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JSW Steel Ltd ------------------------------------------------------------- Maintain UNDERPERFORM
Erosion of location premium compounded by high leverage
● We provide relevant highlights from the Lokayukta (anti-corruption
commissioner) report on illegal iron ore mining in Karnataka and
implications for JSW steel. JSW got 50% of its ore from Bellary,
where iron ore mining has been banned by the Supreme Court.
● The report quantifies the volume of illegally mined ore exports (~13
mn t), flags a possibility of a ban in the neighbouring Chitradurga
and Tumkur districts as well, and mentions instances of alleged
bribery by JSW affiliates and under-pricing by PSU miners.
● In our view, the ban on mining may continue for several months
even for legal mines. Further, the illegal supply may never come
back, like we saw in Orissa. It can impact JSW’s volumes (lack of
infrastructure to move ore from a distance) and EBITDA (higher
freight and ore shortage imply higher ore cost).
● We cut volumes by 400 kt and raise average iron ore costs by
US$15/t. Given its high leverage, the impact of lower volumes and
lower EBITDA/t on fair value is meaningful (Figure 1). Our fair value
falls to Rs550/share from Rs750 earlier. We did not find it cheap at
Rs1392 and still don’t find it cheap. We maintain UNDERPERFORM.
Bellary-Hospet accounts for a large part of iron ore mining in
Karnataka (~80% as per media reports, implying 36 mtpa). The
Supreme Court ban on mining can thus meaningfully impact ore
availability and hence steel output. Around 36 mtpa of ore can support
~20 mtpa of steel production; of this, according to JSW, about 16 mn t
is in Bellary.
Relevant highlights of the Lokayukta report
● Around 12.8 mn t of iron ore illegally exported from Karnataka in
2010 (of total estimated production of 45 mn t). Even after the export
ban, about 1.8 mn t was exported (including 75,000 t by Sesa Goa).
● While encroachment details have been worked out fully in Bellary,
13 of the 18 leases surveyed in Tumkur District have been found
to be in violation; survey has now been ordered in the Chitradurga
region. There is a possibility that the scope of the ban may expand.
● Alleged bribery: The report also alleges that (1) JSW through its
affiliates paid Rs100 mn to Prerna Education Trust (run by the
Chief Minister’s family) in Mar-10 and (2) bought 1 acre of land
from CM’s family members for Rs200 mn (16x market value).
According to the report, the timing of payments seems close to the
applications made for mining lease and the payments seem
inappropriate.
● Under-pricing by PSU: The report says that the state-owned MML,
which supplies to JSW, underpriced its ore to suit private players.
It also mentions NMDC, but for its export price, not local sales.
Impact on stock price due to iron ore ban
Of the 13 mn t of iron ore JSW bought in FY11, 2.2 mtpa (17%) was
from VMPL (its JV with MML; JSW owns 40%), 2 mtpa (16%) from
NMDC and the rest 67% from the spot market. Its low integration was
compensated by its proximity to mines, which added meaningfully to
profits: it procured ~50% of its ore from the Bellary region. Freight
rates for iron ore are high, especially when compared to average cost:
Rs200/t from Chitradurg (110 km) to Rs2,600/t from Goa (400 km).
Given the widespread nature of issues raised in the report, the ban on
mining in our view may continue for several months; even legal mines
may see delays in resumption. Further, the illegal supply may never
come back, like we saw in Orissa. Given the infrastructure-heavy
nature of iron ore, this can hurt Bellary-based producers in two ways:
● Volumes: Sourcing the appropriate volumes of iron ore locally
could be a challenge. JSW indicates that it has managed
alternatives from Chitradurga and Tumkur for its current
operations. Of the 40 kt/day it needs, it now sources 33 kt from the
two districts. Expanding sourcing for its 10mtpa capacity may be
difficult.
● Costs: As indicated by Sesa on its conference call a week ago,
their Chitradurga output is already seeing better realisations than
in 1Q FY12. This can see a further increase. So far the impact on
JSW’s steelmaking cost is only Rs500/t (~$11)—but it can rise.
The stock has corrected by ~Rs200 since last week when the news of
the Lokayukta report started to come out. Given its high leverage, the
impact of lower volumes and lower EBITDA/t on fair value is
meaningful (Figure 1). We have cut JSW’s Vijayanagar steel volumes
by 400 kt and raised average iron ore costs by US$15/t. This brings
our fair value to Rs550/share from Rs750 earlier.
