Edelweiss: Usha Martin - operational issues hit earnings; Buy

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n  Breakdown at power plant to hit Q3FY11 production

Usha Martin’s (UML) 30 MW captive power plant (total: 73 MW) is shut down since last month due to a breakdown in the turbine. Management expects to restart operations post repairs in the next 7 days. However, since the company failed to procure adequate power from a local power plant in the interim, Q3FY11 production could be hit. Management has reduced its guidance for FY11 billet production to 540 kt from 575-600 kt earlier, while it has maintained its FY12 guidance at 800 kt. We are, however, cutting our volume estimates from 547 kt to 519 kt for FY11 and from 750 kt to 700 kt for FY12.

n  Captive coal supply disrupted due to truck unavailability

Thermal coal supply from UML’s captive mines has been affected since the Jharkhand government has allowed loading of only 15t per truck against 30t earlier. Hence, there is an increased requirement of trucks, which is not fully met. As a result, captive coal availability is expected to reduce from 120kt in Q2FY11 to 70-80kt in Q3FY11. The landed cost of coal is also likely to increase by INR 150/t.

However, the management is confident of being able to resolve the truck unavailability issue in due course. Until then, we have a cautious stance on this issue. Accordingly, we revise down our FY12 estimates for captive coal from 100% to 75%. For FY11, captive coal proportion is 50%.

n  Outlook and valuations: Near term issues; maintain ‘BUY’

We have reduced our billet production estimate by 5% and 7% for FY11 and FY12, respectively. For FY12, we have increased coal costs by 16%, blended power tariff by 10% and other operational costs by 10%. Led by this and the reduced proportion of captive coal, our revised assumptions lead to 17% and 16% cut in EBITDA for FY11 and FY12, respectively; EPS is cut by 30% and 28% for the respective years. We maintain ‘BUY’ on UML, but downgrade the relative rating to ‘Sector Performer’ from ‘Sector Outperformer’. We cut our fair valuation from 125/share to INR 91/share.