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JSW Steel
Downgrade to Underperform
„Downgrade to Underperform on mining ban uncertainty
We downgrade JSW Steel (JSW) to Underperform from Buy as the Supreme
Court has only allowed one of its iron ore suppliers (NMDC) to resume mining in
Bellary, but retained ban for other firms. JSW sources 60% of its ore from Bellary,
where mining was recently banned. A continued Bellary mining ban could (1)
constrain FY12 vols. due to iron ore supply issues, & (2) lift costs due to sourcing
from other areas. We cut our FY12E-13E EPS by 25-12% due to lower volumes &
higher costs. Despite the correction in the stock price over last month, we see
more downside risk. We cut our PO (NPV based) to Rs650, implying 6x FY12E
EBITDA broadly in line with domestic steel peers.
Supreme Court only allows NMDC to resume Bellary mining
The Apex Court allowed NMDC (20% of JSW’s FY11 iron ore supply) to mine up
to 12mtpa of ore at two Bellary mines. The ban on other mines will be reviewed
after an environmental review is done in three months. NMDC’s output from the
two mines was 5-6mt before the ban. A large increase is unlikely near term as (1)
one mine was closed in FY11 & has to be restarted, & (2) logistics issues exist.
Iron ore shortage to constrain volume; cut volume estimate
We forecast FY12 volumes of 7.5mt (-10%) as we think sourcing the 16mtpa iron
ore needed for 8.3mt of FY12 steel vol. guidance will be difficult despite restarting
NMDC’s mines. Assuming JSW gets 4mt of ore from NMDC (contracted volume
pre-ban), it will need 11-12mtpa from Tumkur and Chitradurga, close to total
output in the region. It may have to source iron ore from elsewhere at higher cost.
Higher iron ore procurement costs to dent margins
JSW sourced 2-3mtpa of ore from its JV at cost plus (US$16/t) which now has to
be sourced from NMDC at higher cost (US$60/t). Also freight cost is higher on ore
from other areas. NMDC may pass on higher royalty cost imposed by the Court
Downgrade to Underperform
We downgrade JSW Steel from Buy to Underperform as the Supreme Court has
only allowed NMDC (20% of JSW’s iron ore supply in FY11) to restart mining in
Bellary and has retained the mining ban for other companies. JSW sources about
60% of ore from Bellary where the Court recently banned mining. The court order
only offers partial relief to JSW Steel in our view. We believe the mining ban
could (1) constrain JSW Steel’s FY12E volume due to iron ore sourcing issues,
and (2) increase costs due to sourcing from other sources. We cut our FY12E-
13E EPS by 11-25% as we pare our FY12-13 volumes forecast 4-7% and raise
our iron ore cost estimates by 6% to factor in iron ore shortages and higher freight
costs. Despite a sharp correction in the stock price over last month led by
negative news around the Lokayukta mining scam allegations against JSW Steel
(denied by the company) and the Bellary mining ban, we expect the shares to
Underperform due to iron-ore sourcing and cost concerns, amid slowing steel
fundamentals. We cut our PO (NPV based) to Rs650, which implies 6x FY12E
EBITDA broadly in line with domestic peers. Upside risks to our rating/PO are 1)
Bellary mining ban resolution; 2) stronger steel fundamentals.
Court only allows NMDC to resume mining at Bellary
The Supreme Court has allowed NMDC (20% of JSW Steel’s iron ore supply) to
mine up to 12mtpa of iron ore at two mines (pre-ban output 5-6mtpa) in Bellary
until further notice. The ban on other mines in Bellary will continue. This may be
reviewed after an environmental assessment is completed in three months. We
highlight the Supreme Court had issued an interim order on 29 July suspending
mining operations in 10,868ha of the Bellary District (80% of Karnataka’s iron ore
output) until further notice due to environmental degradation (Bellary Mining Ban).
Key highlights of the Supreme Court order
„ The Supreme Court has allowed NMDC to produce up to 1mt per month from
the two specified mines in Bellary until further notice. The production will be
sold to states in consultation with the Ministry of Steel. No production will be
allowed to be exported.
