Steel Authority of India Ltd - Subdued performance continues, downgrade to sell - Centrum

We downgrade SAIL to Sell from Hold reducing our target price to Rs36 from Rs49 as operational performance continued to remain subdued in Q1. The company found it difficult to push volumes leading to further inventory build up which has now started to go out of hand. SAIL's competitive strength remains low among large domestic steel producers and profitability will remain under pressure going ahead on the back of the high inventory overhang. Expansion related commissioning has started, but we do not expect SAIL to find markets for its expanded capacity in the near future with already swelling inventory. We revise our volume estimates lower leading to sharp cut in earnings estimates.

Volumes disappoint again: Sales volumes at 2.6 MT (~3% lower than our exp.) was a negative surprise and production of finished steel at 3.2 MT, will add to inventory levels which is going out of hand slowly. Blended realizations were up 2.4% QoQ on account of higher value added product mix.

Operational performance inspires no confidence: Operational performance was marginally better than expectations but did not inspire any confidence as EBITDA/tonne stood at ~Rs3700/t (lowest in the past 5 yrs except for Q4FY13). EBITDA margin of 9.6% was higher by 200bps QoQ, but SAIL remains the highest cost converter among large domestic steel players and employee costs have gone up further. Inventory sales going forward could keep margin subdued in coming quarters also.

Earnings estimate reduced further on lower volumes: SAIL's finished steel inventory of ~1.2MT at FY13 end should swell up further and keep earnings muted going ahead. With the company finding it tougher to push volumes in a competitive domestic market, we have cut volume estimates for FY14E/15E to 11.7MT/13.8MT on the back of delayed expansions and subdued demand. We also reduce our EBITDA estimates for SAIL by 16.4%/12.3% for FY14E/15E.

Valuation and risks - downgrade to Sell: We have remained bearish on SAIL for long on account of reduced competitive capability and high operational cost structure in a tough demand environment and competitive market. We value the company at 5x FY15E EV/EBITDA and expected outstanding CWIP at 0.7x to arrive at a target price of Rs36. Downgrade to Sell. Key risks to our call would be sharp run up in steel prices and higher volumes as well as inventory sales and faster execution of expansion and modernization plan.

Source : Equity Bulls

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