SAIL: Near-term headwinds

Last Updated: Wed, Aug 08, 2012 05:53 hrs

While ongoing capacity expansions will help improve volumes and margins in the long term, subdued steel demand and price volatility may weigh on the stock in the immediate future

Steel Authority of India (SAIL) continues to brave its way forward in an unfavourable environment. While SAIL continues with its massive capacity expansion plans to tap future growth prospects, the current sluggish demand environment has taken its toll. The June 2012 quarter saw lower steel sales volumes of 2.5 million tonnes (MT) against production of three MT. However, margin improvement was a good sign. Though it is early days and challenges on demand and pricing persist, from the second half of FY13 analysts anticipate further improvement in margins, driven by expansions at various facilities. In other words, the September quarter may also see some pain.

The December 2012 quarter onwards is expected to be better with steel demand likely to see some improvement led by a pick-up in construction activities and festival season (higher demand for automobiles and consumer durables).

in Rs crore Q1' FY13 FY13E FY14E
Net sales 10,641 47,830 51,153
% change y-o-y 1.7 3.6 6.9
Ebitda 1,515 7,739 9,654
Ebitda (%) 14.1 16.2 18.9
Net profit 696 4,462 5,022
% change y-o-y -17.9 2.4 12.5
EPS (Rs) 1.7 10.8 12.2
PE (x)

8.1 7.2
E: Estimates Source: Company, CapitaLine Plus, JP Morgan

The stock, which is down nearly 25 per cent in the last one year against 1.7 per cent gain in the Sensex, prices in most of the concerns. However, looking at the longer-term prospects there are potential gains. Though some analysts have a target price of up to Rs 125 for the stock currently priced at Rs 87, the consensus target price of Rs 103.58 according to Bloomberg suggests a potential upside of 19 per cent.

Volumes disappoint, margins up
For the June quarter, steel sales volumes came in at 2.5 MT as against 2.8 MT in the year-ago period and 3.2 MT in the March quarter, and were the key disappointments. Respite for revenues and profitability was provided by realisations, which at Rs 42,563 a tonne were up 1.7 per cent sequentially and 10.2 per cent year-on-year. This helped restrict the fall in revenues.

Lower costs provided further boost on the operating front. The recent decline in coking coal prices led to lower raw material costs. At Rs 14,451 a tonne, these were down 12.5 per cent year-on-year and 30.5 per cent sequentially. Some of these gains were offset by rise in power and fuel costs. Nevertheless, margins were up. Ebitda per tonne at Rs 5,514 improved 15 per cent sequentially and 26 per cent year-on-year, estimates Morgan Stanley. Though forex losses to the tune of Rs 257 crore dented profits; adjusted profits were up two per cent at Rs 874 crore.

Capacity expansions
While there have been delays earlier that had shaken investor confidence, completion of most of SAIL's projects is just 3-12 months away. SAIL is expanding its crude steel capacity from 13.7 MT to 21.4 MT and saleable steel capacity by 7.8 MT to 20.2 MT. The Bokaro plant's 1.2 MT expanded capacity is likely to be commissioned in October this year. While individual facilities at IISCO at West Bengal have started getting commissioned, the integrated commissioning will be completed by December 2012, according to analysts. Rourkela expansions are also to be completed in FY13.

Margins to improve gradually
SAIL has commissioned two coke oven batteries with total capacity of 1.6 MT at its plants at IISCO (West Bengal) and Rourkela (Orissa). Analysts feel ramp up of these should allow SAIL to reduce its power and fuel costs, which in turn will help margins. The sinter plant problems that were seen at some of the plants last year, too, have been resolved now. This should further help SAIL's operational performance. Analysts at JP Morgan believe that over the next few quarters, investor focus should shift to how quickly the projects stabilise.

Analysts at Edelweiss Securities in their earlier reports had observed that operating margins may increase from the second half FY13. While the cost of power & fuel and stores & spares have remained high, with gradual commissioning of projects in a phased manner, SAIL expects these costs to normalise in the second half of FY13 and FY14.

Near-term issues
While the commissioning of expanded facilities will add to volumes and margins in the long-run, there are near-term headwinds in the form of subdued steel demand and volatile prices. Also, the June quarter saw almost two MT of steel imports from countries like China, Korea, Japan, Russia and Ukraine on the back of trade agreements with these countries allowing them to pay lower duties. Analysts at JP Morgan add that in flat products, unlike peers like JSW, SAIL has never been aggressive in the export market (product mix is also against it). Hence, SAIL, for now, will continue to depend on domestic steel demand only.

While the concerns persist, analysts are also looking at the benefits that will accrue to SAIL over a period of time. Analysts at JP Morgan have increased their FY13-14 EPS estimates by 4-10 per cent and add that faster ramp-up of coke oven batteries and other allied facilities is the key upside risk.

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