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Steel Authority of India (SAIL.BO)
Domestic Safety: But Low Growth
Maintain Hold — SAIL has the highest iron ore integration (100%) relative to Tata
Steel’s cons ~30% and JSW Steel’s ~20%. The recent environmental clearance for iron
ore mines with 1bnt of reserves at Chiria helps secure reserves for expansions. Flattish
steel prices, falling iron ore prices, likely equity issuance in 1HFY12 and lower volume
growth (relative to domestic majors for 2 years) means we do not expect Sensex
outperformance. However with a 23% fall in the past 6 months, underperformance is
unlikely. Hence we maintain Hold but change to Low Risk from Medium Risk.
Cutting TP — We roll forward to FY12 and value SAIL at 7x EV/EBITDA (vs. 6.5x
Jun11 earlier), at a premium to JSW Steel’s standalone target multiple of 6.5x. SAIL
has the advantage of largely Indian exposure (stable growth outlook) and 100% iron
ore. Our target multiple is in line with SAIL's 3-yr average EV/EBITDA. At our TP of
Rs185 (vs.Rs234), it would trade at 11.7x FY12E PE. Tata Steel offers greater share
price upside, has stronger domestic volume growth/raw material integration and is our
top pick – keeping in mind our flattish steel price outlook.
SAIL is aiming to get fitter and add value — SAIL is trying to raise crude steel
capacity from 13.5m tpa to 21.4m tpa by FY14 at a capex of Rs700bn, which should
help in: lower average costs (more modernization), improved labor productivity, higher
prices (value-added products, no semis). We expect sales volume to grow 6% in FY12
and 16% in FY13. SAIL has only 4% of its own coking coal and the rest is sourced from
Coal India/imports. Some captive coal will likely be available only after 2-3 years.
Estimate revisions — We are reducing PAT by 42% & 17% for FY11E-12E on 4%-7%
cut in volumes and higher raw material/power costs despite higher prices/FX rates. The
government plans a 20% equity sale in two tranches, half through a Follow Public Offer
(FPO). However given the delay, we have not accounted for this in our estimates.
Risks — Upside: Higher prices/volumes; FX weakness; more captive coking coal.
Downside: Lower steel prices than expected; delayed expansion plans; Rp appreciation
Steel Authority of India
Company description
Steel Authority of India (SAIL) is an integrated steel producer with crude steel
capacity of 13.5mtpa and saleable steel capacity of 12.6mtpa. It has five integrated
steel plants and three special steel plants, mostly located in eastern and central
India, near its own iron ore mines, though it lacks coal. SAIL is a Public Sector
Undertaking (PSU) in which the Government of India owns 85.8%. It plans to
expand its capacity gradually, taking its crude steel capacity to 21.4mtpa and
saleable steel capacity to 20.2m tpa by FY14 at a total capex of ~Rs700bn. SAIL
also plans to increase power capacity (through JVs) to match its expansion plans.
The company makes both flat (58% of production) and long (34%) products,
including value added products such as pipes, plates and coated products. Most of
SAIL's output is sold within India and exports account for only c.2%-3% of sales.
Investment strategy
We rate SAIL as Hold/Low Risk (2L). It has the highest iron ore integration (100%)
relative to peers and recent environmental clearance for iron ore mines with 1bnt of
reserves at Chiria helps secure reserves for expansions. SAIL had a marginal net
cash position as of Sept-2010 and largely domestic exposure as advantages, but
debt to equity is expected to rise in FY12 as it takes on debt to fund expansion. The
government has approved a 20% equity sale in two tranches of 10% each. On
completion, share capital will rise to Rs45.4bn (from Rs41.3bn) and the government
stake will fall to 69% (from 86%). However, given the delay in the planned equity
issuance, we have not yet incorporated it in our forecasts. SAIL’s target to raise
crude steel capacity, from 13.5m tpa to 21.4m tpa by FY14, should help with: lower
average costs (more modernization), improved labor productivity, higher prices
(value-added products, no semis). However, flattish steel prices, falling iron ore
prices, likely equity issuance in 1HFY12, and lower volume growth (relative to
domestic majors for the next two years), means we don’t expect outperformance vs.
Sensex. SAIL has fallen 23% in the past six months, and with underperformance vs.
the broader indices unlikely, we continue to rate it Hold.
