Steel Authority of India Is it worth making steel? ::Macquarie Research,

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Steel Authority of India
Is it worth making steel?
Event
 SAIL reported 1Q FY12 results which were well below our estimate. We
have reduced our estimates by 14% to account for higher costs and slightly
lower production. We maintain our Neutral rating but reduce our target price to
Rs126 from Rs150. We believe delaying its expansion and overhang of equity
dilution can delay the re-rating.
Impact
 Weak Q1 results: Net Sales at Rs108bn is up 20% YoY, as sales volume
increased though production volumes remained flat. However, raw material
costs at $368/t were up 12% YoY and EBITDA at Rs11.9bn is down 31%
YoY. PAT at Rs8.38bn was down 29% YoY, due to an increase in interest
expense and depreciation. This profit level was actually 1% lower than
Rs8.43bn reported in 3QFY09, at the height of the financial crisis.
 Margins still have downside risks: It reported EBITDA per ton of US$94/t in
Q1 FY12. We are estimating US$124/t for FY12, which seems to be on the
higher side given the sharp increase in coking coal costs and inability for SAIL
to reduce costs. We are building in some improvement in SAIL’s product mix
to enhance realisation, however at this point, SAIL could see further downside
if steel prices do not move up sharply.
 Consensus to also see downgrades: Street is estimating Rs13.7/share of
EPS for FY12 versus our new estimate of Rs12.6/share. We believe that
lower volumes during the year and pressure on margins will result in
downgrades of SAIL’s estimates.
 Expansions might get delayed: SAIL management has been quoted in the
media suggesting steel production for FY12 at 12.6mnt. They are expecting to
commission two blast furnaces in Rourkela by January 2012 and trial runs at
the Burnpur plant will commence by the year-end (3mt). This can increase
capacity next year and will help volumes increase. However, for FY12, volume
growth remains muted and we are reducing our assumptions.
Earnings and target price revision
 We are reducing our FY12 estimates by 14% on the back of lower volume
estimates and lower margins. We also reduce TP to Rs126/share.
Price catalyst
 12-month price target: Rs126.00 based on a PER methodology.
 Catalyst: Announcement of FPO timeline
Action and recommendation
 Maintain Neutral: SAIL currently looks fairly valued at 10x PER on FY12E,
with subdued earnings. The stock also has an overhang of the upcoming
equity issuance which will increase the free float by 66%. We believe it is a bit
too early to play the volume expansion story here.