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Indian Steel Industry
Tata Steel forms auto grade steel JV with Nippon Steel
Tata Steel announces JV with Nippon for auto grade steel
Tata Steel has announced formation of a JV with Nippon Steel for a 0.6mn tonne
cold rolling mill at Tata Steel's Jamshedpur plant at a capital cost of ~INR23bn.
This JV formalizes the long-term technology relationship between Nippon and Tata
Steel. While this will dilute future returns from value-added products for Tata Steel
shareholders, we believe that Nippon would not have extended its technology
agreement without an equity stake and hence the JV is part of the emerging new
norm in the Indian steel industry. Reiterate Buy.
Globalization of steel end-user industries has made JVs and strategic stakes
preferable modes of partnership in India
With India emerging as a major hub for auto manufacturing, we believe that the
world steel majors and particularly those steel producers that enjoy a dominant
market share in auto body steels now have a strategic drive to follow their
automobile customers to India. As a result of accelerating globalization of the steel
end-user industries (particularly the automobile sector), technology-sharing
agreements in return for a mere royalty fee are no longer acceptable to steeltechnology providers. The Japanese steel companies – leaders in auto-body steels
– are increasingly looking for a footprint in India through equity partnerships with
leading steel producers. As we highlighted in our earlier note (“JFE in India – the
morning after” dated 28 July’10), we believe that JFE’s strategic investment in
JSW Steel (July’10) and Nippon Steel’s JV with Tata Steel, announced today, will
increase pressure on Sumitomo to push for faster implementation of a JV with
Bhushan Steel in India (Sumitomo is the technology supplier to Bhushan Steel).
We expect trend to gather momentum as Indian steel producers look to
move into higher value-added products
We believe that steel companies in India that aspire to move into higher valueadded products will need to build the strategic architecture to continue providing
value-added steel solutions to the fast-changing needs and demands of end users.
Consequently, access to sophisticated steelmaking technology – for both
applications and steelmaking – and in-house R&D are likely to emerge as critical
success factors. We expect the trend to gather further momentum as Indian steel
companies aspire to move into new high-margin, value-added product segments.
We use EV/EBITDA as the primary valuation methodology for Indian steel makers.
Key risks: overhang of an inflation-wary government of India; higher-thananticipated increases in iron ore and/or coking coal prices
Tata Steel announces JV with
Nippon Steel
Investments by Japanese steel producers in India gaining
momentum
Tata Steel’s JV with Nippon Steel follows JFE’s recent strategic investment in JSW Steel.
This is the second investment by a major Japanese Steel producer to establish a local
production base in the high-growth Indian steel market. Japanese steel producers had, until
these moves, articulated no strategy of setting steel plants overseas and had stayed focused
on producing value-added steels in Japan. However, with the tectonic shift in auto
manufacturing to emerging markets like India, the Japanese steel industry has begun looking
at JV’s/strategic investments in India
On account of Maruti (Suzuki’s Indian subsidiary), the Japanese auto companies already have
a market share above 50% in India. Our auto analysts Srini Rao and Amyn Pirani expect India
to emerge as a top-four auto producer globally within the next five years, and believe that the
market share of Japanese auto producers is set to consolidate around the 50% level, making
India one of the fastest-growing automobile markets in the world. As we highlighted in our
earlier note (“JFE in India – the morning after” dated 28 July’10), we believe that JFE’s
strategic investment in JSW Steel (July’10) and now Nippon Steel’s JV with Tata Steel will
increase pressure on Sumitomo to push for faster implementation of a JV with its partner
(Bhushan Steel) in India.
JVs and strategic stakes have emerged as preferable modes of partnership
With India emerging as a major hub for auto manufacturing, we believe that the world steel
majors and particularly those steel producers that enjoy a dominant market share in auto
body steels will now have a strategic drive to follow their automobile customers to India. As
a result of accelerating globalization of the steel end user industries (particularly the
automobile sector), technology-sharing agreements in return for a mere royalty fee are no
longer acceptable to steel technology providers. Japanese steel companies now want equity
stakes in Indian steel companies.
We expect trend to gather momentum as India steel producers look to move into
higher value-added products
We believe that steel companies in India that aspire to move into higher value-added
products will need to build the strategic architecture to continue providing value-added steel
solutions to the fast-changing needs and demands of end users. Consequently, access to
sophisticated steelmaking technology – for both applications and steelmaking – and in-house
R&D are likely to emerge as critical success factors. We expect the trend to gather further
momentum as Indian steel companies aspire to move into new high-margin, value-added
product segments.
We see foreign steel companies forging JV’s with Indian companies
With setting up new ventures in India emerging as a challenge, foreign steel companies
attracted by India’s robust demand potential have begun looking at joint ventures with Indian
producers. Indian players lack the capability to produce high value-added products and
foreign players have filled this void thorough technical and strategic collaboration.
