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Jindal Steel & Power
Go for Growth & Raw Metals
Integration: Turning OW
Investment conclusion: Post its market performance
in 2010, we upgrade JSPL to Overweight with a price
target of Rs816 (22% upside). We are more constructive
on the stock owing to: (1) Profitability of JSPL’s new
projects that are coming closer to commissioning are
underestimated by the market; (2) In an inflationary
environment JSPL’s long iron ore status, full thermal
coal self sufficiency and low dependence on coking coal
should likely stand out, and (3) JSPL’s growth slope
looks stronger and less riskier than its peers.
What's new? We adjust our steel price assumptions for
F11-F13, build in the recent delay in commissioning of
the 135 MW power units, and revise our consolidated
F2011-13 EPS forecasts.
Why Overweight: Strong steel price trends, a likely
jump in earnings in the next 2-3 years, and progress on
2,400MW Tamnar II power plant and the 1.6mt Angul
steel plant do not seem to be reflected fully in the stock
price. In addition, JSPL’s annual iron ore and coal
production of 7mt and 5mt along with its reserves of
180mt and 1,000mt, respectively, will likely be assigned
enhanced valuations as this advantage becomes fully
reflected in coming quarters. At F2012e EV/EBITDA of
7.8x, JSPL looks attractive to us given our forecast of
EBITDA CAGR of 25% in F10-F13, its low earnings
volatility, and strong competitive advantages.
Possible catalysts include: Favorable steel pricing
news flow in the next six months; quarterly results in
1H11, which should highlight JSPL’s raw materials
advantage and profitability of its recently commissioned
pellet plant; commissioning of more 135 MW power units
in next 2-3 quarters; and start of construction on steel
making facility at Angul project.
Investment Debates Summary: Steel Prices, Valuations,
Environmental Clearances, Acquisitions, Mining Tax
1. Will steel prices rise from here?
Market’s view: Global steel industry utilization is low and with
sustained level of poor demand in the West, steel prices are
unlikely to move up much from here.
Our view: Steel prices should grow 12-15% in 2011, touching
US$900/t in the process. Low steel inventories, sustained
producer discipline in the West, healthy demand in China, and
rising steel deficit in India support our positive view.
Leading indicators: Scrap, iron ore and coking coal prices
have already moved up substantially.
Where we could be wrong : Deterioration in sovereign debt
situation in Europe, knee-jerk reaction by China to control
inflation are some of the issues that could cause a sudden drop
in steel demand globally, driving a slump in steel prices.
2. Power capacity ramp up timelines
Market’s view: Skeptical on JSPL’s ability to ramp up more
135 MW units in next 2-3 quarters and in its ability to complete
Tamnar II even by end-F2013.
Our view: Completion of 3 rd and 4th unit of 135 MW are likely by
F1Q12, Tamnar II should be commissioned by end- F2014
given the restoration of environmental clearances for the latter.
Where we could be wrong: We believe meaningful regulatory
and environmental set back on projects like Angul and Tamnar
II could derail investor sentiment and could cause a decline in
profitability of JSPL
3. Growing Bigger Faster?
Market’s view: JSPL’s new projects like Angul, Patratu and
Raigarh may not become material in next 3-4 years.
Our view: While Raigarh plant is still some time away, we feel
Angul and Patratu should start contributing materially (via their
rolling and finishing mills) to JSPL’s earnings in next 4-6
quarters. Steel-making facilities too should witness start of
construction in next 2-3 quarters.
Where we could be wrong: Regulatory and environmental
issue, slump in steel industry trends prompting the company to
scale back its investment program
4. Would Mining Tax impact profits?
Market’s view: JSPL will be affected to a great extent by the
mining tax since it has large iron ore and thermal coal reserves.
Our view: As JSPL sells around 1.5 mt of iron ore in the
merchant market, we believe JSPL will be able to pass on the
impact to a large extent. Assuming a partial pass-through for the
merchant market realizations, we believe the impact should be
limited to 5.3% of F2012 PAT.
Where we could be wrong: If JSPL is not able to pass on the
tax impact through higher iron prices or merchant realizations
due to a sump in demand in both, steel and power markets, the
stock could face some downward pressure.
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