from this deal.
Action and recommendation
ƒ Maintain Outperform; accumulate on dips: JSW’s growth profile remains
robust but we think the oversupply in the global steel market and pressure
from raw material prices will keep margins muted. Also, the increased risk
profile could lead to a PER de-rating in the near term. Hence, we would
advise waiting for an earnings downgrade to enter this stock.
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