„ It has directed the government to carry out an environmental impact
assessment of the Bellary region in three months. The Court may review the
issue after this period. Our base case assumes it will allow some mines
(legal mines) to resume operations in FY12. However, as we have seen in
the past, the resolution of these issues could take a while.
„ SC has directed the Karnataka government to charge royalties at 10% of
current market value of the iron ore from NMDC instead of 10% of the value
as determined by the Indian Bureau of Mines (IBM) (which is generally lower
than market price). The difference will be deployed by the Karnataka
government toward rehabilitation of the area.
Iron ore shortage could constrain volumes in FY12E
We have cut our FY12 volume estimate 10% to 7.4mt as meeting the entire 16mt
iron ore needed to reach its FY12 volume guidance of 8.3mt could be tough,
despite resumption of production at NMDC’s mines. We estimate a 1% change in
volume impacts EPS by 2.3%.
„ JSW Steel has cut production post Bellary mining ban: JSW had recently
shut two blast furnaces and was operating at 65-70% utilization due to an
iron ore shortage after the ban. We understand, after the mining ban, JSW
was sourcing iron ore at the rate of 30,000 tons per day (10-11mtpa) from
Chitradurga/Tumkur and around 7,500 tons per day (2.7mtpa) from NMDC’s
Chhattisgarh mines at high cost. JSW Steel’s sourcing costs had increased
by about US$11/ton (around US$20/t of steel) as a result, after the ban was
imposed. JSW now expects to achieve ~80% utilization post the Court order.
„ Court order only offers partial relief to JSW Steel: NMDC’s iron ore output
from the two mines was 5-6mt (about 4.2mt in FY11E) over the past few
years. Though the Court order allows NMDC to produce up to 1mn tons per
month (12mtpa), we believe a sharp ramp-up in volume is unlikely near term
as (1) one of the mines (Kumaraswamy mine – ML1111) was closed in FY11
and has to be restarted, and (2) logistic constraints exist as Kumaraswamy
mine is not mechanized.
„ Sourcing required iron ore remains a challenge: Though the proportion of
NMDC production that will be allocated to JSW is not yet clear, assuming
JSW gets 4mt from NMDC (contracted volume pre-ban, 60% of NMDC
volume), it will need an additional 11-12mt from Tumkur and Chitradurga
mines to achieve steel production guidance of 8.3mt. Karnataka ex Bellary
production was 8mt in FY09 (as per IBM statistics). Though we don't have
the recent production data, we estimate the total availability in Karnataka ex
Bellary is unlikely to exceed ~11-12mt (even after factoring in Sesa Goa’s
expansion). Also the risk of the Supreme Court extending the mining ban to
these areas is high as the Supreme Court has already ordered an
environmental assessment of the Tumkur and Chitradurga area within three
weeks. In addition, JSW Steel may have to source iron ore from other
sources (Orissa, Chhattisgarh) at higher cost.
Higher iron ore sourcing costs to dent margins
We believe lower iron ore integration due to suspension of JSW’ Steel’s captive
mine (JV) located in Bellary due to the ban, tighter iron ore supply, and higher
iron ore transportation costs could increase iron ore procurement costs and dent
JSW Steel’s margins. Local market iron ore prices have increased to export parity
(vs discount to parity) due to a tighter domestic market led by mine closures. Also
JSW’s iron ore integration fell from 16% to 0% due to suspension of mining at
VMPL’s (captive JV) mines, located in Bellary. In addition, transportation from
alternate iron ore sources entails higher transportation costs. We estimate a
US$1/t increase in blended costs reduces our FY12E EPS by 2.8%.
„ Reduction in iron ore integration: JSW sources 2-3mtpa (2.2mt in FY11e)
of ore from its captive JV (VMPL) at cost plus (around US$16/t), which has to
be replaced by higher cost NMDC ore (about US$60/t). To put this in
perspective, if the ban continues through FY12E, the increase in iron ore cost
will be about US$132mn (around 10% of FY12E EBIDTA) or about
US$18/ton of steel. In our base case, we assume the Supreme Court allows
VMPL to resume production during the year. We assume 1.5mt of production
from VMPL mines. Our estimates will have further downside risks if the
operations at VMPL remain suspended through the year.
