JSW Steel: Buy:: Business Line

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Strong volume growth from better utilisation of recently added capacity, greater efficiencies at the acquired Ispat Industries' facilities and scope for margin expansion make JSW Steel an attractive buy in the steel space. The company has been first off the block in implementing its expansion programme among the larger steel companies, allowing it to capitalise on strong demand especially for flat products.

The stock trades at Rs 958 or around 15.6 times estimated consolidated FY11 earnings. On an Enterprise Value/Tonne basis the stock is among the least expensive in the steel space. On a EV/tonne basis, the company is valued at Rs 30,500/tonne on its current capacity, which is at a discount of 30 per cent to replacement cost. Compared to peers, this value represents a discount of between 16 and 36 per cent to peers such as SAIL and Bhushan steel. This excludes the 41 per cent stake held by the company in Ispat Industries.

An improving product mix with the addition of rolling capacity coupled with a near doubling of steel production capacity will enable the company to enjoy better realisations on a higher proportion of steel over the next two-three years. With the acquisition of Ispat Industries, the company controls 14.2 million tonnes of crude steel production capacity, the largest in India. Given that the company's steel output (including Ispat) in 2010-11 was at just 6.5 million tonnes, there is scope for substantial increase in volumes given the strong demand outlook.

The company's consolidated nine-month sales figures for the period ended December 2010 grew by 24 per cent on the back of higher steel prices, which were up by 15-20 per cent during the period. However, raw material cost pressures, particularly coking coal, have moderated net profit growth to 5 per cent.

The hikes in steel prices (around 15 per cent) usually lag those of the raw materials such as iron ore and metallurgical coal. Therefore, this margin squeeze phenomenon is likely to remain the case over the next 15 months. However, for JSW Steel this may be offset by sharp volume growth from its brownfield capacity additions and operational improvements at Ispat Industries.

The company's iron ore requirement is largely serviced by NMDC, however this bill is subject to a lot less volatility given the longer term of contracts at rates significantly lower than international prices. The company enjoys no such advantage on coking coal, which is largely imported. However, the company has initiated moves to boost margins. The acquisition of iron ore mines at Chile and coking coal mines in the US, which will be imported for use in its Indian operations (initially accounting for around 10 per cent and ultimately reaching 20-25 per cent of requirement), will make the operations more integrated and less susceptible to swings in input costs.

The ongoing financial year is a crucial one for the company in terms of attaining domestic operational stability at its added brownfield capacity and at Ispat. The company's debt:equity ratio stood at 0.85 at the end of December 2010, with EBIT covering interest 3.3 times over