Motilal Oswal is bearish on Steel Authority of India
(SAIL) and has recommended sell rating on the stock with a target of Rs 59 in its January 7, 2013 research report.
“SAIL seems to have traversed the full circle in the last 10-12 years. At the beginning of the last decade, it had low profitability, high debt and near zero equity value. CWIP/MCap was 40%, though this is no benchmark, as MCap was very small (EV comprised largely of debt). Thereafter, its fortunes turned due to the boom in the sector and complete absence of capex until FY08. From net debt of ~INR140b in FY01, the balance sheet had net cash surplus of INR111b by the end of FY08, which led to massive re-rating and huge stock performance (stock was up >50x in 7 years). Even during the financial crisis of 2008, SAIL outperformed the sector due to its strong balance sheet. Since FY09, however, SAIL’s earnings have come under pressure due to inflation of wages, lack of volume growth, related productivity gain and increased financial leverage, with net debt increasing by ~INR400b on account of INR721b capex. The stock has witnessed de-rating and market cap has dipped below 5x one-year forward EBITDA.”
“SAIL’s CWIP/MCap ratio has zoomed past its historical high of 50% in FY01 to 92% in FY13. This is the second highest in the Metals sector after Hindalco. The ratio is worse than the last two cyclical distresses in FY00-01 and FY09. The question is, once the capex cycle peaks for SAIL over the next 2-3 years, can we expect significant returns? SAIL is undertaking expansion and modernization across plants to increase its saleable steel capacity from 12.4mtpa to 20.2mtpa. The total capital outlay for the project is INR721b, of which it has already incurred INR456b until September 2012. We expect various capacities to commence operations over FY14-16, with 6-18 months delay from the current schedule.”
“At steel prices USD518/ton (HRC FOB) and iron ore prices at USD106/ton, SAIL’s projects will have an NPV of INR344b, with an IRR of 5.3%. This is an optimistic scenario, in our view. In our base case scenario (please refer to our recent Sector Update, Downhill Run), where we have assumed that iron ore prices will correct to USD83/ton, with corresponding correction of USD39/ton in steel prices and EBITDA per ton (please note we are ignoring coking coal prices here because SAIL hardly has any captive mines and its earnings, therefore, have low sensitivity to coking coal prices), the total NPV will be INR480b, with an IRR of 2.8%. Lower iron ore prices will reduce the benefit of iron ore integration significantly, leading to lower NPV. We believe that spreads between prices of inputs like iron ore, coking coal, etc and steel prices will remain subdued due to huge overcapacity in the steel sector. Hence, change in raw material prices will be completely passed through in steel prices.”
Applying our two alternative approaches to valuation, we find that SAIL has downside in all 4 situations.
1. SOTP: We have valued operational assets at an EV of 5x one-year forward EBITDA. We have adjusted the CWIP against the NPV of the projects to capture their intrinsic value. SAIL’s valuations are highly sensitive to steel/iron ore prices. In the base case scenario, where we assume iron ore prices of USD83/ton, we arrive at a value of INR52/share. In the optimistic scenario, where we assume iron ore prices of USD106/ton FOB, we arrive at a value of -INR5/share.
2. FY20 valuations discounted for five years: We arrive at FY20 valuations to factor in completion of all ongoing projects and the possible delays. We have discounted these valuations backwards for five years by SAIL’s cost of equity of 18.1%. In the base case scenario, we arrive at a value of INR44/share. In the optimistic scenario, we arrive at a value of INR74/share.
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