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SAIL: Noise on Coking Coal, Some Project Delays to Limit Upside –
Downgrade to EW
Why We Are Downgrading
1) Delays in project-related gains: Our assessment is
that some of the earlier project-related gains (volumes,
costs, and product mix) may be delayed by 6-12 months.
This may also cause disappointment on the Street in the
coming quarters.
2) Coking coal cost escalation: We think that steel price
increases will be sufficient to compensate for the
upcoming coking coal cost escalation in the next two or
three quarters. However, we still believe this may
impose some sentimental barriers over that period too.
Apart for the above two factors, the proposed FPO, in the
absence of acceleration in the company’s capex, could also
hinder the stock. It will point towards more conservative
capital structure, which could curb the company’s value.
Why We Are Still Positive on Long-Term Prospects
1) Strong steel pricing to enable expansion in EBITDA
per ton: With subdued 1HF11 performance, pessimism on
SAIL’s performance has risen, which we think should ease
over the coming quarters. Steel price strength in the Indian
market in the next 4-6 quarters should enable an expansion
in EBITDA per ton.
2) Solid plans for transformation
Key elements of cost reduction due to modernization
• Proportion of continuous casting projected to increase to
100% by F2H14 from 67% in F1H11.
• Semis proportion to gradually decrease to nil from 8%
currently.
• Production through twin hearth furnaces to fall to nil by
F15 from current 24%.
3) Value Enhancement through Alliances
SAIL recently announced a JV with Kobe Steel: The aim
is to develop upstream and downstream projects with an
initial focus on itmk3 (technology for aggregation of iron ore
fines). We regard this as a positive development for SAIL,
reinforcing the theme that we sought to explore in our recent
report of November 30, Mid-Long term Strategies Capturing
Asian Demand Growth (a collaborative work between our
Japanese, Korean and Indian steel teams).
While the Japanese companies are getting access to the fast
growth Indian market Indian companies are getting access to
technology for quality and cost up gradation.
As per the agreement, SAIL may continue to explore
other JV possibilities: According to recent media reports
(“SAIL, Posco near Rs16,000-crore plant JV deal”,
Hindustan Times, January 4, 2011), SAIL and Posco have
signed an MOU for a 3mt steel plant at Bokaro. According to
the report the two firms have finalized the details of the
project and work should start at the site in about a month’s
time. The JV could involve an outlay of Rs160 b and would
involve constructing the 3mt steel plant at Bokaro adjacent to
the existing facilities. The new plant plans to use Posco’s
finex technology, which could lower the cost of production by
20-25%. We are currently not taking the above two projects
in our model for want of more clarity.
Earnings Estimate Changes
1) We have lowered our F11 sales volume from 12.9mt to
12.06mt to factor in the subdued 2QF11 performance.
2) We have also pushed ahead our capacity step-up
assumptions. We now expect volume growth of 10% for
F11-F13 vs 12% earlier. We reduce our coke rate
reduction to 3% in F13 vs 4% earlier.
3) We push up iron ore, coking coal and steel price
assumptions for F12 and F13.
Why Equal-weight
• Strong steel price trends
• Unmatched iron ore sufficiency amid
raw material price inflation
• Capacity set to grow from 12 mt to 21
mt in next three years
• Solid cost reduction likely in next 2-3
years
• However, some of the large projects
may take longer than earlier
anticipated and hence may cause
some disappointment on the Street
• Even though we expect a full
pass-through, rising coking coal prices
may restrain sentiment in the short
term
• The proposed FPO may continue to
act as a short term overhang
• The stock trades at an F12E
EV/EBITDA multiple of 6.4x, implying
a premium of 8% over its Indian peers
which indicates only little upside to us,
given our forecast of EBITDA CAGR of
46% over F11-F13
Key Value Drivers
• Steel price. For every 1% increase in
steel prices, we estimate SAIL’s F12E
EPS rises by 3.5%.
• Project execution. production volume
CAGR of 10% in F10-F14E likely
• Production costs. Higher coking coal
cost in F12 and F13 (vs. base case of
US$260/t and US$251/t of steel) could
impair margins.
Key Catalysts
• Progress on projects and divestment
• Quarterly results in 1HCY11
Risks
• Stunted growth or government
intervention in steel prices
• Abnormal delay in expansion projects
• Larger than expected coking coal cost
increase
• Divestment at abnormally low prices
Valuation
Price Target Changed from Rs259 to Rs196
In our DCF model, our base-case value changes from Rs259
to Rs196 per share, following the changes
• We push up our long-term steel price assumption
by 5% to US$550/t, coking coal by 13% to US$125/t
and iron ore by 36% to US$83/t.
• We postpone commissioning of Bokaro and
Rourkela and Durgapur by 3 quarters each.