We expect that large foreign companies looking at the attractiveness of India, but with
trepidation on account of its challenges, will look at tying up with smaller Indian companies
that have received mining approvals for either iron ore or coal and have the perceived
execution ability to push through projects. We see a high possibility of stake purchases of
smaller Indian steel companies by foreign steel producers.
Valuation and risks
SAIL
Valuation
Our target price of INR245/share is based on an EV/EBITDA multiple of 6.2x FY2012E. We
believe that this is justified on the back of SAIL's robust balance sheet and exposure to India -
which is set to become the world's fastest-growing steel market, behind China.
Risks
1) Sharp appreciation of the Indian rupee could put pressure on the landed costs as Indian
steel prices are benchmarked to global steel prices. Consequently, if the Indian rupee
appreciates without any corresponding rise in global steel prices, there could be downside
risk to our steel pricing assumptions and therefore our EPS estimates. 2) Any delay in the
implementation of SAIL’s modernization and upgrade programme could hit the firm's costreduction initiatives and is a potential downside risk. 3) If an inflation-wary government of
India decides to rein in domestic steel prices using regulatory measures or price curbs,
sentiment for all steel stocks, including SAIL, may be impacted negatively.
JSW
Valuation
We value JSW Steel at 5.5x FY12E EV/EBITDA, a 10% discount to the corresponding target
multiple for SAIL. We believe that the discount is justified on account of JSW Steel’s lack of
captive access to iron ore. We do expect this discount to narrow as the visibility on the
company’s raw material initiatives (both iron ore and coking coal) improves going into FY12.
At our TP, JSW Steel would trade at FY12E PER(x) of 10x, in line with the average PER(x)
over the last three years.
Risks
(1) Higher-than-anticipated increase in steel making raw material prices. If raw material price
hikes are higher than our assumptions, there could be a risk to our target price and
recommendation. (2) Based on our raw material assumptions we expect Indian steel
companies to attempt to pass on a large component of raw material price hikes. If an
inflation-wary government of India begins frowning on price hikes, sentiment for all steel
stocks, including JSW Steel, may be impacted negatively. (3) With volume growth being the
dominant theme in our positive investment case for JSW Steel, any delay in the company’s
ongoing expansion programme would be a strong negative, both for earnings and sentiment.
Tata Steel
Valuation
We value the Indian operations at 6.5x FY12E EBITDA. Though this is a premium to the
historical valuations of Tata Steel’s Indian operations, we believe there is a strong case for
the re-rating of the India operations on account of the company’s access to captive raw
material (100% iron ore, 60% coking coal), thus providing a sustainable cost advantage. We
also believe that over the course of the current decade valuation multiples of Indian steel
companies are set for a re-rating on account of structural demand growth (sustainable
double-digit demand growth in emerging markets relative to low-single-digit sustainable
demand growth in the developed world, on our estimates). We have assigned a valuation of
5.5x to Tata Steel’s European operations. Given Corus’s lower profitability relative to the
Indian operations and lack of captive access to raw materials, we assign a 15% discount to
the valuation multiple of Tata Steel India. Asian operations are converters and do not have
upstream steelmaking capacity. Hence, we believe they should be valued at a marked
discount to the Indian and European operations – both of which are integrated steel
producers. We thus assign a multiple of 2.8x. Our SOTP methodology leads to a target price
of INR786/share, which translates into a blended implied FY12E EV/EBITDA multiple of 6.1x
and FY12E PER(x) of 8.6x.
Risks
(1) Higher-than-anticipated increase in steel making raw material prices. (2) Steel demand
environment remaining challenging in Europe especially in the long product segment into
CY11 and delay in steel demand recovery. (3) The overhang of an inflation-wary government
of India. If an inflation-wary government begins frowning on price hikes, sentiment for all
steel stocks, including Tata Steel, may be impacted negatively.
Bhushan Steel
Valuation
With earnings growth being the key investment argument for Bhushan Steel, we use an
earnings-based valuation methodology for our target price. We value the company at a FY12E
PER of 8x, which leads to a target price of INR480/share. Our target multiple implies a PEG of
0.27 for Bhushan Steel and represents a 20% premium to the average multiple at which the
stock has traded since 2007, the year that marked the beginning of the company’s vertical
integration initiative with the commissioning of its first sponge iron unit at Orissa. We believe
that the premium is justified by the company’s backward integration into HRC and its
transition into a vertically integrated steel producer from solely a steel converter. We would
expect this premium to widen once the company has articulated its plans on the captive
mining of iron ore and thermal coal.
Risks
Risks include a delay in the execution/ramping up of new capacity at Orissa, intensifying
competition in the auto grade steel market in India, high leverage and capex intensity leading
to risk of dilution, and an increase in royalty/license fee to Sumitomo (US$7-8m per year at
present) for providing access to its high grade steel technology. If Sumitomo were to raise
this license fee/royalty, this could constrain Bhushan’s profitability.
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