„ Higher transportation costs from other sources: JSW has to incur higher
transportation costs of around US$5/t (US$9/t of steel equivalent) on ore
from Chitradurga/Tumkur. Also the transportation cost of ore from
Chhattisgarh is about US$44/t (US$80/t of steel equivalent)
„ Potential pass thru of higher royalty cost by NMDC: The Court has
directed NMDC to pay higher royalties based on the market value of the ore,
which, at present, is higher than the current royalties of 10% of the IBMdetermined notional value (Rs2,400/t). We believe NMDC may pass the
incremental royalty costs on to customers.
Cutting FY12E EPS 11-25% on lower volume, higher costs
We cut our FY12 volume forecast by 10% to 7.5mn tons and FY13 volume by 5%
to 8.7mn tons. We also factor in higher iron ore costs (up 6%). Our base case
forecasts assume more mines (including VMPL) will resume operations in Bellary
in FY12E. We believe there could be further downside to EPS estimates if the
ban continues through the year. We now also include profits from US coking coal
mines in our estimates, which cushion the impact of higher costs to some extent.
Price objective basis & risk
JSW Steel (XJWJF)
Our PO of Rs 650 is based on our NPV estimate. This assumes a WACC of
12.5% and a perpetuity growth of 0%. At our PO, JSW would trade at 6.0x FY12e
EBITDA (broadly in line with domestic steel peers) and 10.6x FY12e EPS. Our
model assumes volumes of 7.50mt in FY12e and 8.75mt in FY13e.
Downside risks to our PO are lower-than-expected steel prices and volumes, and
higher input costs, continued mining ban in Bellary. Upside risks are higher-thanexpected steel prices and volumes, and lower input costs, resolution of the
Bellary mining ban.
India Equity Research Reports, IPO and Stock News
Visit http://indiaer.blogspot.com/ for complete details �� ��
JSW Steel
Downgrade to Underperform
„Downgrade to Underperform on mining ban uncertainty
We downgrade JSW Steel (JSW) to Underperform from Buy as the Supreme
Court has only allowed one of its iron ore suppliers (NMDC) to resume mining in
Bellary, but retained ban for other firms. JSW sources 60% of its ore from Bellary,
where mining was recently banned. A continued Bellary mining ban could (1)
constrain FY12 vols. due to iron ore supply issues, & (2) lift costs due to sourcing
from other areas. We cut our FY12E-13E EPS by 25-12% due to lower volumes &
higher costs. Despite the correction in the stock price over last month, we see
more downside risk. We cut our PO (NPV based) to Rs650, implying 6x FY12E
EBITDA broadly in line with domestic steel peers.
Supreme Court only allows NMDC to resume Bellary mining
The Apex Court allowed NMDC (20% of JSW’s FY11 iron ore supply) to mine up
to 12mtpa of ore at two Bellary mines. The ban on other mines will be reviewed
after an environmental review is done in three months. NMDC’s output from the
two mines was 5-6mt before the ban. A large increase is unlikely near term as (1)
one mine was closed in FY11 & has to be restarted, & (2) logistics issues exist.
Iron ore shortage to constrain volume; cut volume estimate
We forecast FY12 volumes of 7.5mt (-10%) as we think sourcing the 16mtpa iron
ore needed for 8.3mt of FY12 steel vol. guidance will be difficult despite restarting
NMDC’s mines. Assuming JSW gets 4mt of ore from NMDC (contracted volume
pre-ban), it will need 11-12mtpa from Tumkur and Chitradurga, close to total
output in the region. It may have to source iron ore from elsewhere at higher cost.
