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Inordinate delays, high capex in the face of weakening demand hurt valuations
● After a five-year period where demand grew at a strong 14%
CAGR we fear medium-term growth outlook is now in single digits,
and the weakness seen lately is not just a soft patch. Most
demand segments, especially, infrastructure are hitting a plateau.
● The significant capacity addition in India (34% of FY11 production in
two years) will thus be difficult to absorb locally. Exports are likely to
pick-up but will have US$25-30/t lower margins (no import duty),
and India turning net exporter will also erode domestic margins.
● Further, we are likely to see a growing disconnect between
investors and management on greenfield expansions: these erode
value. Continuing high capex at SAIL is thus a concern. We do not
believe its large CWIP needs to be valued separately given low
return expectations.
● SAIL has rarely been cheaper on P/B in the last decade. However
the industry itself has changed dramatically (Fig 1): RoCEs are down
sharply. With further downside to consensus, and a steel value chain
unwind on, we don’t see a trading opportunity yet too. We cut our
target price from Rs150 to Rs110, and maintain UNDERPERFORM.
Our sector view is detailed in Still not cheap enough; Significant
compression in ROCEs.
● Indian steel market slowing: After a five-year period where
demand grew at a strong 14% CAGR we fear medium-term
growth outlook is now in single digits, and the weakness seen
lately is not just a soft patch. After seeing rapid acceleration most
infrastructure segments are hitting a plateau: e.g., power capacity
addition of 20GW/year now adds zero to steel demand. Industrial
capex is also slowing, hurting demand for capital goods.
● India turning net exporter to hurt margins: The significant
capacity addition in India (34% of FY11 production in two years)
will thus be difficult to absorb. Exports are possible given the low
cost structures in India, but without the 5% import duty, EBITDA
will be US$25-30/t lower. Worse, even domestic margins would
lose duty protection if India is no longer a net importer. Lastly, we
are likely to see a growing disconnect between investors and
management on Greenfield expansions: these will erode value.
● Cheap, but not cheap enough: The stocks have fallen and on
P/B they have rarely been cheaper in the last decade. However
the industry itself has changed dramatically: RoCEs are down
sharply as the transition of raw material contracts to
quarterly/monthly from annual has shrunk smelting margins and
added to working capital requirements. They are thus not value
investments yet. With further downside to consensus, and a steel
value chain unwind on, we don’t see a trading opportunity yet too.
Should we value CWIP?
With CWIP of ~ US$5.9 bn (Rs 64/share), a substantial part of market
value is lost if CWIP is discounted. Theoretically, one should not value
CWIP as part of debt, but 1) long delays in capacity expansion 2)
near-term weakness and medium-term uncertainty in market lead to
projects with long gestation period not getting valued by the investors.
Even on planned capex/T, SAIL will have to generate ~US$300/T
EBITDA to make the investment value neutral which we think would
be difficult. We cut our FY12/13 estimates by 22%/13% and reduce
our target price to Rs110. With 20% downside to the current market
price, we maintain our UNDERPERFORM rating.
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