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UBS Investment Research
JSW Steel
Too much pessimism priced in
Expansion plans on track; valuing investment in Ispat at book value
The 3.2mt brownfield expansion at Vijaynagar appears on track for March 2011
completion, increasing capacity to 11mt. We value JSW Steel’s (JSW) investment
in Ispat at book value. JSW will buy a 41% stake at Rs21.57bn, implying a
contribution of Rs97 to our price target of Rs1,300. We do not value the West
Bengal expansion. JSW plans to invest approximately Rs53bn.
Assume full dilution of promoter warrants
Consolidated net debt/equity declined to 0.8x in September 2010 (compared to
1.6x in Q1 FY11) due to debt repayments of Rs.23.3bn. Net debt is at Rs121.88bn.
JSW expects Rs24.88bn in further equity injections over the next two years. We
have assumed dilution of 54m shares (issued to JFE and promoters).
Lower earnings estimates on lower volume/ASP and higher cost estimates
We lower our FY11/12/13 earnings estimates 32%/32%/11% due to higher input
costs and lower ASPs. However, our FY11/12/13 EPS estimates decline from
Rs103.08/170.28/248.60 to Rs54.24/96.89/183.40 as we have assumed shares
outstanding rise from 187m to 241m. We change volume -9%/+9%/+21% and
lower realisation assumptions -2%/-5%/-6% for FY11/12/13. Our EBITDA
estimates are 26%/28%/16% lower due to higher raw material cost assumptions.
We expect EBITDA/tonne to decline to US$134/t in FY11 from US$160/t in
FY10. EBITDA/t of US$152/t in H1 FY11 (US$131/t in Q2 FY11).
Valuation: upgrade from Neutral to Buy and raise price target to Rs1,300
Despite our lower EPS estimates, we raise our price target as we: 1) roll forward
our earnings to include FY13E EBITDA (now valued on normalised FY12-13E
EBITDA) since the impact of full 11mt capacity (from 7.8mt) should come in
FY13; and 2) adjust for JFE’s and promoter’s cash infusion.
Key worries
Lower sales volume: A key worry on the stock has been lower sales volumes
in FY11 compared to capacity. JSW has sold 2.77mt of saleable steel
compared to a crude steel capacity of 7.8mt (finished steel capacity of
c7.4mt). The company says this is because of lower sinter capacity. The
company has 4.6mt of sinter capacity and 1.7mt of pellet capacity. It is
increasing sinter capacity by 8.2mt and pellet capacity by 4.2mt by April
2011.
Increase in raw material costs: JSW imports 100% of its coking coal
requirements and has only 20% captive iron ore. It buys 40% of its iron ore
from spot in Karnataka (where prices are under pressure due to an export
ban) and buys 40% from NMDC, which sells at a discount to global prices.
Ispat acquisition: JSW has acquired a controlling stake of 41.3% for a
consideration of Rs21.6b in loss-making Ispat Industries. Though this will
increase JSW’s combined crude capacity to 14.3mt (JSW’s additional 3.2mt
will be commissioned in March 2011) making it the largest steel company in
India, the market is concerned about turning around Ispat and the leverage
because of the acquisition.
Positive developments
Capacity expansion: JSW’s earnings should benefit from increased capacity
expansion in March/April 2011. JSW is increasing crude steel capacity by
3.2mt to 11mt. However, we are assuming lower volumes in FY12 given
time to ramp up production (we assume volumes of 8.6mt, lower than the
company guidance of 9.5mt). We assume steady increase in production
ramp up to achieve sales of 10.2mt in FY13. Our volume assumptions are
conservative and there could be upside risk to our estimates
Increase in sinter/pellet capacity: Increase in sinter/capacity should not only
assist the company in operating at full capacity but also lower costs.
Increase in captive power plants: JSW’s captive power capacity will increase
to 920MW from 320 MW in FY10. With this, JSW will become fully selfsufficient
in power.
We assume a slight margin decline in FY12 despite the benefits of increased
sinter/captive power.
JSW Ispat acquisition
JSW Steel has acquired a controlling stake of 41.3% for a consideration of
Rs21.6b in Ispat Industries. Post this, JSW’s combined crude capacity will
increase to 14.3mt (JSW’s additional 3.2mt will be com
Deal positive for JSW in the medium term
Valuation not expensive: JSW is buying ready 3.3mt capacity at an EV/T of
US$824/t (compared to replacement cost of US$1,000/t). Given India has
been a significant net importer of steel in FY11 and given that all large
greenfield expansion projects are being delayed due to environmental/land
clearance issues, JSW gets the advantage of an additional 3.3mt ready
capacity. New capacity normally takes three to four years to come on stream.