Higher iron ore procurement costs to dent margins
JSW sourced 2-3mtpa of ore from its JV at cost plus (US$16/t) which now has to
be sourced from NMDC at higher cost (US$60/t). Also freight cost is higher on ore
from other areas. NMDC may pass on higher royalty cost imposed by the Court
Downgrade to Underperform
We downgrade JSW Steel from Buy to Underperform as the Supreme Court has
only allowed NMDC (20% of JSW’s iron ore supply in FY11) to restart mining in
Bellary and has retained the mining ban for other companies. JSW sources about
60% of ore from Bellary where the Court recently banned mining. The court order
only offers partial relief to JSW Steel in our view. We believe the mining ban
could (1) constrain JSW Steel’s FY12E volume due to iron ore sourcing issues,
and (2) increase costs due to sourcing from other sources. We cut our FY12E-
13E EPS by 11-25% as we pare our FY12-13 volumes forecast 4-7% and raise
our iron ore cost estimates by 6% to factor in iron ore shortages and higher freight
costs. Despite a sharp correction in the stock price over last month led by
negative news around the Lokayukta mining scam allegations against JSW Steel
(denied by the company) and the Bellary mining ban, we expect the shares to
Underperform due to iron-ore sourcing and cost concerns, amid slowing steel
fundamentals. We cut our PO (NPV based) to Rs650, which implies 6x FY12E
EBITDA broadly in line with domestic peers. Upside risks to our rating/PO are 1)
Bellary mining ban resolution; 2) stronger steel fundamentals.
Court only allows NMDC to resume mining at Bellary
The Supreme Court has allowed NMDC (20% of JSW Steel’s iron ore supply) to
mine up to 12mtpa of iron ore at two mines (pre-ban output 5-6mtpa) in Bellary
until further notice. The ban on other mines in Bellary will continue. This may be
reviewed after an environmental assessment is completed in three months. We
highlight the Supreme Court had issued an interim order on 29 July suspending
mining operations in 10,868ha of the Bellary District (80% of Karnataka’s iron ore
output) until further notice due to environmental degradation (Bellary Mining Ban).
Key highlights of the Supreme Court order
„ The Supreme Court has allowed NMDC to produce up to 1mt per month from
the two specified mines in Bellary until further notice. The production will be
sold to states in consultation with the Ministry of Steel. No production will be
allowed to be exported.
„ It has directed the government to carry out an environmental impact
assessment of the Bellary region in three months. The Court may review the
issue after this period. Our base case assumes it will allow some mines
(legal mines) to resume operations in FY12. However, as we have seen in
the past, the resolution of these issues could take a while.
„ SC has directed the Karnataka government to charge royalties at 10% of
current market value of the iron ore from NMDC instead of 10% of the value
as determined by the Indian Bureau of Mines (IBM) (which is generally lower
than market price). The difference will be deployed by the Karnataka
government toward rehabilitation of the area.
Iron ore shortage could constrain volumes in FY12E
We have cut our FY12 volume estimate 10% to 7.4mt as meeting the entire 16mt
iron ore needed to reach its FY12 volume guidance of 8.3mt could be tough,
despite resumption of production at NMDC’s mines. We estimate a 1% change in
volume impacts EPS by 2.3%.
„ JSW Steel has cut production post Bellary mining ban: JSW had recently
shut two blast furnaces and was operating at 65-70% utilization due to an
iron ore shortage after the ban. We understand, after the mining ban, JSW
was sourcing iron ore at the rate of 30,000 tons per day (10-11mtpa) from
Chitradurga/Tumkur and around 7,500 tons per day (2.7mtpa) from NMDC’s
Chhattisgarh mines at high cost. JSW Steel’s sourcing costs had increased
by about US$11/ton (around US$20/t of steel) as a result, after the ban was
imposed. JSW now expects to achieve ~80% utilization post the Court order.
„ Court order only offers partial relief to JSW Steel: NMDC’s iron ore output
from the two mines was 5-6mt (about 4.2mt in FY11E) over the past few
years. Though the Court order allows NMDC to produce up to 1mn tons per
month (12mtpa), we believe a sharp ramp-up in volume is unlikely near term
as (1) one of the mines (Kumaraswamy mine – ML1111) was closed in FY11
and has to be restarted, and (2) logistic constraints exist as Kumaraswamy
mine is not mechanized.
