JSW Steel - Balance Sheet concerns now take centre-stage ::Credit Suisse

● The surprise during the quarter was the increase in debt. With just
Rs10 bn of the Rs50 bn of planned capex incurred, debt increased
by Rs34 bn QoQ. The INR fall (translation on forex debt) and the
increase in inventory we believe were the primary drivers.
● This underscores two concerns: 1) a weak INR helps revenues
very visibly, but it hurts too, especially when foreign currency debt
is taken due to the natural hedge of all sales effectively being in
USD; 2) Despite lower-than-normal production, inventory rose –
the targeted clearance in 2Q we fear may impact realisations.
● With capex continuing and EBITDA anemic, the rising debt burden
is already reaching unsustainable levels, in our view. With capex
still continuing and the domestic steel market unlikely to recover
meaningfully, debt/EBITDA ratio can be 5x by end-FY14.
● 1Q P&L was unexciting: sales missed by 4% and EBITDA 15%
(we take half of the forex loss on coking coal contracts in material
costs: without this EBITDA was 12% ahead). We cut estimates by
80/54% for FY14/15, and cut TP to Rs330 from Rs400, after
reducing debt by 50% of CWIP (else TP would be Rs124 lower).

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EBITDA missed estimates, but rise in debt a bigger issue
Sales were 4% below estimates due to lower than expected steel
realization. Export sales dropped significantly q/q over the quarter as
JSW de-emphasized exports due to a drop in global prices in May.
Material costs were lower than expected but EBITDA still missed by
15%. For all steel companies we add half of the forex loss (Rs8.6 bn
for JSW in 1Q14) to material costs. Companies report this as
exceptional costs, but these are translation losses on funding related
to coking coal contracts which are usually for six months. If we do not
make this adjustment, EBITDA would be 12% higher. The company
attributes cost improvement to setting up of additional waste recovery
boilers, lower coking coal prices and better quality of iron ore.
However, as average iron ore price went up to Rs3,450/t from
Rs3,150 in 4Q13, the net advantage from iron ore seems minimal.

Lower ‘other income’ was offset by negative tax owing to carried
forward losses from Ispat (accumulated losses of ~Rs90 bn which
should provide tax benefits in the coming quarters too).
The worry though is the sharp increase in net debt. Whereas most
models built in Rs257 bn of consolidated net debt (Rs195 bn for JSW
end-FY13 + Rs62 bn of Ispat's debt), the June-end debt was Rs291
bn. Part of this was translation, but almost half the increase was
borrowing, driven largely by the increase in working capital. Inventory
rose 290kt, of which 75kt was semis. The company hopes to clear
200kt in Sep-13 quarter: this may pressure prices, we fear.
Takeaways from conference call
● Of the Rs50 bn of capex planned this year, Rs10 bn spent so far
● Guidance of 12mt of production in FY14 seems aggressive (CS:
11.5mt), esp. as they did only 2.86mt in 1Q (Corex-1 at Vijaynagar
was down for 25 days) and 2Q will see Corex-II shut similarly.
● JSW expects the pellet plant and the coke oven batteries at Ispat
to commission end-CY14, which should improve EBITDA/t. Given
the deteriorating supply-demand balance in India, such
improvements can at best allow them to maintain profitability.
● International operations continue to struggle: all of US plate and
pipe mill, Chilean iron ore and US coal operations were marginal
profit contributors in 1Q14: each had less than $1 mn of EBITDA.
As we build in the higher debt levels into our valuation (6x
EV/EBITDA), with a marginal cut in profitability, our fair value falls
from Rs400 to Rs330/share. We maintain UNDERPERFORM.