Steel Authority of India - Headwinds pile up - ICICI Securities

Steel Authority of India (SAIL) reported lower than expected EBITDA at Rs61.5bn. Even after adjusting for wage revision provision (long due) from April 1, 2020, EBITDA falls short of estimates. This also leads to increase in employee costs estimates for FY22/23E. Full year FY21 dividend also falls short of expectations at Rs 2.8/share. The investment thesis continues to face the dual headwinds of i) higher employee costs and ii) possibility of higher capex. Coupled with peak spreads and most of the deleveraging expectations in the price, the investment thesis looks clouded. The pace of deleveraging, given capex programs will take time to ramp-up, limits downside risks to an extent, unlike past cycles. We downgrade to SELL with an unchanged target of Rs 99/share.

- Dual headwinds of higher employee costs and higher capex, at peak spreads. Employee wage revisions are due, and ~Rs11.5bn has been provided on an estimated basis in Q4FY21 (provided for past four quarters). While, more clarity will be obtained in the post result call (scheduled at 11am IST today), higher profits will bring in the headwind of higher employee costs. Also, there have been media reports of higher steel capex from SAIL to take steel capacity upto 50mtpa in keeping with the company's 'Vision 2030' program. Dual headwinds along with peak spreads, don't allow for any constructive thesis on the name.

- Significant reduction in Net debt. Net Debt (ex of capital advances) has reduced by ~ Rs 161bn to Rs 353bn in FY21. If a controlled capex trajectory is followed, SAIL has the option to reduce Net Debt to EBITDA to 0.7x and 0.37x by FY22/23E. The significant deleveraging prospects can only materialise and benefits maintained if capital discipline is witnessed.

- Downgrade to SELL with a target of Rs99/share (unchanged): Notwithstanding the present earnings scenario, we continue to ascribe ~ 0.55x P/B to FY23E. We believe perhaps the FY22E volume assumptions are also at risk given a weak Q1FY22. Also, given the peak spreads, and the cycle now 5 quarters long, caution is warranted.

- Upside and downside risks. Its still not clear, whether royalty incidence on sale of captive iron ore can allow the same level of profitability as was previously anticipated. Steel sales volume is expected to touch 17-18mnte in FY22E. However, a weak Q1FY22 will perhaps lead to the target being extended out. Also, higher long product mix in Bhilai, Durgapur and IISCO may lead to underperformance of margins (due to diverging prices of flats and longs) in the medium term.

Change in earnings and valuations

We have changed our earnings to adjust for higher employee costs and diverging trend seen in flat and long product prices. Also FY23E has seen a higher steel price and EBITDA assumption as we have factored in 2-3 quarters additional duration in the steel cycle.

We downgrade to SELL rating with a price target of Rs99/share (unchanged). We value the company at 0.55x P/B (unchanged) based on FY23E.

Key upside and downside risks

Key downside risks are i) Cycle corrects itself ii) Higher organic capex announcement. Key upside risks are i) Higher iron ore sales to continue fetching additional EBITDA ii) better than expected deleveraging over FY21-23E.

Shares of STEEL AUTHORITY OF INDIA LTD. was last trading in BSE at Rs.135.05 as compared to the previous close of Rs. 128.55. The total number of shares traded during the day was 9222362 in over 43552 trades.

The stock hit an intraday high of Rs. 135.7 and intraday low of 129.45. The net turnover during the day was Rs. 1220047105.

Source : Equity Bulls

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