India Equity Research Reports, IPO and Stock News Visit http://indiaer.blogspot.com/ for complete details �� ��
SAIL: Noise on Coking Coal, Some Project Delays to Limit Upside –
Downgrade to EW
Why We Are Downgrading
1) Delays in project-related gains: Our assessment is
that some of the earlier project-related gains (volumes,
costs, and product mix) may be delayed by 6-12 months.
This may also cause disappointment on the Street in the
coming quarters.
2) Coking coal cost escalation: We think that steel price
increases will be sufficient to compensate for the
upcoming coking coal cost escalation in the next two or
three quarters. However, we still believe this may
impose some sentimental barriers over that period too.
Apart for the above two factors, the proposed FPO, in the
absence of acceleration in the company’s capex, could also
hinder the stock. It will point towards more conservative
capital structure, which could curb the company’s value.
Why We Are Still Positive on Long-Term Prospects
1) Strong steel pricing to enable expansion in EBITDA
per ton: With subdued 1HF11 performance, pessimism on
SAIL’s performance has risen, which we think should ease
over the coming quarters. Steel price strength in the Indian
market in the next 4-6 quarters should enable an expansion
in EBITDA per ton.
2) Solid plans for transformation
Key elements of cost reduction due to modernization
• Proportion of continuous casting projected to increase to
100% by F2H14 from 67% in F1H11.
• Semis proportion to gradually decrease to nil from 8%
currently.
• Production through twin hearth furnaces to fall to nil by
F15 from current 24%.
3) Value Enhancement through Alliances
SAIL recently announced a JV with Kobe Steel: The aim
is to develop upstream and downstream projects with an
initial focus on itmk3 (technology for aggregation of iron ore
fines). We regard this as a positive development for SAIL,
reinforcing the theme that we sought to explore in our recent
report of November 30, Mid-Long term Strategies Capturing
Asian Demand Growth (a collaborative work between our
Japanese, Korean and Indian steel teams).
While the Japanese companies are getting access to the fast
growth Indian market Indian companies are getting access to
technology for quality and cost up gradation.
As per the agreement, SAIL may continue to explore
other JV possibilities: According to recent media reports
(“SAIL, Posco near Rs16,000-crore plant JV deal”,
Hindustan Times, January 4, 2011), SAIL and Posco have
signed an MOU for a 3mt steel plant at Bokaro. According to
the report the two firms have finalized the details of the
project and work should start at the site in about a month’s
time. The JV could involve an outlay of Rs160 b and would
involve constructing the 3mt steel plant at Bokaro adjacent to
the existing facilities. The new plant plans to use Posco’s
finex technology, which could lower the cost of production by
20-25%. We are currently not taking the above two projects
in our model for want of more clarity.
Earnings Estimate Changes
1) We have lowered our F11 sales volume from 12.9mt to
12.06mt to factor in the subdued 2QF11 performance.
2) We have also pushed ahead our capacity step-up
assumptions. We now expect volume growth of 10% for
F11-F13 vs 12% earlier. We reduce our coke rate
reduction to 3% in F13 vs 4% earlier.
3) We push up iron ore, coking coal and steel price
assumptions for F12 and F13.
Why Equal-weight
• Strong steel price trends
• Unmatched iron ore sufficiency amid
raw material price inflation
• Capacity set to grow from 12 mt to 21
mt in next three years
• Solid cost reduction likely in next 2-3
years
• However, some of the large projects
may take longer than earlier
anticipated and hence may cause
some disappointment on the Street
• Even though we expect a full
pass-through, rising coking coal prices
may restrain sentiment in the short
term
• The proposed FPO may continue to
act as a short term overhang
• The stock trades at an F12E
EV/EBITDA multiple of 6.4x, implying
a premium of 8% over its Indian peers
which indicates only little upside to us,
given our forecast of EBITDA CAGR of
46% over F11-F13
Key Value Drivers
• Steel price. For every 1% increase in
steel prices, we estimate SAIL’s F12E
EPS rises by 3.5%.
• Project execution. production volume
CAGR of 10% in F10-F14E likely
• Production costs. Higher coking coal
cost in F12 and F13 (vs. base case of
US$260/t and US$251/t of steel) could
impair margins.
Key Catalysts
• Progress on projects and divestment
• Quarterly results in 1HCY11
Risks
• Stunted growth or government
intervention in steel prices
• Abnormal delay in expansion projects
• Larger than expected coking coal cost
increase
• Divestment at abnormally low prices
Valuation
Price Target Changed from Rs259 to Rs196
In our DCF model, our base-case value changes from Rs259
to Rs196 per share, following the changes
• We push up our long-term steel price assumption
by 5% to US$550/t, coking coal by 13% to US$125/t
and iron ore by 36% to US$83/t.
• We postpone commissioning of Bokaro and
Rourkela and Durgapur by 3 quarters each.
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