Credit Suisse, India Steel Sector -Cutting steel price assumptions; Downgrade Tata to UNDERPERFORM

● With steel prices falling more than expected (1Q avg $650/t versus
$715/t in 4Q), we cut our estimates. Prices are unchanged in INR,
but only because of the fall in the rupee. The weaker currency limits
impact on EBITDA/t, though it falls too in dollars (Fig 1).
● As EBITDA for steel firms has flattened/fallen but depreciation and
interest costs have risen, leverage below the line has increased.
Thus, the impact on EPS is 5-25% (Fig 2). For company-specific
reasons, price targets are unchanged for SAIL, Tata and JSW (Fig
3), mostly as new capacities are now nearing completion.
● We downgrade Tata from Neutral to UNDERPERFORM: our upgrade
in January was on grounds of valuation, which are no longer
supportive. Over and above the problems in EU, and the macro
troubles in India, the ongoing uncertainty in China, once translated to
iron ore/coal prices can meaningfully impact Tata’s valuations.
● We cut our target price for JSPL from Rs600 to Rs534 but maintain
P/P. A very small part of the cut is due to lower profit assumptions on
steel. Instead, the reduction is mainly due to higher costs at CPP
units, lower value of 2400MW plant and removal of Bolivia.

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Revising down steel price estimates
With steel prices falling much more than we had anticipated (1Q
averaging at around $650/t versus $715/t in 4Q), we have cut our
estimates. In rupee terms prices are broadly unchanged, but the fall in
the rupee has brought down dollar realisations. We have now made
the steel price change assumptions steadier—we were earlier building
in a 5% fall in 2HFY13 due to domestic factors. But the global price
weakness has brought forward this change.


Our volume estimates are largely unchanged. The differing changes in
EBITDA/t are driven by dollar linked costs and other industry level
cost changes. For example, in Europe even if steel prices do fall
US$100/t for argument’s sake, profitability is unlikely to fall as much,
as capacity shutdowns will compensate. With 60%-plus of its
expected FY13 European output from its Ijmuiden facility, which is in
the top quartile of European producers, Tata should be able to keep
its volumes up.


Due to lower EBITDA/t levels but flat/rising depreciation and rising
interest costs, operating leverage has risen sharply for these
companies. Thus, relatively minor EBITDA/t changes on unchanged
volumes drive much sharper EPS changes


● Tata Steel: As has been seen for the company over the past few
instances of growth in domestic capacity, the market starts to
value it in advance. We have therefore now given them credit for
about 1mt of extra output in India (over and above the 7.6mt of
sales in FY13). Our upgrade of Tata to Neutral in January was a
valuation call, and we do not find these supportive. We therefore
downgrade the stock to UNDERPERFORM.
● SAIL: With the ISP commissioning finally imminent (though further
delays cannot be ruled out), we have now started to give the
company credit for some of the capex by valuing Rs25 bn of
CWIP.


Our target price for JSPL is revised down to Rs534 from Rs610 mainly
as we bring down valuation of the 1350MW power plants due to
higher costs sustaining for longer than expected, bring down the
CARV adj value of the 2400MW plant, and remove Bolivia from the
SOTP. Maintain OUTPERFORM rating.