SAIL a value buy at current price

Last Updated: Wed, Mar 27, 2013 05:04 hrs

The best time to invest in a stock is when no one is buying it. In the first three months of the current year, Steel Authority of India (SAIL) has lost a little over 40 per cent of its market capitalisation and the stock price has crashed to an eight-year low.

Part of this is explained by short-term concerns such as lower steel demand, falling steel prices and delay in capacity expansion. More important, the correction is due to selling pressure on account of its recently concluded Offer For Sale (OFS) by the government, promoter and the largest shareholder. At its current stock price of Rs 60 a share, SAIL is trading at a huge discount to its historical valuation and is one of the cheapest stocks in the metal segment.

Earnings-based valuation
"At the current price, I do not think you have anything to lose and most of the concerns such as delay in capex are priced in. If we look at historical valuations such as price to earning ratios and price to book value, the stock has a lot of value," says Goutam Chakraborty, who tracks the company at Emkay Global Financial.

In the past five years, the stock has traded at about 10 times its one-year forward earnings. Currently, it is trading at eight times its FY14 estimated earnings, indicating further room for re-rating.

Below historical price to book
At its current price, SAIL is trading at a 40 per cent discount to its trailing 12-month book value or net worth. Based on its net profit for the past four quarters, the net worth is estimated at Rs 42,200 crore, much higher than its market capitalisation of Rs 26,000 crore. SAIL has a strong balance sheet, with a debt to equity ratio of less than one. It is spending nearly Rs 42,000 crore on expansion of existing capacity by nearly 50 per cent in the next two years. Two-thirds of the capex amount is being funded through internal accrual, giving the management the financial flexibility in case the profitability worsens.

The company has been cheaper in the past but its finances are not comparable. In 2001, the company was available at half its book value but was loss-making and staring at the prospect of turning sick due to accumulated losses.

Valuable assets
The company plans to double its capacity by FY15 at a total cost of Rs 72,000 crore. The projects have been delayed but analysts expect a part of these capacities to come onstream in FY14 and balance in FY15. "The expansion projects are estimated to be commissioned in a phased manner from FY14. Volume growth, which has remained stagnant over the last five years, is expected to be strong from the second half of FY14," says Tarang Bhanushali, who tracks the company at IIFL.

This could trigger a re-rating of the stock, since capex will be revenue and profit-accretive from the start. Steel demand in India continues to grow and the landed cost of steel in the domestic market is still higher than the cost of production. In the past 10 years on average, SAIL has generated revenue of Rs 97 for every Rs 100 worth of investment in fixed assets (or gross block). If the company is able to commission its ongoing capex worth Rs 28,000 crore, its revenues is projected to cross Rs 70,000 crore in FY15, against a rise of 50 per cent from its FY12 figures. If we apply the current net profit margin of eight per cent and a price to earnings multiple of 8x, its market capitalisation should be in the region of Rs 45,000 crore, higher by 70 per cent from the current level.

Though SAIL looks attractive on various valuation ratios and other parameters, the stock re-rating could be derailed in the case of delay in ongoing capacity expansion. Further, improvement in steel demand and steel prices will be key to its growth. Also, since the company does not have access to captive coal, a rise in coal prices could lead to erosion in margins and this could hit earnings.

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