See limited downside for JSPL; Hindalco top pick: Edelweiss

The government on September 1 told Supreme Court that it wanted to re-auction 218 coal blocks that were declared as illegal allocation but spared 46 blocks out of which 40 are operational mines and six others are in absolute readiness to be operational for end use plant.Prasad Baji Edelweiss Financial Services in an interview to CNBC-TV18 shared his views on the likely impact of this decision on various metal stocksAccording to him one could expect a penalty of Rs 2500 crore to be imposed on Jindal Steel and Power Limited (JSPL) and one-time penalty of around Rs 800 crore on Hindalco.However, he thinks the worst is priced-in for JSPL post the steep correction and although the stock may not see a big upside, the downside too will be limited.His target price for both JSPL and Hindalco post penalty stands at Rs 252 per share and Rs 232 per share respectively.His top picks in metals are JSW Steel, Sesa Sterlite and Hindalco.

Below is the transcript of Prasad Baji's interview with Latha Venkatesh & Sonia Shenoy on CNBC-TV18.Sonia: What would be the impact of yesterday’s announcement be on stocks like Jindal Steel and Power (JSPL) and Hindalco Industries?A: One of the fears and concern that the existing blocks will also be cancelled, seems to have reduced, of course assuming the Supreme Court agrees to that view of the government. Nevertheless, there is a penalty which was also expected and effectively the way they have structured in terms of additional royalty of Rs 295 per tonne payable since start of production. It appears from the media reports that this is for companies which do not have PPA, which is the case for the metal companies and for JSPL since the Jindal Power plant was working on merchant basis until recently where they have signed one PPA. Therefore in terms of impact, the penalty for JSPL will also definitely be high because they have 12 million tonne coal production. Therefore, the penalty could be in order of Rs 2,500 crore considering that they have done such high mining, almost 100 million tonne all these years.However, for Hindalco, it will not be a very big number. They are mining 2.5 million tonne currently which was earlier a lower number. So, we expect around Rs 800 crore or thereabouts to be the one time penalty, for Usha Martin; it’s around Rs 70 crore odd.

Going forward with higher royalty, there is a higher cost per tonne of coal assuming it is Rs 295. There will be 3 percent cut in JSPL EBITDA for FY16, for Hindalco it’s only around 1 percent and 2 percent for Usha Martin. So, the EBITDA cut is not very big but on recurring basis the valuation impact will be as well. On pro forma basis for JSPL the target price which is Rs 304 could go down to Rs 252, for Hindalco it could go down to Rs 232 from Rs 240. Therefore, net-net unfortunately for JSPL the impact seems to be the highest but for the rest it is not that high.Latha: At the moment in the calculations you gave us, you are taking a penalty only for power or for steel as well?A: Currently I am taking for both. There is lack of clarity but it looks like the penalty is stable if you do not have a power purchase agreement (PPA). I assume that all metal companies not have a PPA, they been captive producers maybe given penalty. However, I would like to see what court has to say. I do not know, court may not give all the fancy carve outs and they may just say that anyway it is illegal so everybody has to pay it. Sonia: What would your view be on JSPL because the stock has fallen from Rs 350 to Rs 250 in the last three months? Do you think the worst of this news has already been priced in?A: The worst is priced-in with the correction. Currently, we have a hold rating and unfortunately that doesn’t change much because the decline is there and after the cut in target price it could be around Rs 250-260 levels. Therefore, I do not see very big upside but the downside is not there.

Latha: Adani Enterprises had a lot of coal blocks allotted to it, nothing came of that but has the stock price corrected. Now it looks like all those will be deallocated?A: I do not track Adani directly but it is very simple in terms of principles, so only those coal blocks which have started or six which are about to start, I think there is some protection for them, the rest go away. So, for Adani, their Parsa Kente mine has started and one mine is close to starting. I am not sure of whether it is included in the six lists but at least Parsa Kente having started should be counted in the 46 coal blocks. I am not sure about the rest at this stage.Sonia: What are your top picks within the metal space now?A: Our top picks are JSW Steel, Sesa Sterlite and Hindalco. Essentially for JSW Steel, we see the EBITDA per tonne rising much higher on percentage basis as compared to other stocks. We see 33 percent rise in EBITDA per tonne, volume growth will also be steady. On non-ferrous side, we are more positive or sectorally we feel that the prices have strong upside both for zinc and alluminium, in that order. Therefore, Sesa Sterlite and Hindalco benefit from that.Latha: What I heard from steel guys specially, all over the world they say that coal blocks are not auctioned because it is not like spectrum; it is very difficult to prospect and then acquire land and then the environmental clearance. Their point is that you may not even know how to bid. Can there be one of these reserve price confusions and overbidding or overpricing as we saw in the spectrum case?A: Till recently in many countries auction was not an allotment method but since then auction has been introduced in many countries. So, it is partly true that that auction is not the only mechanism. Also there are specific challenges to mining for auction, for example you do not have approvals, you don’t have land. You are not very sure of the reserves; detail study is not done unlike in spectrum where the moment you bid and win an auction for a spectrum you are ready to start business. In mining even after auction you can take seven-eight years to start a mine with huge amount of uncertainty on whether it will actually happen. So, there are huge differences between telecom and mining. Therefore, I do not think it is right to compare it that way. Unfortunately, at the macro level that the courts are seeing, I do not think they are making those kinds of distinctions. Sonia: Yesterday’s hearing, do you think has raised the possibility of a quicker resolution of the case because as I understand now a formation of a committee has been ruled out and the court will resolve the matter directly?A: I think it seems to be the case. The court certainly seems to be not looking at a committee. They are simply going to hear all the parties and arrive at a conclusion. So that seems to be the case.