JSW Steel - Factoring in the positives; Hold - Anand Rathi

Exports to enhance volumes. With utilization at ~88%, JSW Steel is likely to have enhanced production from sequential levels, to 3.2m tons. With greater production, operating leverage and efficiency would have improved in 3QFY14. Inventory de-stocking and a flexible export network would have led to sequentially stable sales volume growth. However, a poorer product mix would have led to a subdued, 3%, sequential realization improvement. Exports are likely to come at 30% of volumes as the company has been able to display strong leverage in export opportunities and spreads.

Drop in input prices offset by currency depreciation. Savings in costs from the drop in coking-coal prices would have been offset by depreciation of the Indian currency and higher iron-ore prices. We estimate no impact from higher iron-ore prices in 3QFY14 as material quality would have improved efficiency. So, improvement in iron-ore mining volumes in Karnataka and Orissa would have led to higher utilization levels and lower raw material costs.

Debt de-leveraging to materialise. The next trigger for re-rating is based on the de-leveraging cycle for JSW Steel as it moves towards lower capex and stable working capital. In the near term, higher realisations would follow from price hikes effected in the last two quarters. The lag effect of higher raw material costs due to a depreciated currency and inflation in production factors would chip away factors underlying the EBITDA improvement.

Our take. With prices of raw materials declining globally, terms of trade on a longer-term basis are shifting from miners to metal converters, but the near term looks challenging for converters with historic low prices of coking coal, and domestic iron-ore deficit resurfacing. We maintain our Hold, maintaining a target of Rs. 819 as we believe valuations now factor in the conversion strength, but for further re-rating raw-material challenges have to register long-term solutions. Risks. Lower utilization rates and regulatory policies.

Source : Equity Bulls

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