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Losing competitive advantage
SAIL has benefited from iron ore integration over the last decade. The prices of
iron ore increased 10x, pushing up cost of steel production for most steel producers
across the world. In the resultant scenario of high global steel prices, many of
SAIL's operating inefficiencies like sharp increase of 70-75% in labor cost to
US$126/ton and other fixed operating costs to US$170/ton were overlooked. This
situation is changing. Global steel consumption is tapering down and new iron ore
supplies are likely to come on stream over the next couple of years, leading to
softening of iron ore prices. In the mean time, ~30% increase in domestic steel
production over 12-15 months, largely from primary producers will create temporary
oversupply, leading to compression in margins.
Managing costs will be a challenge, which will get increasingly exposed as spreads
between coking coal and steel prices start narrowing. Capacity expansion to
20mtpa will ensure that specific labor cost does not increase, assuming total
headcount remains constant. However, per ton labor cost (6x new private Indian
players) is non-competitive. Though headcount has halved and steel production
has doubled, the basic working on ground has not changed in over 15 years. SAIL
needs to urgently invest in adopting best management practices and restructuring.
Plant and machinery is old, requiring frequent repairs and maintenance.
Sustenance capex has been just US$11/ton/year during FY01-FY09. Under the
company's Rs700b growth plan, Rs158b (US$269/ton over five years) is being
spent on sustenance.
Capex of Rs700b is being funded by internal cash flows, FPO and debt. Though
debt/equity ratio will still remain comfortable, the change from net interest earnings
to net interest expense will drag the bottomline.
RoIC too will decline sharply due to low returns on new investment. Rs540b are
being invested to create 7mtpa of new saleable steel capacity, translating into
capital investment of US$1,628/ton v/s US$245/ton currently. RoIC will drop every
year because new investment will yield just 5.3% v/s the current RoIC of >35%.
We have cut our EPS estimate by 24% to Rs10.5 for FY12. The stock is expensive
at 14.9x FY12E EPS and an EV of 9.6x FY12E EBITDA. SAIL will have CWIP of
Rs254b by FY11 end. Adjusting for CWIP, the stock is trading at an EV of 5.3x
FY12E EBITDA, which is comparable to peers. We believe as CWIP moves into
gross block, the declining RoIC because of low returns on new gross bock will
drag stock performance. We downgrade the stock to Sell.
India Equity Research Reports, IPO and Stock News
Visit http://indiaer.blogspot.com/ for complete details �� ��
Losing competitive advantage
SAIL has benefited from iron ore integration over the last decade. The prices of
iron ore increased 10x, pushing up cost of steel production for most steel producers
across the world. In the resultant scenario of high global steel prices, many of
SAIL's operating inefficiencies like sharp increase of 70-75% in labor cost to
US$126/ton and other fixed operating costs to US$170/ton were overlooked. This
situation is changing. Global steel consumption is tapering down and new iron ore
supplies are likely to come on stream over the next couple of years, leading to
softening of iron ore prices. In the mean time, ~30% increase in domestic steel
production over 12-15 months, largely from primary producers will create temporary
oversupply, leading to compression in margins.
Managing costs will be a challenge, which will get increasingly exposed as spreads
between coking coal and steel prices start narrowing. Capacity expansion to
20mtpa will ensure that specific labor cost does not increase, assuming total
headcount remains constant. However, per ton labor cost (6x new private Indian
players) is non-competitive. Though headcount has halved and steel production
has doubled, the basic working on ground has not changed in over 15 years. SAIL
needs to urgently invest in adopting best management practices and restructuring.
Plant and machinery is old, requiring frequent repairs and maintenance.
Sustenance capex has been just US$11/ton/year during FY01-FY09. Under the
company's Rs700b growth plan, Rs158b (US$269/ton over five years) is being
spent on sustenance.
Capex of Rs700b is being funded by internal cash flows, FPO and debt. Though
debt/equity ratio will still remain comfortable, the change from net interest earnings
to net interest expense will drag the bottomline.
RoIC too will decline sharply due to low returns on new investment. Rs540b are
being invested to create 7mtpa of new saleable steel capacity, translating into
capital investment of US$1,628/ton v/s US$245/ton currently. RoIC will drop every
year because new investment will yield just 5.3% v/s the current RoIC of >35%.
We have cut our EPS estimate by 24% to Rs10.5 for FY12. The stock is expensive
at 14.9x FY12E EPS and an EV of 9.6x FY12E EBITDA. SAIL will have CWIP of
Rs254b by FY11 end. Adjusting for CWIP, the stock is trading at an EV of 5.3x
FY12E EBITDA, which is comparable to peers. We believe as CWIP moves into
gross block, the declining RoIC because of low returns on new gross bock will
drag stock performance. We downgrade the stock to Sell.
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