Valuation
We use EV/EBITDA as our preferred valuation metric for the Indian steel companies
given the high debt-equity levels for two of the three steel majors under coverage.
SAIL has traditionally traded at a discount to both TSL and JSTL based on its
history, status as a government company and lower rate of volume growth. Our
Rs185 target price is based on FY12E EV/EBITDA of 7x, at a premium to JSTL's
(standalone) target multiple of 6.5x and at a discount to TSL's target multiple (for
Indian operations) of 7.5x. SAIL offers lower volume growth than JSTL although
both offer largely domestic exposure. We take a discount to TSL India's valuation as
it has 100% iron ore, more captive coal (50-55%) and higher volume growth. SAIL's
target EV/EBITDA multiple is at a premium to its 3-year average, but lower than its
highs of 7-9x since then. At our target price, the stock would trade at a P/E of 11.7x.
Risks
We rate SAIL Low Risk in line with the risk rating suggested by our quantitative riskrating
system, which tracks 260-day historical share price volatility. Its exposure to
the Indian market, net cash position, and potential for cost cutting, all back up the
Low Risk rating. Possible upside risks to our target price include: 1) better steel
prices vs. expectation; 2) higher volumes than we expect; 3) lower coking coal
prices than expected; and 4) FX weakness. Downside risks include: 1) lower steel
prices than expected; 2) delays to expansion plans; 3) higher coking coal prices
than we expect; and 4) appreciation of the rupee vs. the USD.
Tata Steel
(TISC.BO; Rs625.00; 1M)
Valuation
We value TSL using SOTP. We use EV/EBITDA as our preferred valuation metric
for TSL largely due to its high leverage. For TSL India, we use a target EV/EBITDA
of 7.5x on FY12E earnings, a premium to the average of 6.5x FY12E for the other
Indian steel majors to reflect greater integration and relatively higher margins. Tata
Steel Europe and its other non-Indian businesses are valued at 5x EV/EBITDA, in
line with the five-year trading average for the European steel sector. Based on the
above, we arrive at a target price of Rs777. At our target price, the stock would
trade at a consolidated FY12E EV/EBITDA of 7x and P/E of 12x.
Risks
We rate TSL Medium Risk vs. the Low Risk suggested by our quantitative risk-rating
system, which tracks 260-day historical share price volatility. We attribute a higher
risk rating due to the near term uncertainty in the steel market. Downside risks to
our target price are: 1) weaker steel prices; 2) higher raw material prices; 3) FX
trends; 4) lower volumes than we expect (especially for Tata Steel Europe). Key
upside risks are: 1) upside in steel prices in Europe or India driven by better
demand or plant shutdowns; 2) weaker raw material prices than we expect which
would benefit Tata Steel Europe.
JSW Steel
(JSTL.BO; Rs969.90; 1M)
Valuation
EV/EBITDA is our preferred valuation metric for JSTL due to its high debt-equity
levels. Our target price of Rs1,254 is based on SOTP. We continue to value the
standalone business at 6.5x FY12 EV/EBITDA – at a 10% discount to its 3-yr
average and captures more recent valuation trends - giving a value of
Rs1,334/share. We value its US pipe and plate operations at 3x EV/sales. We use
3x EV/sales as utilization levels at its US business are quite low at 15-30% in FY11-
13. This gives a negative value of Rs65/share. We also incorporate the Ispat
valuation and the Chilean iron ore asset separately. We value Ispat at 6x
EV/EBITDA (at a discount to JSW Steel’s valuation) which gives a negative value of
Rs51. The Chilean iron is valued at 7x FY12 PE giving a value of Rs35. All this
results in a net target price of Rs1,254/share. At our target price, the stock would
trade at a consolidated FY12 EV/EBITDA of 6.9x and P/E of 14.8x.
Risks
We rate JSTL Medium Risk in line with the Medium Risk rating suggested by our
quantitative risk-rating system, which tracks 260-day historical share price volatility.
JSTL's exposure to the Indian market, strong volume growth, EBITDA/t at US$186/t
during FY11-12 and greater value addition warrant a Medium Risk, in our view.
Possible downside risk factors to our target price are: 1) weaker steel prices than
we forecast; 2) higher raw material costs; 3) lower volumes than we expect; and 4)
FX trends.
