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JSW Steel - Well Poised For Volume Growth
With the 3.2mtpa capacity expansion scheduled in March 2011, JSW
Steel is slated to become the second largest steel producer in the
country. While the company currently has a low level of raw material
integration, its high exposure to India (where demand is relatively
resilient and hence less risky compared with other geographies),
increased economies of scale and efficient conversion costs should
benefit the company’s financials.
Key Investment Drivers
19.4% sequential sales volume growth in 2HFY11: We expect
domestic sales volume in 2HFY11E to rise 19.4% over 1HFY11 led by the
seasonally strong activity in the country. Besides the recent pick-up in steel
prices, which will positively impact all the companies in the sector, volume
exposure to the domestic market where economic activity and steel
demand is robust, is a positive for JSW Steel in our view.
Expect news flow to have a positive impact: The 3.2mtpa Vijaynagar
plant expansion is on schedule and is expected to be completed (on target)
by March 2011. We expect consensus to upgrade JSW Steel’s FY12 and
FY13 earnings on the back of this expansion. Going forward, the
commissioning of sinter plants, coke oven batteries and starting of coking
coal mines in the USA will increase the operating efficiency of the
company and provide support to margins.
West Bengal project — the next leg of growth: JSW Steel’s current
capacity is 7.8mtpa and the recent announcement of setting up a steel
plant in West Bengal (by FY15) with an estimated capacity of 4.5mtpa
should help the company to continue on its growth part. The company has
already acquired 1,400 acres of land for the proposed project, which is a
key milestone in the current political context (where land acquisition has
become a sensitive issue). Further, since the project will have captive coal
mines, this will help improve profitability.
Acquisition to provide backward integration in the long term: JSW
Steel has acquired 39% of Ispat Industries at a cost of Rs21,570mn and
has made an open offer for an additional 20%. The deal adds existing hot
rolled coil capacity of 3.3mtpa and facilities involving 1,200 acres of land
and a captive port. It values Ispat’s assets at ~US$870/t of HRC capacity
compared with an industry replacement cost of ~US$1,000/t. The deal
values Ispat at an EBITDA/t of Rs4,500/t, which JSW management expects
to achieve in 4QFY11 itself. From a JSW Steel shareholder’s perspective,
the deal is favourable but not compelling because value creation through
margin expansion will however take at least couple of years to generate.
Valuation, Recommendation and Outlook
In October 2010 Japanese steelmaker JFE, acquired a 14.99% stake in JSW
Steel which led to deleveraging the JSW Steel balance sheet (net debt/equity
expected to fall to 0.7x in FY11). Beyond the usual risk of a fall in steel prices,
JSW Steel faces the risk of higher-than–expected raw material prices as its
operations are largely non-integrated.
We maintain our BUY recommendation on the stock with a September 2011
TP of Rs1,500. At the current market price, the stock is trading at 6.8x
EV/EBITDA and 13.9x P/E, both on an FY12E basis compared to 5 years
historical average of 6.5x.
With 3.2mtpa capacity expansion scheduled in March
2011, JSW Steel is slated to become the second largest
steel producer in the country with a capacity of
11.0mtpa. On the top of this, if one adds the recent
Ispat acquisition announced in December 2010, which
adds 3.3mtpa of Hot Rolled capacity, in terms of
management control, JSW Steel will be the largest steel
group in India. The company has a low level of raw
material integration but this is offset by its low
conversion cost (employee, power and fuel and other
expenses together were only Rs 6,100/t in FY10).
In October 2010 Japanese steelmaker JFE, acquired a
stake in JSW Steel. The deal has been structured such
that JFE will have a 14.99% stake in the company.
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