India Equity Research Reports, IPO and Stock News
Visit http://indiaer.blogspot.com/ for complete details �� ��
JSW Steel Ltd ------------------------------------------------------------- Maintain UNDERPERFORM
Erosion of location premium compounded by high leverage
● We provide relevant highlights from the Lokayukta (anti-corruption
commissioner) report on illegal iron ore mining in Karnataka and
implications for JSW steel. JSW got 50% of its ore from Bellary,
where iron ore mining has been banned by the Supreme Court.
● The report quantifies the volume of illegally mined ore exports (~13
mn t), flags a possibility of a ban in the neighbouring Chitradurga
and Tumkur districts as well, and mentions instances of alleged
bribery by JSW affiliates and under-pricing by PSU miners.
● In our view, the ban on mining may continue for several months
even for legal mines. Further, the illegal supply may never come
back, like we saw in Orissa. It can impact JSW’s volumes (lack of
infrastructure to move ore from a distance) and EBITDA (higher
freight and ore shortage imply higher ore cost).
● We cut volumes by 400 kt and raise average iron ore costs by
US$15/t. Given its high leverage, the impact of lower volumes and
lower EBITDA/t on fair value is meaningful (Figure 1). Our fair value
falls to Rs550/share from Rs750 earlier. We did not find it cheap at
Rs1392 and still don’t find it cheap. We maintain UNDERPERFORM.
Bellary-Hospet accounts for a large part of iron ore mining in
Karnataka (~80% as per media reports, implying 36 mtpa). The
Supreme Court ban on mining can thus meaningfully impact ore
availability and hence steel output. Around 36 mtpa of ore can support
~20 mtpa of steel production; of this, according to JSW, about 16 mn t
is in Bellary.
Relevant highlights of the Lokayukta report
● Around 12.8 mn t of iron ore illegally exported from Karnataka in
2010 (of total estimated production of 45 mn t). Even after the export
ban, about 1.8 mn t was exported (including 75,000 t by Sesa Goa).
● While encroachment details have been worked out fully in Bellary,
13 of the 18 leases surveyed in Tumkur District have been found
to be in violation; survey has now been ordered in the Chitradurga
region. There is a possibility that the scope of the ban may expand.
● Alleged bribery: The report also alleges that (1) JSW through its
affiliates paid Rs100 mn to Prerna Education Trust (run by the
Chief Minister’s family) in Mar-10 and (2) bought 1 acre of land
from CM’s family members for Rs200 mn (16x market value).
According to the report, the timing of payments seems close to the
applications made for mining lease and the payments seem
inappropriate.
● Under-pricing by PSU: The report says that the state-owned MML,
which supplies to JSW, underpriced its ore to suit private players.
It also mentions NMDC, but for its export price, not local sales.
Impact on stock price due to iron ore ban
Of the 13 mn t of iron ore JSW bought in FY11, 2.2 mtpa (17%) was
from VMPL (its JV with MML; JSW owns 40%), 2 mtpa (16%) from
NMDC and the rest 67% from the spot market. Its low integration was
compensated by its proximity to mines, which added meaningfully to
profits: it procured ~50% of its ore from the Bellary region. Freight
rates for iron ore are high, especially when compared to average cost:
Rs200/t from Chitradurg (110 km) to Rs2,600/t from Goa (400 km).
Given the widespread nature of issues raised in the report, the ban on
mining in our view may continue for several months; even legal mines
may see delays in resumption. Further, the illegal supply may never
come back, like we saw in Orissa. Given the infrastructure-heavy
nature of iron ore, this can hurt Bellary-based producers in two ways:
● Volumes: Sourcing the appropriate volumes of iron ore locally
could be a challenge. JSW indicates that it has managed
alternatives from Chitradurga and Tumkur for its current
operations. Of the 40 kt/day it needs, it now sources 33 kt from the
two districts. Expanding sourcing for its 10mtpa capacity may be
difficult.
● Costs: As indicated by Sesa on its conference call a week ago,
their Chitradurga output is already seeing better realisations than
in 1Q FY12. This can see a further increase. So far the impact on
JSW’s steelmaking cost is only Rs500/t (~$11)—but it can rise.
The stock has corrected by ~Rs200 since last week when the news of
the Lokayukta report started to come out. Given its high leverage, the
impact of lower volumes and lower EBITDA/t on fair value is
meaningful (Figure 1). We have cut JSW’s Vijayanagar steel volumes
by 400 kt and raised average iron ore costs by US$15/t. This brings
our fair value to Rs550/share from Rs750 earlier.
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