The deal may not look attractive when compared on earnings/cash flow as
Ispat has been making losses, but JSW hopes to turn Ispat around by
reducing interest costs by refinancing.
We do not see significant near-term upside for JSW as Ispat is a loss-making
entity and it is likely to take some time before it turns profitable. The
acquisition is not EPS accretive now.
JSW should also benefit by setting off accumulated losses of Ispat post
merger of the two companies. Ispat has accumulated losses of cRs25bn.
We do not consolidate Ispat’s earnings in JSW’s consolidated earnings as of
now and value the Ispat stake on book value.
Key drivers
Lowering cost of debt: Ispat has been suffering from very high debt
(Rs80.4bn) and a very high cost of debt. Its weighted average cost of longterm
debt is 10% (Rupee debt is as high as 12% compared to foreign
currency debt at 6.5%). We think JSW will be able to renegotiate lower
interest rates from lenders given its lower leverage, strong execution track
record and international alliance credibility (JFE has a 15% stake in JSW).
Interest cost was Rs12,854.45m for the 15 months ended June 2010, whereas
in the quarter ended September 2010 it was Rs2,645m.
Lowering net debt: Net debt will decline from Rs80.40bn (exlcuding
working capital debt) to Rs52.066bn due to JSW’s equity infusion
(Rs21.57bn), partial conversion of preference shares (Rs4.85bn) and partial
conversion of debt by lenders (Rs1.91bn).
Freight efficiency: Ispat operates primarily in Western India in Maharashtra
(plants in Dolvi and Nagpur) whereas JSW operates primarily in Western
and Southern India. They can rationalise on freight costs. Total freight cost
for the 15 months ended June 2010 was Rs1,153.8m. Ispat is a port-based
plant (Dolvi is 75km from Mumbai) and therfore has lower freight costs on
raw material imports.
Lower manufacturing costs: EBITDA/T for the 15 months ended June
2010 was Rs3,867— the company expects to increase it by Rs4,000/t due to
savings on coke, pellets and power. We believe most of the savings will
come in only from FY12 onwards. Ispat imports coke and pellets. JSW’s
group company Jindal Stainless has spare coke capacity of 350,000t (until its
upstream capacity is ramped up) and Ispat should benefit from that. JSW will
have excess pellet capacity of 2mt from May 2011 that they can supply to
Ispat. Ispat procures power at Rs5.75/unit, a cost JSW expects to lower
(JSW Energy sells power at Rs4.75/unit)
Capex: In the medium term JSW plans to spend Rs31.4bn in implementing a
110MW power plant, 3mt pellet plant, 1mt coke plant, increasing capacity to
4mt and in cost-saving programmes.
Key highlights of Ispat Industries
Crude steel capacity of 3.3mt (sponge iron capacity of 1.6mt and blast
furnace capacity of 2mt).
Operates an integrated steel plant with its own port at Dolvi (75km from
Mumbai) and has a downstream unit at Nagpur in central India.
Ispat focuses on Flat products (HRC, CRC, Galvanized, Galvalume and
Colour Coated Sheets).
Does not have raw material integration —imports coke, iron ore.
The company is a case of corporate debt restructuring.
Operations were closed due to lack of working capital at the time of the offer.
Ispat’s net debt (including preferred capital) as of September 2010 was
Rs80.4bn (including preferred capital of Rs10bn) and net worth of only
Rs2.07bn (adjusted for accumulated losses).
Ispat made a net loss of Rs3.2bn in the 15 months ended June 2010 and a net
loss of Rs3.3bn in the quarter ended September 2010.
JSW Steel valuation
We upgrade our rating from Neutral to Buy given the share price’s significant
underperformance. JSW is trading at attractive valuations of 4.1x/3.0x
FY12E/FY13E EV/EBITDA, 10.3x/5.5x FY12E/FY13E PE and 1.2x/1.0x
FY12E/FY13E P/BV compared to the large cap steel peer average of 5.1x/4.4x
FY12E/FY13E EV/EBITDA; 11.3x/7.6x FY12E/FY13E PE and 1.6x/1.4x
FY12E/FY13E P/BV.
Though we lower our earnings estimates, our price target increases as we: 1) roll
forward our earnings to include FY13 EBITDA estimates (we now value it on
normalised EBITDA on FY12-13E)—we assume the full impact of the
increased capacity of 11mt (from 7.8mt) will come in FY13; and 2) adjust for
JFE’s cash infusion of Rs54bn (c36m shares/GDRs issued to JFE at
Rs1,500/share).
We value Ispat on book value of investments for a 41% stake purchase.
We consider consensus numbers very bullish. However, though consensus
estimates could be revised downwards, the stock has already corrected c25%
from recent peak, and we believe this is a good buying opportunity
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