JSW Steel - Losing Its Steely Grip

The ban on mining came at a time when JSW Steel had just started the commercial operation of its 3.2 million tonne blast furnaces at its Karnataka plant. This means that the efficiency and output of producing additional steel would take a beating despite its new plants having ramped up the production capacity from 7.8 million tonnes in FY11 to 11 million tones. By putting up this plant JSW Steel has emerged as the largest steel making plant at a single location. But now this single location plant is becoming an issue with the company due to the non-availability of iron ore at competitive prices. In fact, the Bellary region has 16 million tonnes’ steel making capacity of which as high as 10 million tonnes is with JSW Steel. This explains why JSW Steel is the most affected.

The present situation for the steel sector across the country is looking weak. In the first five months of the current financial year steel consumption merely grew by 1.3 per cent to 28.05 million as against 11 per cent recorded during the same period last year. This is mainly due to a continuous slowdown in the industrial activity, retail and infrastructure sectors. Also, with rising interest rates and firm inflation we believe that the steel using industries, especially auto and the infrastructure sectors, would report slower growth, thus impacting the demand for steel. JSW Steels’ 75 per cent of production is for flat products and any slowdown in automobiles and rate-sensitive sectors impact it the most.
For the year ended March 2011, the company derived 43 per cent of its revenues by catering to the infrastructure and auto segment (for detail break-up on end use market for JSW Steel please refer to the pie chart). But our discussion with the company spokesperson revealed that the industry has not seen any major contraction yet in the overall demand and the company is continuing to sell whatever has been produced without any inventory holding. He further stated that he doesn’t see any contraction in the coming quarters as well. This discussion took place just before the company announced its production cut to 30 per cent.[PAGE BREAK]

The ground realities were quite a different picture from what was stated. When we look at the latest July IIP numbers which have shown the slowest growth in the past 21 months, it indicates a downtrend in industrial activity primarily led by a substantial contraction in the capital goods output (up to 15.2 per cent) and the manufacturing sector which merely grew by 2.8 per cent. We went a step ahead and spoke to sector analysts in the auto and the infrastructure sectors. They too sounded pessimistic on the respective industries which consumes steel in a big way. Therefore we believe that the overall demand in the coming quarters will remain weak for steel companies, forcing them to hold on to a higher inventory in the books. For JSW this will spell double trouble due to the production cut and the falling demand.

Frankly speaking, we don’t see JSW being able to sort out its iron ore problem too soon. The present prices in Karnataka for iron ore are at Rs 4,200-4,400 per tonne compared to Rs 3,100-3,400 per tonne before the ban. JSW Steel requires about 17,000 tonnes of iron ore per day to run its 10 million tonne per annum Vijaynagar plant. However, due to a 100 per cent shutdown of private iron ore mining companies like Sesa Goa, VMPL and others, JSW Steel has no other option but to buy iron ore at elevated prices from NMDC (the only company allowed to mine iron ore there).

The situation seems to have worsened further as the apex court has ordered NMDC to sell iron ore through an e-auction and is barred to sell on a contract basis to anyone. JSW Steel has a long-term contract with NMDC but has not been able to source its raw material due to this court order. Therefore the only other alternative is to buy iron ore from other states and if that is not viable, the only option is to cut down the production. We are not sure when the situation would normalise in case of iron ore supplies and hence are keeping our fingers crossed about the production schedule of JSW Steel.

Looking at the financials in FY11 the company has performed better with a 29 per cent YoY growth in topline to Rs 25,130 crore. The growth in sales was primarily on the back of 7 per cent increase in sales volume and a favorable product mix. However, because of higher coking coal and iron ore prices, the EBITDA margin of JSW Steel has seen a major contraction by 540 bps to 20.8 per cent in FY11. Moreover, we believe the pressure on margins will continue in the second half of FY12 due to higher iron ore prices which may remain firm until there is any major respite on normal mining activity from the Supreme Court. We expect the company to report poor numbers for the September quarter and also for the year ended March 2012.

Looking at the situation we believe that the counter would continue to underperform in the coming months. Also, a slowdown in the global economy does not augur well for metal companies and hence even the fancy for steel stocks would be on the lower side amongst the investing fraternity. Keeping these facts in mind we advise our readers to stay away from the counter. Fresh purchases are not recommended at this point of time. In case you are holding JSW Steel you may exit at the present moment and think of buying once there is some news on the lifting of the ban.