SAIL - Fizz gone, hangover remains - ElaraCapital

We met management of Steel Authority of India (SAIL IN) recently to get an update on its expansion plans and the probable reduction in operating cost. The following are the takeaways:

FY13-16E volume CAGR at 13% but profitability below peers

With most expansion expected to be completed by Q3FY15, SAIL can deliver a volume CAGR of 13% during FY13-16E to 16 mn tonnes in FY16E. However, high initial cost of stabilization and employee cost would keep profitability lower than peers for the next two years. We expect it to record an EBITDA/tonne of INR 6,200 in FY16E vs Tata Steel's INR 14,500 and JSW Steel's ~INR 8,000.

Full potential of current expansion to accrue only from FY18

We expect SAIL to record an EBITDA/tonne of INR 4,170 in FY14E. SAIL guides for an incremental EBITDA/tonne savings of ~INR 5,000 at peak capacity of 20 mn tonnes, which may accrue in FY18. The company attributes this to lower employee cost, savings in energy cost and value addition. The reduction in energy cost would take place by incorporating the coal dust injection system in blast furnaces, thereby replacing expensive coking coal with thermal coal, replacement of open hearth furnaces and reduction in yield loss due to 100% continuous casting. Though the target seems to be optimistic, it is achievable if SAIL manages to execute it properly. We estimate even with the reduction in employee cost/tonne to ~INR 6,100 in FY18 from INR 7,800 in FY13, it would still be much higher than peers (Tata Steel's INR 4,800 and JSW Steel's INR 950).

Net debt to rise further; free cashflow to remain negative until FY16

SAIL's net debt is expected to increase further from INR 195bn at Q2FY14-end to ~INR 364bn by FY16-end, as cashflow from operations will not be sufficient to fund its expansion plans. We believe it will have negative free cashflow until FY16.

Expensive valuation – we reiterate Sell

Though SAIL has underperformed peers, it has provided 37% return in the past six months on the back of an expected global recovery and improvement in domestic steel prices. However, with this sharp runup, we believe the current price has fully factored in even FY16 earnings, and, thus, provides no upside. The stock is trading at 0.6x FY16E P/B, which, we think, is more than justified with weak return ratios (ROE of 6.9% in FY15E and 7.4% in FY16E). We raise our TP to INR 54 from INR 47 as we now value the company on 6.5x EV/EBITDA and assign a 75% weightage to FY15E earnings and a 25% weightage to FY16E earnings. We reiterate Sell.

Source : Equity Bulls

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