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India Equity Research Reports, IPO and Stock News
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Metals & Mining
India
More room for downside. Indian steel stocks have corrected by up to 25% in the past
two months with some trading below book value. However, the stocks are still not
attractive enough, in our view (except for Tata Steel). Overcapacity (globally and in
India), the slowdown in domestic demand and leveraged balance sheets will likely
constrain returns. Muted financial performances in the near term will not help stocks
either. We have a cautious view on steel stocks with Tata Steel our only BUY.
Steel stocks have more scope for downside
Steel stocks have corrected by up to 25% in the past two months with some trading below book.
This appears attractive, but we believe returns will be kept in check that by (1) a domestic
slowdown, (2) concentrated capacity addition that will ramp up and (3) leveraged balance sheets.
Steel stocks have traded in a historical P/B band of 0.5-2X and EV/ EBTIDA range of 5-7X. Indian
metal stocks are currently trading at a 12-month rolling forward P/B of 0.7-1.2X, lower than the
historic average trading band but still not at the distress levels that would trigger aggressive bets.
Domestic slowdown to hurt
Apparent steel consumption from April-August 2011 has slowed down to 1.3% from 8-10%
growth in recent years. A slowdown in industrial activity, lack of meaningful new projects and
slowdown in automobiles have impacted domestic steel demand. We believe steel demand is
unlikely to accelerate any time soon. We expect modest steel consumption growth of 5.6% in
FY2012E and model some pick-up in FY2013E. The demand slowdown has come at a time when
the Indian steel industry will is slated to add close to 24 mn tonnes of capacity over the next two
years. A large portion of this capacity (75%) will be in the flats segment which is likely to see
oversupply. As a result, steel pricing will remain soft and is likely to move away from import parity
pricing. Already, domestic steel prices are trading at a 5% discount to the landed cost of imports.
The only silver lining is the recent 60% cutback in steel production by JSW Steel (JSW accounts for
10% of crude steel production), which if sustained can absorb excess domestic production.
High leverage though most of it is for new capacities
Exhibit 4 details the net debt/ EBITDA and net debt/ equity of various steel names. Admittedly, the
leverage is on account of the aggressive domestic capacity expansion, some of which can be value
accretive. This is in contrast to the previous downturn where a fair bit of leverage related to
acquisition debt; acquired companies also had a dramatic drop in profitability.
Performance may be muted over the next couple of quarters
The financial performance of steel stocks may be muted on account of (1) a decline in average
steel prices and (2) lag impact from higher coking coal prices; note that contract hard coking coal
prices increased to US$330/ tonne in the June quarter from US$225/ tonne in March. However,
the impact was only partly felt in 1QFY12 since companies were carrying ~45 days of inventory.
We expect profitability of domestic steel mills to contract by 10% to 20% qoq.
Tata Steel attractive, others not yet
JSW trades at 0.7X FY2013E book; seemingly inexpensive but which we would view against a
likely permanent impact on iron ore sourcing costs that will impact profitability and return ratios.
JSPL has corrected but still does not offer material enough upside when evaluated against
potential risks to earnings estimates. Tata Steel has corrected and trades at attractive valuations.
Rationale behind our BUY rating on Tata Steel
Tata Steel trades at 4.6X FY2012E and 4.3X FY2013E EBITDA (adjusted for CWIP and value
of investments in group companies). The stock is trading at below June 2011 book value.
Admittedly, the stock is currently trading at a 12-month rolling forward P/B of 0.8X versus
that of 0.5X in the downturn of 2008. However, Tata Steel is decidedly better off than in
2009 for several reasons:
Better balance between profitable domestic and weak Corus operations. In fact,
after commissioning of brownfield expansion, Tata Steel will likely have a 40:60 split of
production between domestic and Corus operations versus 20:80 in 2008
Successful cost reduction and restructuring measures undertaken by Corus have led
to successful reduction in cost structure, and
More manageable leverage. In any case, a part of the current leverage is for projects
that may start delivering results in the next 12-18 months (brownfield expansion and
investments in raw material projects).
We do note near-term negatives: (1) pension funding, we would not be surprised if the
pension slips in deficit in September 2011, and (2) Corus may report EBTIDA loss in 3Q.
However, we note that cost rationalization measures undertaken by Tata Steel in the past
are likely to mitigate EBITDA losses at Corus. On the positive side, vertically integrated
domestic operations will continue strong performance.
