Accumulate Bhushan Steel– 3QFY2011 Result Update - Angel Broking

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 Bhushan Steel– 3QFY2011 Result Update

            Angel Broking recommends an Accumulate on Bhushan Steel with a Target Price of Rs. 419.

Strong top-line growth: For 3QFY2011, Bhushan Steel reported net profit growth

of 35.9% yoy and 13.0% qoq to `1,943cr on account of a) higher sales volumes,

which grew by 30.1% yoy and 13.2% qoq to 467kt and b) an increase in blended

realisations by 6.9% yoy (but flat qoq) to `45,073/tonne. Flat product sales

volume increased by 43.0% yoy and 11.5% qoq to 367kt, while long product

sales volume declined by 2.4% yoy (but up 19.8% qoq) to 100kt. In 3QFY2011,

the 1.9mn-tonne hot strip mill produced 241kt of hot rolled (HR) coils.

Flat operating performance: During 3QFY2011, BSL’s EBITDA increased by

37.7% yoy and 9.9% qoq to `537cr. This was mainly due to captive consumption

of HR coils, which led to raw-material cost (as a percentage of net sales) declining

to 56.7% from 61.4% in 3QFY2010. However, other expenses increased by

92.8% yoy to `270cr. Hence, EBITDA/tonne increased to US $256 from US $233

in 3QFY2010, however it remained flat qoq. Interest expenses increased by

74.4% yoy and 1.4% qoq to `102cr, while other income fell by 61.1% yoy and

14.0% qoq to `10cr. Thus, net profit grew by 23.3% yoy and 8.2% qoq to `280cr.

Outlook and valuation: At the CMP, the stock is trading at 10.5x FY2011E and

7.7x FY2012E EV/EBITDA, a significant premium of 30% over its peers. Although

we expect sales volume growth of 26.7% over FY2010–15E, rising prices of iron

ore and coal will affect margins of non-integrated players such as BSL in the

medium term. Moreover, BSL’s debt-equity ratio remains high at 2.8x.

Nevertheless, we believe the recent decline in the stock price broadly factors in the

above-mentioned concerns. Hence, we upgrade the stock to Accumulate (Neutral)

with a Target Price of `419, valuing the stock at an EV/EBITDA of 8.0x on our

estimated FY2012 EBITDA.

Result highlights

Strong top-line performance

BSL’s 3QFY2011 net revenue grew by 35.9% yoy and 13.0% qoq to `1,943cr on

account of a) higher sales volume, which grew by 30.1% yoy and 13.2% qoq to

467kt and b) an increase in average gross realisations by 6.9% yoy (but flat qoq)

to `45,073/tonne.

During the quarter, flat product sales volume increased by 43.0% yoy and 11.5%

qoq to 367kt, while long product sales volume declined by 2.4% yoy (but up

19.8% qoq) to 100kt. The 1.9mn-tonne hot strip mill produced 241kt of HR coils

during 3QFY2011.

Flat operating performance

During 3QFY2011, BSL’s EBITDA increased by 37.7% yoy and 9.9% qoq to

`537cr. This was mainly due to captive consumption of HR coils, which led to

raw-material cost (as a percentage of net sales) declining to 56.7% from 61.4% in

3QFY2010. However, other expenses increased by 92.8% yoy to `270cr.

Hence, EBITDA/tonne increased to US $256 from US $233 in 3QFY2010, but

remained flat qoq.

Net profit grew by 23.3% yoy

During the quarter, interest expenses increased by 74.4% yoy and 1.4% qoq to

`102cr, while other income fell by 61.1% yoy and 14.0% qoq to `10cr. Thus, net

profit grew by 23.3% yoy and 8.2% qoq to `280cr.

Investment rationale

Entering a new orbit

BSL has undertaken an expansion plan in Orissa to increase its foothold in the

industry. The project is being executed in three phases, with Phase-I already

commissioned in FY2007 and Phase-II being commissioned recently. Post the

completion of Phase-II, the company's primary steel-making capacity will increase

to 2.2mn tonnes. Moreover, with the current ramping up of its new HR plant, BSL is

moving from being a steel converter to a leading primary producer of steel,

extending its presence in the steel value chain. Phase-III is currently under

execution and is expected to come on stream by FY2013. On completion of

Phase-III, BSL's primary steel capacity will increase to 4.7mn tonnes, making it one

of the leading steel producers in India.

Volume growth sweetened by increasing EBITDA/tonne

With the commissioning of BSL's Phase-III expansion plan, we expect sales volume

to grow at a 26.7% CAGR over FY2010–15E, much higher than its peers. Despite

BSL not being integrated, cost of production is expected to be low due to

a) combination of BF-EAF technology to produce steel and b) lower conversion

costs. The usage of BF-EAF technology will result in lower coal costs.

Top supplier of niche auto-grade products

Over the years, BSL has been shifting its customer base from the trade segment to

OEMs/exports. We believe growing investments by foreign OEMs and the strategic

alliance with Sumitomo Metal Industries will complement the company’s OEM

relationships and will likely help BSL mitigate demand risks.

Key conference call takeaways

􀂄 BSL is currently procuring 70,000–80,000 tonnes per month of thermal coal

from Coal India Ltd. and its subsidiaries.

􀂄 BSL has not yet finalised details of the joint venture with Sumitomo Metal

Industries.

􀂄 BSL has completed capex for Phase-II expansion. Capex requirement for

Phase-III expansion would be ~`10,000cr.

􀂄 BSL has sufficient coking coal inventories to produce steel until April 2011.

However, the company is currently purchasing coking coal at US $350/tonne.

􀂄 Interest capitalised during 3QFY2011 stood at `70cr.

Outlook and valuation

At the CMP, the stock is trading at 10.5x FY2011E and 7.7x FY2012E EV/EBITDA,

a significant premium of 30% over its peers. Although we expect sales volume

growth of 26.7% over FY2010–15E, rising prices of iron ore and coal will affect

margins of non-integrated players such as BSL in the medium term. Moreover,

BSL’s debt-equity ratio remains high at 2.8x. Nevertheless, we believe the recent

decline in the stock price broadly factors in the above-mentioned concerns. Hence,

we upgrade the stock to Accumulate (Neutral) with a Target Price of `419, valuing

the stock at EV/EBITDA of 8.0x on our estimated FY2012 EBITDA.

We have increased our net sales estimates for FY2012 as we now expect higher

steel prices on account of rising raw-material prices. However, we have lowered

our profitability estimates for FY2012 to factor in higher prices of iron ore and coal

(key inputs) during FY2012.