SAIL: High coking coal costs dent earnings: Religare

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Steel Authority of India Ltd
High coking coal costs dent earnings
SAIL reported Q2FY11 sales, EBITDA and net profit of Rs 106bn (+7% YoY,
+17% QoQ), Rs 16.9bn (-29% YoY, -8% QoQ) and Rs 10.9bn (-35% YoY, -7%
QoQ) respectively. EBITDA/tonne decreased to US$ 111/t in Q2FY11
compared to US$ 163 in Q1FY11, largely due to the spike in coking coal prices
and an inventory draw-down from the previous quarter. Coking coal price for
Q2FY11 was US$ 225/t compared to US$ 128/t a year ago, leading to a sharp
decline in operating performance despite higher net realisations. We believe the
current stock price presents a good buying opportunity as valuations appear
attractive and profitability will likely increase, led by (a) higher realisations
(price hikes effected by SAIL in September ’10), (b) higher volumes, and (c)
employee cost rationalisation. We reiterate BUY with a target price of Rs 270.

Realisations/volumes higher: SAIL reported a 7% YoY and 17% QoQ increase in
net revenues for Q2FY11. Saleable steel volumes at 3mn tonnes grew 30% QoQ
while remaining flat YoY. Net realisations rose 6% YoY but declined 10% QoQ
on account of weak steel prices in the current quarter compared to Q1. We
expect steel realisations to inch up in Q3 as SAIL has effected price hikes in
September ’10. The management has also indicated that domestic steel prices are
expected to remain stable over the next two quarters.

EBITDA hit by higher coking coal costs: Higher coking coal costs at US$ 225/t
(compared to US$ 128/t in Q2FY10) have impacted Q2FY11 earnings, resulting
in a lower EBITDA/t of US$ 111 compared to US$ 159 a year ago and US$ 163 a
quarter ago. We believe the costs could have been higher due to sales from highcost
inventory of Q1. While employee/other conversion costs have come down
on a QoQ basis, raw material costs alone have dented margins.

Margins to improve led by improved realisations: We believe that the EBITDA
margin will likely increase as (a) realisations improve led by price hikes in Sep-10
and improved product mix and (b) coking coal costs climb down with the rampup
of production at SAIL’s Taasra mines and lower mix of previously contracted
high-cost coking coal of US$300 levels.

Valuation attractive; good opportunity to BUY: We value SAIL at Rs 270 based
on 7x FY12E EBITDA and a net debt of Rs 65bn. The stock is currently trading at
5.4x FY12E EBITDA and 8x FY12E earnings—attractive, in our view. We believe
that the current stock price presents a good opportunity to buy on the strength of
attractive valuations, improving steel realisations, capacity expansion, and lower
coking coal costs as production from captive mines increases and inventory of
high-cost coal diminishes.