Is SAIL a value pick?

Chandrakant / 09 Dec 2011

Steel Authority of India, the country's largest steel making company, has continuously underperformed the market in the last one year. The scrip has fallen by 53%, and is currently trading at Rs 85. It has also underperformed in comparison with other major players.
Steel Authority of India (SAIL), the country's largest steel making company, has continuously underperformed the market in the last one year. The scrip has fallen by 53%, and is currently trading at Rs 85. It has also underperformed in comparison with other major players like TATA Steel and JSW Steel, which have fallen by 42% and 50% respectively in the last one year.

In Q2 FY12, the net profits of the company also declined significantly by 54.6% YoY to Rs 495 cr. This was on the back of dismal operating performance, higher interest costs and forex loss of Rs 508 cr, which forced the company to post such dire results.

The steel sector, on the whole, has been facing problems from Oct 2009-10 onwards, when coking coal prices started moving in the upward direction, and continued to do so till Sept 2011. As though this was not enough for the sector, the ban on iron ore mining in Karnataka and the falling demand due to weakening economic conditions further dented the growth of these companies.

SAIL’s underperformance despite similar macro issues as of other players entails a further scrutiny into the companies' operations and business. Let us take a look at the performance of all the 3 major steel players on YTD basis.

                    SAIL             TATA Steel              JSW Steel  
Particulars H1FY 11  H1FY 10  YoY H1FY 11  H1FY 10  YoY H1FY 11  H1FY 10  YoY
Sales  21,921 19,881 10.3 65798 62913 4.6 14702 10456 40.6
Operating Profit  2,649 3,479 -23.8 11176 7998 39.7 2718 2124 28.0
Gross Profit  3,235 4,002 -19.2 9722 6489 49.8 2313 1780 30.0
Net Profit/Loss  1,334 2,267 -41.2 5433 5098 6.6 705 796 -11.3

The key parameter to understand the actual performance is to look at the companies' operating performance. SAIL's operating margin has declined by 540 bps to 12.09% on a YoY basis, whereas that of TATA Steel has increased by 26% and that of JSW Steel has fallen by 183 bps to 18.48%. This means that the operating performance of SAIL has been impacted the most as compared to other players. This was largely on account of the lower realisations it witnessed during H1 FY11. The sales volumes in H1 FY11 increased by 6%, whereas the realisations increased by 4%.

 

EBITDA/Tonne (Rs)

Name of Company

2010-11

2009-10

2008-09

TATA Steel

6806.8

6975.8

6419.7

JSW Steel

7264.7

6807.1

8824.1

SAIL

5630.1

7713.8

7309.4


Expansion Plans

We believe that SAIL’s ongoing expansion plans for its saleable steel capacity from 12.9 MT to 20.1 MT and its crude steel capacity from 13.76 MT to 21.4 MT will put pressure on the company’s balance sheet in the short to medium term. For the ongoing project and further expansion plans, the company will raise funds at a Debt -to-Equity ratio of 1:1.

As of Sept 2011, the company has already spent Rs 34045 cr, and has further placed orders worth over Rs 54021 cr for modernisation and expansion projects. Out of total Rs 34045 cr spent, its debt for the ongoing capex plan is Rs 10073 cr by Sept 2011, and constitutes around 30% of the total capex incurred. The company has also firmed up to raise US$ 300 mn through the ECB route, which is likely to be at competitive rates.

The overall increase in debt will lead to an increase in the interest costs for SAIL, which will impact its profitability, as the company is aggressively increasing its debt level to finance its capex and high cash reserves will be partly used for capex. Moreover, any delay in the project expansion plans will lead to higher cost overrun.

On the back of concerns such as higher interest expense, higher input costs and potential delays in the commissioning of projects, we, at DSIJ, believe that the counter doesn’t provide much value in the short to medium term.

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