Steel Authority of India -SAIL- The wait for operational improvement continues, but not a "lost case" as some argue:: JPMorgan,

Steel Authority of India Ltd Neutral
SAIL.BO, SAIL IN
The wait for operational improvement continues, but
not a "lost case" as some argue


SAIL’s 4Q operationally was a miss, with reported EBITDA of Rs18.8B,
compared to JPMe/consensus of Rs20.4B/Rs21B even as the company benefited
from lower employee costs compared to our/consensus estimates of a Rs3B
increase q/q. In our view, the operational EBITDA improvement was essentially
driven by lower coking coal costs in FY13E, and volume/efficiency in FY14E is
still very much on. Higher volumes and ASPs are a positive and highlight the long
product strength.

��


 What drove the EBITDA miss in the quarter: Coking coal costs remain the
weak point, with raw material costs/MT of steel sold increased q/q 19%. The
sharp increase seen in the quarter was also driven by the higher-priced
inventory sold in the quarter, in our view. There was a q/q swing of Rs18B, and
we believe the higher-cost finished steel inventory (produced in the previous
quarters, but sold in the March quarter) was partially to blame, exaggerating the
impact on total raw material costs. Against this, steel volumes increased 22%
q/q while blended ASP/T increased 4% q/q. SAIL’s reported blended ASP/T is
up 10% from the Sept-11 level and highlights to us the strength seen in the long
product market. EBITDA/T was broadly flat in the quarter at Rs5.8K/T.
Employee costs were flat q/q against expectations of a sharp increase in the
quarter to provide for the wage bill.
 Margin expansion likely: There is a worry that while raw material costs should
decline (SAIL reported average coking coal costs of $288/T in FY12, while
current high grade coking coal prices are ~$220/T), employee costs are likely to
increase from here, resulting in flat margins. In our view, the benefits of lower
coking coal costs will offset higher employee costs, and margins should expand
from here.
 Status on expansions: SAIL expects to commission various facilities in the
much-delayed IISCO steel plant like BF, sinter plant, SMS and casters. We are
likely to see some of the benefits of the capital spend program start flowing
through in 2H FY13, with the volume benefits coming in FY14E. We reduce our
FY13/14 EPS estimates by 9/1% respectively, and consequently decrease our
Mar-13 price target to Rs125. A key upside risk to our rating and price target iss
demand improvements, while downside risks include a spike in coal prices.


Valuation and Key Risks
We reduce our earnings estimates to account for higher costs, and consequently
decrease our Mar-13 PT to Rs125. Our PT is based on 5.5x FY13E EV/EBITDA
adjusted for the CWIP. We value SAIL at a 10% discount to TATA given TATA’s
raw material advantage and better product mix. Key downside risks to our rating and
price target include MTM losses on FX on depreciating INR, further delays in ISP
commissioning and/or decline in spot iron ore prices. Key upside risks are a decline
in coking coal prices and demand improvement in the domestic market.