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Research
REDUCE JSW Steel - IIFL
Posted On : 2012-08-31 21:09:19( TIMEZONE : IST )
A potential merger of JSW Ispat (Ispat) and JSW Steel (JSTL) would lead to a spike in net debt and deterioration of leverage ratios of JSTL. On the other hand, carried-forward tax losses of Ispat would reduce tax expense and boost earnings. However, this would not have a meaningful impact on cash generation and valuation, in our view. JSTL's large dependence on thirdparty iron ore miners in Karnataka (JSTL's peak requirement > 70% Karnataka's production limit) would make iron ore procurement a lingering issue. Additionally, miners' move away from export parity price may increase production cost. At 5.4x FY13ii EV/Ebitda, the risk-reward is not attractive. REDUCE.
Potential merger with Ispat would increase leverage: In the event of merger of JSTL and its 47% associate - Ispat, consolidated net debt would increase from Rs166bn to Rs232bn. Consequently, net gearing ratio would increase from 100% to 130%. On the positive side, the carried-forward losses (tax shield ~Rs25bn) of Ispat would give a fillip to near-term earnings. Swap ratio based on CMP would increase equity base of JSW Steel by ~8%.
Iron ore issues far from resolved: JSTL is well placed to meet its production guidance of 80% capacity utilisation in FY13, thanks to the supply from stock piles. For sustaining this run-rate in FY14, immediate commissioning and ramp-up of production in Karnataka are critical. JSTL faces two risks for iron ore: 1) excessive dependence on Karnataka (needs over 70% of state's production); and 2) iron ore pricing mechanism moving away from export parity pricing.
Low earnings visibility; retain REDUCE: JSTL acquired several businesses in the past five years, including the overseas mining assets, plate and pipe mills in the US, and a steel making capacity in India. Operating performance of these businesses worsened vs. projections made at the time of acquisitions. Low backward integration of standalone operations calls for a valuation discount vis-Ã -vis peers. At 5.4x FY13ii EV/Ebitda, the risk-reward is not attractive. REDUCE.
