Buy Tata Steel, Godawari Power;Sell Bhushan Steel says PINC

Steel: Margins unsustainably low; improvement likely:

Global steel output reached an all-time high in May’11 to ~130mnt (YTD ~631mnt) led by robust growth in emerging economies and demand recovery in developed nations Although steel margin expanded in Q4FY11 on higher prices, we expect margin to contract in H1FY12 as impact of high cost RMs come through with a lag amidst lower steel prices, mainly in China, India. Such low margins are unsustainable: Expect improvement in profitability in H2FY12, FY13 led by reduction in RM cost as supply concerns ease. However, integrated producers benefit from margin expansion on higher steel prices as input costs remain low for captive availability.”

Steel demand improvement likely led by China, India:

China: Steel demand growth may slow down, but has miles to go before the dragon sleeps; Industry consolidation likely. Steel intensity of GDP growth may decline on increasing focus on domestic consumption and energy efficiency. However, we believe that rising FAI investments in hitherto lagging. Western and Central China to keep metal consumption at high levels. Steel output in China reached all-time high in Jan-May’11. We expect output to decline in Q3CY11 given China’s efforts on energy saving and high cost RM impacting profitability.

India: We expect steel supply to outpace demand by FY13E on capacity addition; expect India to turn net exporter in FY13E.  Although near-term demand concerns on inflation and monetary tightening, long-term demand drivers remain intact (infra investment, growing consumerism, increase in steel intensity of investment). WSA expects growth of 13.3% in CY11 and 14.3% in CY12. Supply: Brownfield expansions to increase supply by FY13 leading to net export in FY13E; Capacity addition post FY13 to slowdown as greenfield expansions face regulatory hurdles. We expect domestic pricing to be tight vis-à-vis landed cost.

Outlook: Although there are near-term concerns facing steel industry, we believe valuations factors in the concerns, while underscoring likely improvement from H2FY12 onwards.

Tata Steel : We find the stock attractively valued at 5.0x FY12E and 4.9x FY13E EV/EBITDA. Maintain ‘BUY’ with a revised target price of Rs713 (6.0x consolidated EV/EBITDA).

SAIL : Attractively valued at 3.9x FY12E EV/EBITDA; ‘BUY’ with a TP of Rs168 (5.5x FY12E EV/EBITDA, CWIP at 10% disc. to BV).

JSW Steel : We expect JSW’s EBITDA and EPS to expand on volume growth. 4.5mn tpa WB project and 2.0mn tpa de-bottlenecking at Vijayanagar are future volume growth drivers. Value-added focus, technological collaboration with JFE and focus on resource integration would help in margin expansion. We maintain ‘BUY’ on JSW steel with a revised TP of Rs1,239. (JSW steel @ 5.5X EV/EBITDA, Ispat @5.0x EV/EBITDA).

Godawari Power and Ispat : Valuation: Attractively valued at 3.2x FY12E EV/EBITDA. We expect GPIL to benefit in FY12E from higher steel, DRI and pellet prices amidst increasing pellet and DRI output. Further, stabilisation of operations at Ardent steel is expected to provide additional volume and earnings growth. We maintain ‘BUY’ with a TP of Rs278 (4.5x FY12E EV/EBITDA).

Usha Martin : Although Usha Martin looks attractive at 3.8x FY12E EV/EBITDA, with fully integrated business model and volume growth, we maintain our cautious outlook on the stock given inability to benefit from increased capacity and integration amidst various one-offs impacting performance. We would like to wait and watch for benefits of integration to flow resulting in margin expansion and volume growth. Maintain ‘HOLD’ with a revised target price of Rs68 (4.5x FY12E EV/EBITDA).

Bhushan Steel : Bhushan steel is trading at 6.4x FY12E and 5.9x FY13E EV/EBITDA respectively, most expensive ferrous stock. Given very high exposure to steel cyclicality (lack of resource integration, high leverage), we find the stock expensive. We maintain ‘SELL’ with a TP of Rs 389 (6.0x FY12E EV/EBITDA).

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