JSW Steel (JSTL IN, INR 694, Buy)
JSW Steel (JSW) has announced a merger with its 46.75% associate entity JSW Ispat (Ispat) in the ratio of 1:72. This merger makes JSW the largest steel company in India (14.3mtpa capacity) with potential synergy benefits of INR3-5bn p.a. over time. We currently ascribe negative equity valuation of INR31bn to Ispat considering its weak EBITDA and high net debt. The NPV of tax benefit of INR14bn does not offset this negative valuation and along with the 8.3% equity dilution leads to target price being revised down to INR868 (INR933 earlier). The proforma EPS for the merged entity is estimated to be revised down by ~10.6% and 9.7% for FY13 and FY14, respectively. This is despite 19.5% and 18.2% increase in FY13 and FY14 EBITDA estimates, respectively. Maintain ‘BUY’.
Tax savings expected to be a key benefit
As per the management, Ispat has accumulated losses of ~INR97bn which may help save tax of ~INR22bn. JSW will, however, have to pay MAT and therefore the tax savings will accrue over a period of nearly six years; NPV of which comes to ~INR14bn. Management expects savings of ~INR3-5bn p.a. over a period of time in raw material purchases, marketing and administration costs (not factored by us). Management expects Ispat’s interest burden to reduce by ~200-300bps.
Outlook and valuations: Incrementally negative; maintain ‘BUY’
JSW’s debt will effectively increase by ~INR88bn (including INR20bn of acceptances, which in our view is quasi debt) while its equity will dilute by 8.3%. In our opinion, the benefits of tax savings and additional EBITDA of INR14.5bn are not enough to fully offset the impact of additional debt and equity dilution. As a result, our price target is being revised down to INR868 from INR933 earlier. We continue to value JSW at 5.5x and Ispat at 4x FY14E EV/EBITDA. Maintain ‘BUY/Sector Outperformer’ recommendation/rating. At CMP, the stock trades at 3.1x FY14E EV/EBITDA of our pre-merger financials.
Regards,
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