JSW Steel: TP: INR453 Sell: Motilal Oswal

Please Share::  India Equity Research Reports, IPO and Stock News

Visit http://indiaer.blogspot.com/ for complete details �� ��

Difficult to replicate past growth
Volumes and margins hit by iron ore shortage
 Lowest RoIC but superior ASR over FY07-11.
 RM scarcity and current headwinds to hit production and drag stock
performance despite superior capital allocation plans.
 JSTL will find it difficult to replicate past growth. Maintain Sell.
Superior ASR, lowest RoIC over FY07-11 but RM scarcity hits output
Over FY07-11 JSW Steel (JSTL) posted superior annualized stock return of 20%
despite having the lowest RoIC among key steel makers. This was due to efficient
capital allocation and excellent project execution. Over the past decade, JSTL expanded
its crude steel making capacity 6x to 10mtpa at Vijaynagar. Its saleable steel volumes
increased at a CAGR of 23% to 6.1m tons over FY05-11. The UnIC/CE ratio has
remained lowest in the industry due to efficient capital allocation.
Despite investing over INR335b and being assured of a mining lease from the
government, JSTL could not achieve sufficient raw material integration in iron ore rich
Karnataka. Resultant, recent Supreme Court ban on iron ore mining in Karnataka has
affected its operations. While JSTL expects some relief from the Supreme Court's
orders (to auction iron ore stocks lying idle in the state and allow NMDC to mine up to
12mtpa in Bellary) and recently added iron ore beneficiation and pellet facilities will
help to some extent; we expect volumes and margins to be impacted in FY12. We
believe the ongoing saga will also change the demand-supply equation of iron ore in
Karnataka and costs for local steel producers permanently. We have cut FY12 volumes
from 8.5mt earlier to 6.7mt and increased average iron ore cost from USD60/ton to
~USD90/ton.

Headwinds to drag down stock performance
Despite recent headwinds, JSTL is committed to superior capital allocation with planned
capex in West Bengal and increasing focus on raw material security. In West Bengal,
JSTL is undertaking a 4.5mtpa green-field steel project with capex of INR160b to be
executed over four years. Coking coal blocks of Kulti, Sitarampur and Rohne have been
allotted. Iron ore will be sourced through slurry pipelines from Orissa/Jharkhand.
Global projects undertaken over the past few years to secure raw material sourcing will
increase integration. Shipments from US coal mines have started and we expect JSTL to
receive 350k tons of coking coal in FY12. The company's Chile iron ore mines will produce
1mtpa of iron ore.
However, we believe that in the near to medium term, returns from invested capital will
weaken and drag down RoCE, resulting poor stock performance. The next driver of earnings
from further capacity addition will take a few years and higher interest and depreciation
costs (due to the recently commissioned expansion in Vijaynagar) will impact JSTL's
bottom line.
Difficult to replicate past growth
Over FY07-11 JSTL generated INR170b operating cash flow and invested INR262b in
assets, raising INR170b from debt and equity (in the ratio of 63:37). With deteriorated
business conditions, we expect JSTL to generate INR83b from operations over the next
two years. Although the stock trades at a 56% discount to NAV and P/BV of 0.9x, further
de-rating is possible because JSTL will find it difficult to replicate its past growth with
lower margins unless the iron ore supply situation at Bellary improves. Planned investments
in West Bengal and at JSW Ispat will increase leverage. Maintain Sell.

sector report and other companies

Metals and Mining, RoIC v/s RoCE: The Return Roulette :: Motilal Oswal