JSW Steel

JSW Steel shareholders can hold on to the stock, as the coming quarters may bring improved financial performance, on the back of volumes from newly-commissioned capacities and lower input prices. At Rs 231, a trailing price-earnings multiple of five times, the stock’s valuation is at a discount to steel sector peers.

However, the company’s relatively high overseas exposure, the vulnerability of its US operations to recessionary trends and the debt on its consolidated balance-sheet leading to losses in the recent quarter, appear to justify a valuation discount to peers such as SAIL.

The company’s moves to increase its domestic exposure, aggressive retail expansion plans and steps to reduce interest costs may help improve performance, with a lag of a few quarters. The debt-to-equity ratio stands at a high 1.75 (as against 0.18 of SAIL).
Business overview

With steel plants in Karnataka and Tamil Nadu, JSW Steel produces around 6.8 million tonnes of steel per annum. The company produces hot and cold rolled steel products with galvanised sheets, plates and pipes. The company’s market is concentrated in India with 85 per cent of revenues coming from West and South India.

Even as JSW Steel shifts focus to the domestic market, steel demand has been showing signs of improvement in recent months. CMIE sees steel production growing by 6.5 per cent in 2009-10 as falling interest rates stoke growth in the construction sector, thus increasing demand for long steel products.

An improvement in the passenger vehicle numbers also augur well for steel demand. JSW Steel is looking to capitalise on these trends by turning to value-added products, aggressively expanding its retail presence. The company plans to open another 50 outlets across the country and have a pan-India presence.

The improvement in sales for JSW Steel in the ongoing March quarter (relative to December) may be quite sharp, given the plant shutdowns in the preceding quarter and the commissioning of expanded capacity at Vijayanagar. The company expects its March quarter 2009 sales to expand to 1.2 million tonnes from 0.7 million tonnes recorded in December quarter of 2008. The re-opening of two blast furnaces that were temporarily shut in November and December and the commencement of production at the Vijayanagar works in February may aid volumes.

The new Vijayanagar facility has expanded the production capacity of the steel maker to 6.8 million tpa from 3.8 mtpa earlier. JSW Steel is further looking to expand the capacity to 10 mtpa by 2011.
Subsidiary drags profits

In 2007, the company acquired three plate and pipe mills in the US for a consideration of $940 million. These companies had a capacity of producing 1.2 million tonne of plates, 0.55 million tonne of pipes and 0.35 million of double jointing and coating lines and are under JSW Steel (US). The strategy behind the acquisition was to ship the excess one million tonne of slab produced in the Indian facilities to the acquired US operations for value-addition and subsequent marketing in that region. It was also hoped that the acquisition would be a stepping stone to catering to the oil and gas sector in North America, a key driver of plate and pipe demand.

But recessionary trends in the US markets and the collapse in oil prices have hit the subsidiary’s operations. In the December quarter alone, the company saw sales volume of plates decline by 53.6 per cent and that of pipes by 20.5 per cent sequentially in the December 2008 quarter; the subsidiary reported a net loss of $2.8 million for the quarter.

As demand may take time to recover in North America, the US subsidiary may continue to weigh on numbers for some more time.

JSW Steel has substantial debt outstanding in its book, with long-term loans at Rs 14,153 crore as at end-December 2008. This takes the debt-to-equity ratio of the company to a high 1.75. With the company eyeing another expansion of capacity to 10 mtpa by March 2011, there remains a risk of further addition to these borrowings.

JSW Steel’s consolidated performance in the December quarter of 2008 was hit by interest costs (Rs 330.19 crore) which more than doubled and from forex losses of over Rs 181 crore on FCCBs with the rupee depreciating sharply against foreign currencies.

Last week the company made an announcement stating that it had repurchased its FCCBs to the extent of US $ 47.80 million. However this is only a small amount when compared to the total outstanding dues in the balance sheet.
Relief on input costs

Though factors such as leverage and challenges for overseas operations remain, the company may see substantial relief in input costs.

The company has recently succeeded in negotiating the prices on long-term coking coal contracts downward to $175 per tonne from $300 per tonne, which may provide substantial margin relief in the coming quarters. (Coking coal prices had shot up to $300 in 2008 from $98 in 2007). The company has also locked into lower prices by taking delivery of 2,00,000 tonnes of coal at the negotiated price.

Overall, while JSW Steel’s efforts to increase its domestic presence may pay off only over time, the March and June quarter numbers may see improvement with the prospect of higher sales and lower input costs.