India Equity Research Reports, IPO and Stock News
Visit http://indiaer.blogspot.com/ for complete details �� ��
Metals & Mining
India
More room for downside. Indian steel stocks have corrected by up to 25% in the past
two months with some trading below book value. However, the stocks are still not
attractive enough, in our view (except for Tata Steel). Overcapacity (globally and in
India), the slowdown in domestic demand and leveraged balance sheets will likely
constrain returns. Muted financial performances in the near term will not help stocks
either. We have a cautious view on steel stocks with Tata Steel our only BUY.
Steel stocks have more scope for downside
Steel stocks have corrected by up to 25% in the past two months with some trading below book.
This appears attractive, but we believe returns will be kept in check that by (1) a domestic
slowdown, (2) concentrated capacity addition that will ramp up and (3) leveraged balance sheets.
Steel stocks have traded in a historical P/B band of 0.5-2X and EV/ EBTIDA range of 5-7X. Indian
metal stocks are currently trading at a 12-month rolling forward P/B of 0.7-1.2X, lower than the
historic average trading band but still not at the distress levels that would trigger aggressive bets.
Domestic slowdown to hurt
Apparent steel consumption from April-August 2011 has slowed down to 1.3% from 8-10%
growth in recent years. A slowdown in industrial activity, lack of meaningful new projects and
slowdown in automobiles have impacted domestic steel demand. We believe steel demand is
unlikely to accelerate any time soon. We expect modest steel consumption growth of 5.6% in
FY2012E and model some pick-up in FY2013E. The demand slowdown has come at a time when
the Indian steel industry will is slated to add close to 24 mn tonnes of capacity over the next two
years. A large portion of this capacity (75%) will be in the flats segment which is likely to see
oversupply. As a result, steel pricing will remain soft and is likely to move away from import parity
pricing. Already, domestic steel prices are trading at a 5% discount to the landed cost of imports.
The only silver lining is the recent 60% cutback in steel production by JSW Steel (JSW accounts for
10% of crude steel production), which if sustained can absorb excess domestic production.
High leverage though most of it is for new capacities
Exhibit 4 details the net debt/ EBITDA and net debt/ equity of various steel names. Admittedly, the
leverage is on account of the aggressive domestic capacity expansion, some of which can be value
accretive. This is in contrast to the previous downturn where a fair bit of leverage related to
acquisition debt; acquired companies also had a dramatic drop in profitability.
Performance may be muted over the next couple of quarters
The financial performance of steel stocks may be muted on account of (1) a decline in average
steel prices and (2) lag impact from higher coking coal prices; note that contract hard coking coal
prices increased to US$330/ tonne in the June quarter from US$225/ tonne in March. However,
the impact was only partly felt in 1QFY12 since companies were carrying ~45 days of inventory.
We expect profitability of domestic steel mills to contract by 10% to 20% qoq.
Tata Steel attractive, others not yet
JSW trades at 0.7X FY2013E book; seemingly inexpensive but which we would view against a
likely permanent impact on iron ore sourcing costs that will impact profitability and return ratios.
JSPL has corrected but still does not offer material enough upside when evaluated against
potential risks to earnings estimates. Tata Steel has corrected and trades at attractive valuations.
Rationale behind our BUY rating on Tata Steel
Tata Steel trades at 4.6X FY2012E and 4.3X FY2013E EBITDA (adjusted for CWIP and value
of investments in group companies). The stock is trading at below June 2011 book value.
Admittedly, the stock is currently trading at a 12-month rolling forward P/B of 0.8X versus
that of 0.5X in the downturn of 2008. However, Tata Steel is decidedly better off than in
2009 for several reasons:
Better balance between profitable domestic and weak Corus operations. In fact,
after commissioning of brownfield expansion, Tata Steel will likely have a 40:60 split of
production between domestic and Corus operations versus 20:80 in 2008
Successful cost reduction and restructuring measures undertaken by Corus have led
to successful reduction in cost structure, and
More manageable leverage. In any case, a part of the current leverage is for projects
that may start delivering results in the next 12-18 months (brownfield expansion and
investments in raw material projects).
We do note near-term negatives: (1) pension funding, we would not be surprised if the
pension slips in deficit in September 2011, and (2) Corus may report EBTIDA loss in 3Q.
However, we note that cost rationalization measures undertaken by Tata Steel in the past
are likely to mitigate EBITDA losses at Corus. On the positive side, vertically integrated
domestic operations will continue strong performance.
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