JSW Steel - Standing tall despite challenges; maintain Buy - Centrum

We maintain buy on JSW Steel (JSTL) with a reduced target price of Rs658 (Rs775 earlier) as we cut our FY15E EV/EBITDA multiple to 5x from 5.5x earlier on account of further stress on balance sheet from rupee depreciation (~40% debt in US$ unhedged). At our recent meeting, the management sounded confident on meeting volume guidance and reconfirmed the company's focus on improving productivity, aggressive marketing and offering better product mix, leading us to revise our volume estimates higher marginally. However, we see increase in the cost of iron ore and imported coking coal (due to weak rupee) neutralising the positive impact of price hikes (4-6% across products from Sep'13) and thus expect marginal positive impact on our earnings estimates.

Volume guidance to be met despite Karnataka ore deficiency; iron ore cost to go up: JSTL said there was no new mining restarts in Karnataka in the last few months but it expects to meet volume guidance of 11.5 MT in FY14 with higher purchase of ore from other states and the seaborne market. We expect iron ore cost to increase further and build in blended iron ore cost of Rs3550/t for FY14E with iron ore sourcing from outside Karnataka accounting for 20% for Vijaynagar and 45% for the consolidated operations.

Commissioning of cost efficiency projects key margin trigger: We see timely commissioning of cost efficiency projects (lime calcination, 4 mtpa pellet and 1 mtpa coke oven at Dolvi) to provide the margin trigger for JSTL. Together with higher value added steel share (~25% in FY15E from 18% in FY13) in the product mix post commissioning of the new CR mill at Vijaynagar and new galvanizing lines at Tarapur, EBITDA margin is set to improve by 600bps on a consolidated basis for FY15E.

Earnings revised marginally upwards at operational level: We see traction for volumes in exports on the back of weak rupee to mitigate the impact of weak domestic demand and revise our volume estimates marginally higher to 10.8MT/11.5MT for FY14E/15E. JSTL has indicated price increases of 4-6% from Sep'13 onwards to cover higher costs but we expect partial discounts due to subdued domestic demand. We revise our EBITDA estimates upwards by 4%/3.8% for FY14E/15E. We see upward pressure on debt and interest costs due to the weak rupee as ~40% of the consolidated debt is in US$ (unhedged) and as a result our PAT estimates are revised lower.

Valuations and risks - maintain buy: We like the operations of the company with low conversion cost and superior marketing team but remain concerned on the increased debt exposure post merger with JSW Ispat (~40% debt exposure in US$ unhedged) and ~US$1.6bn of revenue acceptances (expected to result in large MTM forex losses). We cut our FY15E EV/EBITDA to 5x from 5.5x earlier on account of multiple challenges of higher iron ore cost, higher debt and lower return ratios and revise our target price downwards to Rs658 from Rs775 earlier. Maintain Buy. Key risks include delay in projects, rise in coking coal contract costs and high cost iron ore.

Source : Equity Bulls

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