JSW Steel - JSW Ispat Merger -Target Price: Rs732 :Centrum

JSW Steel - JSW Ispat Merger

Neutral

Target Price: Rs732

CMP: Rs694

Upside: 5.5%

Aggressive move in an adverse environment, downgrade to Neutral as valuations set to suffer

JSW Steel has announced the merger of its associate JSW Ispat with itself at a share swap ratio of 1:72 resulting in an equity dilution of 8.3% and creating the largest steel company in India by capacity (14.3 mtpa). We see the merger as impacting negatively on the merged entity in the short term on account of lower margin profile of the merged entity (drop of 160bps in FY14E), high debt levels (to increase by ~Rs78bn in FY14E) putting a strain on balance sheet, no immediate further equity infusion from JFE steel and absence of operational raw material assets in the portfolio. For FY14E, we see proforma EPS for the merged entity reducing 17.5% despite increase in EBITDA by 15.6% on account of lower margin, higher interest costs and equity dilution. We downgrade the stock to neutral from Buy with a target price of Rs732.

Hot to handle : Ispat — Open Offer : SELL: Business Line

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Investors can consider selling their shares in Ispat Industries in the open market instead of tendering to the open offer made by JSW Steel. JSW Steel picked up a 42 per cent stake in Ispat Industries through a fresh equity fund infusion of Rs 2,170 crore in December 2010.

The company has made an offer Rs 22.25 for 20 per cent of Ispat's post-dilution equity, which close on April 5. Ispat's current share price stands at Rs 24.45.

Holding onto Ispat's shares provides little margin-of-safety, given the risk from rising raw material costs or the event of a possible failure or over-runs (time and cost) in turning around the operations.

Negligible levels of integration and an EV/tonne value of Rs 35,000, which is rather generous, makes it a less favoured investment option now. The metric also places it on a par with current multiplies of more successful peers such as SAIL and Bhushan Steel. With net losses over the trailing 12 months, the company is not comparable to peers on a price-earnings basis.

WHAT AILS THE COMPANY

Ispat Industries, through units in Dolvi and Nagpur, has the capacity to produce 3.3 million tonnes of steel, of which 10 per cent is processed into cold-rolled products. The company spent Rs 7,500 crore producing steel, which was sold for Rs 8000 crore. What pushed it into losses was the Rs 1,040-crore in interest charges it paid on Rs 8,000 crore of total debt incurred in building and running the state-of-the-art steel plant. The plant employs‘Conarc' technology, which resulted in a higher electricity bill. This, coupled with the stress of an increasing raw material bill, with steel prices not keeping pace over the last two years, pushed the company which had run through its debt and cash to shutter its plants late last year.

JSW GAMEPLAN

JSW Steel has experience in utilising domestically untested technology to produce steel, not to mention turning around ailing steel plants (at Vijaynagar and Salem). Turning Ispat Industries around may turn out to be a lot quicker than having to setup a 3.3 million tonne Greenfield plant, given the challenges on the land-acquisition front.

JSW Steel is moving in three ways to get the plant running and profitable again: First, by lowering the power costs. Ispat Industries, now helmed by JSW Steel, may reportedly take a 26 per cent stake in JSW Energy's Ratnagiri unit. If it does, it may have access to 300 MW of captive power. Such a move may save the company 20-25 per cent of its current energy bill, resulting in possible savings of Rs 180-250 crore.

The second move is to spend over Rs 3000 crore to operationalise Ispat's iron ore mines (for which the company holds a licence) with 100 million tonnes of reserves and other facilities, including Ispat's delayed projects which are a pellet plant, captive power plant and a coke-oven which will help lower costs. The third move is to lower interest costs on the Rs 8000-crore of total debt held by Ispat.

While promising, these are significant operational challenges for the JSW-Ispat combine to overcome over the next two years making this bet a risky proposition.

Ispat Industries - awaiting turnaround; visit note; Edelweiss

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Ispat Industries (NDEN IN, INR 25, Not Rated)

We recently visited Ispat Industries’ (Ispat) HRC plant near Mumbai. Key takeaways of the same are as follows:

n  Rapid ramp up of HRC production to 70% utilisation; targeting 90%

Ispat has rapidly ramped up HRC production to 70% utilisation after re commissioning operations in end December. Target utilisation is 90%, the key challenges for achieving which will be working capital availability and raw material sourcing. We expect JSW Steel to address these issues over the next two quarters. In 12mFY10, actual capacity utilization was 80%.

Religare Research: Top 10 stocks:: ISPAT INDUSTRIES

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ISPAT INDUSTRIES
CMP (Rs.):24.15 EPS (Rs.): 0.00 52 Week High : 26.20
MCap (Rs. Cr.): 3133 Book Value(Rs.): -2.52 52 Week Low : 15.25
Fundamental View :
 JSW has acquired 41% stake in ISPAT for Rs21.5bn. Ispat is currently operating at
utilisation levels of 80% and generates EBIDTA/ton of USD70. The company needs to
revamp its operations to increase the profitability.
 Ispat Industries Ltd proposes to push the projects whose implementation has been
delayed by the recent meltdown. The projects include coke oven plant at a cost of Rs
1,100 crore, power plant at Rs 490 crore and mining projects at Rs 120 crore. Except the
mining project, the two others will be implemented in partnership with others. The
company said that 110 MW (55 MWx2) plant would be commissioned by the middle of
next year while the coke oven plant by the middle of 2012.
 Ispat Industries is aiming to raise output to 4.2 million tonnes per annum from 3.3 million
tonnes per annum.