SAIL: TP: INR113 Sell: Motilal Oswal

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Project execution disappoints
Fixed costs still rising; Maintain Sell
 CWIP up, drags down RoCE due to project delays; Expansion benefits will
start kicking-in in 2HFY13.
 Rising operating costs impact RoE but RoIC will be highest among peers.
 Net debt to rise USD3.8b but D/E comfortable if expansion is not delayed.
 Stock appears to be expensive, maintain Sell.
Rising CWIP drags RoCE to 13%; Expansion benefits in 2HFY13
SAIL undertook brown-field expansion across its locations along with modernization
of its existing facilities in 2005. However it faced cost and time overruns due to slow
execution and slowdown in the global economy in 2008. A blast furnace at ISP Burnpur
(2mtpa) is expected to be commissioned by March 2012. However, the BOF will take
some time for commissioning and capacity utilization is unlikely to cross 50% in the
first six months after the start up. Thus, incremental saleable steel volumes will be
available only in 2HFY13.
SAIL is expected to commission two blast furnaces of 2.5mtpa each in Rourkela and
Bhilai in FY13. The delayed commissioning has affected SAIL's return ratios. CWIP
as a percentage of capital employed increased from 8% in FY07 to 45% in FY11 and
is expected to increase to 56% in FY13. This is dragging RoCE as project execution is
slow. RoCE declined from 47% in FY07 to a mere 13% in FY11.
Over FY11-13 we expect SAIL to post volume CAGR of 8% to 13.8mt. However
margins will improve only after the completion of modernization of SAIL's old plants,
addition of downstream facilities and development of new coal mines.


Rising operating costs impact RoE; but RoIC will be highest among peers
Over FY07-11, SAIL's profitability was impacted badly by rising coking coal costs, labor
cost and other operating costs. This has impacted RoE, which slipped from 42% in FY07
to 12% in FY11. Ongoing capacity expansion will ensure specific labor cost remains at
similar levels, but per ton labor cost will still be highest among key players. Over 2001-10,
sustenance capex has been just USD11/ton/year, resulting in further deterioration of ageold
machinery. This however is being corrected through its INR720b capex plan and
INR158b (USD269/ton over five years) is being spent on sustenance.
Over FY07-11, the share of invested capital fell from 50% to 22% as it made significant
capex only recently, which is lying in CWIP. However going forward, as the facilities start
coming on stream, IC will increase. RoIC will continue to decline as RoIC on new facilities
will be much lower due to higher invested capital. SAIL is investing INR540b on its
incremental 7mtpa of production which will drag RoIC but it will still be the highest among
its peers (except JSP).


We expect earnings growth to be lackluster over FY11-13 despite an 8% volume growth
due to SAIL's uncompetitive cost structure and poor operating efficiencies. Return ratios
will decline until FY13. The benefits of its INR720b capex will be seen only in FY15. Over
the past few years, SAIL has traded in line with its NAV. In FY11 it traded at a discount
to its NAV as it could not meet the deadline of commissioning its ISP Burnpur project. At
CMP of INR107, the stock trades at a 53% discount to NAV and it appears to be expensive
at 11.2x FY13E EPS and an EV of 7.7x FY13E EBITDA. Maintain Sell.

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