JSW Steel

Investors may consider retaining the stock of JSW Steel in view of the company's proven execution ability, improved product mix and volumes which should enable it to capitalise on growing demand from the infrastructure, automotive and consumer durables segment.



However, lower levels of raw material integration, high debt levels and international operations are a possible drag. At the current market price of Rs.1028, the valuation of 12.2 times FY10 earnings for the stock is at a discount to peers such as SAIL and Tata Steel.

THE OPERATIONS

JSW Steel operates three domestic facilities with a combined production capacity of 7.8 million tonnes at Vijaynagar and Salem. This is expected to rise to 10.8 mtpa by the end of the curren fiscal.The company is the least integrated steel producer among the top three producers, both Tata Steel and SAIL having their entire iron ore demand met by captive mines.

Currently, JSW has less than 20 per cent of its iron ore requirements met by captive production. Despite acquiring mines locally and globally, meaningful improvement in captive mine production is at least two to three years away. The company's domestic sales accounted for 85 per cent of its revenue, compared with 72 per cent in FY09, with exports and international operations accounting for the remaining 15 per cent.

The company posted a rise of 66 per cent in saleable steel volumes to 5.7 million tonnes, courtesy its brownfield expansion at the Vijaynagar unit. The company's production of flat steel and other value added variants stood at 60 per cent of saleable steel volumes; The company also hopes to eliminate lower margin semis products.

The company also operates a slab and pipe facility in the US which, due to the struggling US economy, continued to be a drag on the consolidated profits.

THE NUMBERS

The company's consolidated sales have grown at a compounded rate of 30 per cent since FY07 while net profits during the same period have grown at a slower pace of 7 per cent.

Net profit margins have averaged at 9.5 per cent. FY10 saw revenues up by 18 per cent due to the aforementioned capacity additions, net profits were up about 50 per cent (not accounting for losses/gains on forex transactions).

Also coming to the aid were raw material costs, which were three percentage points lower as a proportion of sales. The company's consolidated debt-equity ratio stands at 1.75:1, with EBIT covering interest three times over.

This leaves the company with limited space for additional borrowing in the event of a downturn in the steel cycle. The company is unlikely to repeat the base-effect aided 2009-10 annual net profit growth, but the possibility of higher utilisation rates at Indian facilities in FY11 and capacity additions, which are likely to be operationalised over FY12, will aid in significant volume growth. The losses registered at the expensive US slab and pipe facility are likely to be reduced as the demand from the oil industry improves, with increasing crude oil prices fuelling pipe demand and increased utilisation rates.

RAW MATERIAL OUTLOOK

Iron ore and coking coal prices are in the midst of a rather turbulent period, with prices slumping in the first quarter of FY11.

Despite spot market weakness, several miners have planned to hike iron ore prices for the third quarter of the calendar year. Domestic iron ore major NMDC has hiked prices by 11 per cent for the coming quarter in a sign of buoyant volume demand from domestic steel producers.

Coking coal contracts have taken a similar trajectory with Japanese steel producers expected to agree to a 12 per cent hike in coking coal contract prices for the September quarter. With raw material prices holding firm, the pressure is on steel producers to keep costs and inventory low and pass on the price hikes to the consumer.

Indian prices are expected to remain tight owing to import risk and global weakeness. Reports indicate that Indian steel players are likely to cut flat steel prices by up to 7 per cent in July.

STEEL PRICE OUTLOOK

Indian flat steel imports for the month of May were double that of the same period a year ago. A second dip in the European economy could spell serious trouble which, coupled with a cooling Chinese economy, for which there is mounting evidence including a lower PMI figure, could spell moderation in global commodity prices that have just hit the comeback trail.

India has seen volume-demand remain buoyant with skyrocketing car sales and consumer durables helping cold-rolled steel producers. Demand from the infrastructure segment has remained sober. In a rather ironic twist, steel companies, which during the last quarter of 2010 had experienced a sweet spot of low raw material prices and high demand driven realisations, now find themselves in the reverse situation of higher raw material costs coupled with slipping realisations.

Realisations for the next six months are likely to remain on a tight leash, which leaves JSW's bottom line on one as well.

via BL