India Equity Research Reports, IPO and Stock News
Visit http://indiaer.blogspot.com/ for complete details �� ��
Steel Authority of India (SAIL.BO)
Domestic Safety: But Low Growth
Maintain Hold — SAIL has the highest iron ore integration (100%) relative to Tata
Steel’s cons ~30% and JSW Steel’s ~20%. The recent environmental clearance for iron
ore mines with 1bnt of reserves at Chiria helps secure reserves for expansions. Flattish
steel prices, falling iron ore prices, likely equity issuance in 1HFY12 and lower volume
growth (relative to domestic majors for 2 years) means we do not expect Sensex
outperformance. However with a 23% fall in the past 6 months, underperformance is
unlikely. Hence we maintain Hold but change to Low Risk from Medium Risk.
Cutting TP — We roll forward to FY12 and value SAIL at 7x EV/EBITDA (vs. 6.5x
Jun11 earlier), at a premium to JSW Steel’s standalone target multiple of 6.5x. SAIL
has the advantage of largely Indian exposure (stable growth outlook) and 100% iron
ore. Our target multiple is in line with SAIL's 3-yr average EV/EBITDA. At our TP of
price upside, has stronger domestic volume growth/raw material integration and is our
top pick – keeping in mind our flattish steel price outlook.
SAIL is aiming to get fitter and add value — SAIL is trying to raise crude steel
capacity from 13.5m tpa to 21.4m tpa by FY14 at a capex of Rs700bn, which should
help in: lower average costs (more modernization), improved labor productivity, higher
prices (value-added products, no semis). We expect sales volume to grow 6% in FY12
and 16% in FY13. SAIL has only 4% of its own coking coal and the rest is sourced from
Coal India/imports. Some captive coal will likely be available only after 2-3 years.
Estimate revisions — We are reducing PAT by 42% & 17% for FY11E-12E on 4%-7%
cut in volumes and higher raw material/power costs despite higher prices/FX rates. The
government plans a 20% equity sale in two tranches, half through a Follow Public Offer
(FPO). However given the delay, we have not accounted for this in our estimates.
Risks — Upside: Higher prices/volumes; FX weakness; more captive coking coal.
Downside: Lower steel prices than expected; delayed expansion plans; Rp appreciation
Steel Authority of India
Company description
Steel Authority of India (SAIL) is an integrated steel producer with crude steel
capacity of 13.5mtpa and saleable steel capacity of 12.6mtpa. It has five integrated
steel plants and three special steel plants, mostly located in eastern and central
India, near its own iron ore mines, though it lacks coal. SAIL is a Public Sector
Undertaking (PSU) in which the Government of India owns 85.8%. It plans to
expand its capacity gradually, taking its crude steel capacity to 21.4mtpa and
saleable steel capacity to 20.2m tpa by FY14 at a total capex of ~Rs700bn. SAIL
also plans to increase power capacity (through JVs) to match its expansion plans.
The company makes both flat (58% of production) and long (34%) products,
including value added products such as pipes, plates and coated products. Most of
SAIL's output is sold within India and exports account for only c.2%-3% of sales.
Investment strategy
We rate SAIL as Hold/Low Risk (2L). It has the highest iron ore integration (100%)
relative to peers and recent environmental clearance for iron ore mines with 1bnt of
reserves at Chiria helps secure reserves for expansions. SAIL had a marginal net
cash position as of Sept-2010 and largely domestic exposure as advantages, but
debt to equity is expected to rise in FY12 as it takes on debt to fund expansion. The
government has approved a 20% equity sale in two tranches of 10% each. On
completion, share capital will rise to Rs45.4bn (from Rs41.3bn) and the government
stake will fall to 69% (from 86%). However, given the delay in the planned equity
issuance, we have not yet incorporated it in our forecasts. SAIL’s target to raise
crude steel capacity, from 13.5m tpa to 21.4m tpa by FY14, should help with: lower
average costs (more modernization), improved labor productivity, higher prices
(value-added products, no semis). However, flattish steel prices, falling iron ore
prices, likely equity issuance in 1HFY12, and lower volume growth (relative to
domestic majors for the next two years), means we don’t expect outperformance vs.
Sensex. SAIL has fallen 23% in the past six months, and with underperformance vs.
the broader indices unlikely, we continue to rate it Hold.