„ Sourcing required iron ore remains a challenge: Though the proportion of
NMDC production that will be allocated to JSW is not yet clear, assuming
JSW gets 4mt from NMDC (contracted volume pre-ban, 60% of NMDC
volume), it will need an additional 11-12mt from Tumkur and Chitradurga
mines to achieve steel production guidance of 8.3mt. Karnataka ex Bellary
production was 8mt in FY09 (as per IBM statistics). Though we don't have
the recent production data, we estimate the total availability in Karnataka ex
Bellary is unlikely to exceed ~11-12mt (even after factoring in Sesa Goa’s
expansion). Also the risk of the Supreme Court extending the mining ban to
these areas is high as the Supreme Court has already ordered an
environmental assessment of the Tumkur and Chitradurga area within three
weeks. In addition, JSW Steel may have to source iron ore from other
sources (Orissa, Chhattisgarh) at higher cost.
Higher iron ore sourcing costs to dent margins
We believe lower iron ore integration due to suspension of JSW’ Steel’s captive
mine (JV) located in Bellary due to the ban, tighter iron ore supply, and higher
iron ore transportation costs could increase iron ore procurement costs and dent
JSW Steel’s margins. Local market iron ore prices have increased to export parity
(vs discount to parity) due to a tighter domestic market led by mine closures. Also
JSW’s iron ore integration fell from 16% to 0% due to suspension of mining at
VMPL’s (captive JV) mines, located in Bellary. In addition, transportation from
alternate iron ore sources entails higher transportation costs. We estimate a
US$1/t increase in blended costs reduces our FY12E EPS by 2.8%.
„ Reduction in iron ore integration: JSW sources 2-3mtpa (2.2mt in FY11e)
of ore from its captive JV (VMPL) at cost plus (around US$16/t), which has to
be replaced by higher cost NMDC ore (about US$60/t). To put this in
perspective, if the ban continues through FY12E, the increase in iron ore cost
will be about US$132mn (around 10% of FY12E EBIDTA) or about
US$18/ton of steel. In our base case, we assume the Supreme Court allows
VMPL to resume production during the year. We assume 1.5mt of production
from VMPL mines. Our estimates will have further downside risks if the
operations at VMPL remain suspended through the year.
„ Higher transportation costs from other sources: JSW has to incur higher
transportation costs of around US$5/t (US$9/t of steel equivalent) on ore
from Chitradurga/Tumkur. Also the transportation cost of ore from
Chhattisgarh is about US$44/t (US$80/t of steel equivalent)
„ Potential pass thru of higher royalty cost by NMDC: The Court has
directed NMDC to pay higher royalties based on the market value of the ore,
which, at present, is higher than the current royalties of 10% of the IBMdetermined notional value (Rs2,400/t). We believe NMDC may pass the
incremental royalty costs on to customers.
Cutting FY12E EPS 11-25% on lower volume, higher costs
We cut our FY12 volume forecast by 10% to 7.5mn tons and FY13 volume by 5%
to 8.7mn tons. We also factor in higher iron ore costs (up 6%). Our base case
forecasts assume more mines (including VMPL) will resume operations in Bellary
in FY12E. We believe there could be further downside to EPS estimates if the
ban continues through the year. We now also include profits from US coking coal
mines in our estimates, which cushion the impact of higher costs to some extent.
Price objective basis & risk
JSW Steel (XJWJF)
Our PO of Rs 650 is based on our NPV estimate. This assumes a WACC of
12.5% and a perpetuity growth of 0%. At our PO, JSW would trade at 6.0x FY12e
EBITDA (broadly in line with domestic steel peers) and 10.6x FY12e EPS. Our
model assumes volumes of 7.50mt in FY12e and 8.75mt in FY13e.
Downside risks to our PO are lower-than-expected steel prices and volumes, and
higher input costs, continued mining ban in Bellary. Upside risks are higher-thanexpected steel prices and volumes, and lower input costs, resolution of the
Bellary mining ban.
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