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Steel Authority of India Management Meet Update

July 5, 2012, Thursday, 15:41 GMT | 10:41 EST | 19:11 IST | 21:41 SGT
Contributed by Nirmal Bang

We had a meeting with the management of SAIL to get an update about the current status of expansion projects. We are confident about the company commissioning its projects according to schedule as most of the projects would get completed in just 3-12 months. However, there would not be a material change in our earnings estimates as the long ramp-up time ensures that most of the benefits flow in only from FY14. We revise our capex guidance and fine tune our earnings estimates following the meeting, leading to a 1% drop and a 2% rise in FY13E and FY14E EBITDA, respectively. We retain our Sell rating as well as TP of Rs81, which is 11% below the CMP.

No significant delay expected incrementally: The company has been grappling with severe delays in the expansion of its key projects since the past two years, which has shaken the confidence of investors and is one of the reasons behind de-rating of the stock. We don’t expect any significant delay incrementally as completion of most of the projects is just 3-12 months away. However, we believe SAIL would face some teething problems, thereby leading to most of the benefits flowing in only from FY14.

Wage cost provisioning inadequate: SAIL’s non-executive pay revision (accounting for 50% of total wage costs) is effective from 1 January 2012, but, the company made a provision for 7.5% wage hike during 4QFY12. Although wage negotiation would be a long-drawn process, the 7.5% wage hike provision remains inadequate, in our view. We would like to highlight that other public sector undertaking, i.e. Coal India, which operate in the same vicinity, had to shell out a 25% hike in non-executive pay. SAIL has made a provision for around Rs700-800mn relating to the wage hike in 4QFY12, but this was offset by lower provisioning for long-term employee benefits due to a change in the interest rate scenario.

Costs escalation unlikely: Unlike the IISCO expansion, which witnessed a Rs20bn rise in costs due to re-tendering of ground piling work, other projects would not witness any increase in costs as most of the tendering work has been completed. Out of total Rs619bn of steel expansion projects, only Rs56bn (9% of total capex) worth of projects are yet to be awarded.

Re-rating unlikely due to deteriorating return ratios: SAIL is investing Rs620bn to hike saleable steel capacity from 12.4mt to 20.2mt, which includes re-building of 2.2mt of saleable steel capacity at Bhilai steel plant. Thus, the addition of 10mt additional saleable steel capacity with a capex of Rs670bn (half of the mining capex has also been included), which would result in significant deterioration in return ratios. As per our backward calculation, SAIL needs to generate EBITDA/tn of Rs14,140 in order to generate a respectable 14% RoE, which leads to 10.6% RoCE.

Valuation: SAIL currently trades at P/E multiples of 9.8x and 8.6x FY13E and FY14E earnings, respectively, while EV/EBITDA multiples are at 7.3x and 6.7x for the same period. We retain our Sell rating with a TP of Rs81 (5.0x FY14 EV/EBITDA).