Valuation
We use EV/EBITDA as our preferred valuation metric for the Indian steel companies
given the high debt-equity levels for two of the three steel majors under coverage.
SAIL has traditionally traded at a discount to both TSL and JSTL based on its
history, status as a government company and lower rate of volume growth. Our
Rs185 target price is based on FY12E EV/EBITDA of 7x, at a premium to JSTL's
(standalone) target multiple of 6.5x and at a discount to TSL's target multiple (for
Indian operations) of 7.5x. SAIL offers lower volume growth than JSTL although
both offer largely domestic exposure. We take a discount to TSL India's valuation as
it has 100% iron ore, more captive coal (50-55%) and higher volume growth. SAIL's
target EV/EBITDA multiple is at a premium to its 3-year average, but lower than its
highs of 7-9x since then. At our target price, the stock would trade at a P/E of 11.7x.
Risks
We rate SAIL Low Risk in line with the risk rating suggested by our quantitative riskrating
system, which tracks 260-day historical share price volatility. Its exposure to
the Indian market, net cash position, and potential for cost cutting, all back up the
Low Risk rating. Possible upside risks to our target price include: 1) better steel
prices vs. expectation; 2) higher volumes than we expect; 3) lower coking coal
prices than expected; and 4) FX weakness. Downside risks include: 1) lower steel
prices than expected; 2) delays to expansion plans; 3) higher coking coal prices
than we expect; and 4) appreciation of the rupee vs. the USD.
Tata Steel
(TISC.BO; Rs625.00; 1M)
Valuation
We value TSL using SOTP. We use EV/EBITDA as our preferred valuation metric
for TSL largely due to its high leverage. For TSL India, we use a target EV/EBITDA
of 7.5x on FY12E earnings, a premium to the average of 6.5x FY12E for the other
Indian steel majors to reflect greater integration and relatively higher margins. Tata
Steel Europe and its other non-Indian businesses are valued at 5x EV/EBITDA, in
line with the five-year trading average for the European steel sector. Based on the
above, we arrive at a target price of Rs777. At our target price, the stock would
trade at a consolidated FY12E EV/EBITDA of 7x and P/E of 12x.
Risks
We rate TSL Medium Risk vs. the Low Risk suggested by our quantitative risk-rating
system, which tracks 260-day historical share price volatility. We attribute a higher
risk rating due to the near term uncertainty in the steel market. Downside risks to
our target price are: 1) weaker steel prices; 2) higher raw material prices; 3) FX
trends; 4) lower volumes than we expect (especially for Tata Steel Europe). Key
upside risks are: 1) upside in steel prices in Europe or India driven by better
demand or plant shutdowns; 2) weaker raw material prices than we expect which
would benefit Tata Steel Europe.
JSW Steel
(JSTL.BO; Rs969.90; 1M)
Valuation
EV/EBITDA is our preferred valuation metric for JSTL due to its high debt-equity
levels. Our target price of Rs1,254 is based on SOTP. We continue to value the
standalone business at 6.5x FY12 EV/EBITDA – at a 10% discount to its 3-yr
average and captures more recent valuation trends - giving a value of
Rs1,334/share. We value its US pipe and plate operations at 3x EV/sales. We use
3x EV/sales as utilization levels at its US business are quite low at 15-30% in FY11-
13. This gives a negative value of Rs65/share. We also incorporate the Ispat
valuation and the Chilean iron ore asset separately. We value Ispat at 6x
EV/EBITDA (at a discount to JSW Steel’s valuation) which gives a negative value of
Rs51. The Chilean iron is valued at 7x FY12 PE giving a value of Rs35. All this
results in a net target price of Rs1,254/share. At our target price, the stock would
trade at a consolidated FY12 EV/EBITDA of 6.9x and P/E of 14.8x.
Risks
We rate JSTL Medium Risk in line with the Medium Risk rating suggested by our
quantitative risk-rating system, which tracks 260-day historical share price volatility.
JSTL's exposure to the Indian market, strong volume growth, EBITDA/t at US$186/t
during FY11-12 and greater value addition warrant a Medium Risk, in our view.
Possible downside risk factors to our target price are: 1) weaker steel prices than
we forecast; 2) higher raw material costs; 3) lower volumes than we expect; and 4)
FX trends.
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