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JSW Steel – Acquisition to dilute earnings :: RBS
JSW Steel announced the acquisition of a 41.3% stake in Ispat Industries. We expect the deal to
be earnings dilutive. We factor in higher coking coal prices and reduce our FY11-13 forecasts by
11-16%. Maintain Sell, with a new TP of Rs850.
Acquisition of Ispat Industries – not cheap
JSW Steel announced it will acquire a 41.3% controlling stake in Ispat Industries for Rs21.6bn
(US$475m) by subscribing to a fresh equity issue. Ispat has capacity of 3.3mt and operates at
less than 85% capacity. The proportionate share of Ispat’s debt will be Rs33bn, taking total cost
of the acquisition for 1.1mt steel capacity to Rs54.6bn (US$1.1bn). This is similar to the historical
greenfield capex investment for greenfield capacity of US$1bn per 1mt of capacity. However, we
believe it saves JSW a few years of hard work to set up capacity. Published news reports suggest
JSW is the top bidder for asset sales at Bellary Steel and Alloys at Rs2.1bn, although there has
been no press release yet.
Management strategy to turnaround – would require substantial investments
According to JSW Steel, there should be significant savings stemming from freight transportation
costs, common sharing of rolling facilities, state sales taxes, common purchase of raw materials,
JSW’s expertise and experience in turnaround companies, etc. While we believe there would
certainly be savings, substantial investments would be required to address Ispat’s core issues of
1) high-cost power, 2) investment towards coke oven batteries, and 3) lack of raw materials, etc.
We believe Ispat’s strong and experienced management team would be a positive for JSW Steel.
We cut our FY11-FY13 earnings 11-16%; maintain Sell, with a new TP of Rs850
We believe serious efforts would be required to turn around Ispat’s operations and to reduce
debt, improve productivity and efficiency, etc. With a cash infusion by JSW Steel and resumption
of Ispat’s operations, we expect Ispat to report EBITDA/ton of US$100 and volume of 2.5mt for
FY12-13. Based on these assumptions, this could add US$100m to JSW Steel’s EBITDA for
2012-13. We see high coking coal prices as a major headwind for earnings. We factor in 5%
higher coking coal price of US$230/t and US$216/t for FY12F and FY13F, respectively, and cut
our FY11-13F earnings by 11-16%.
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