JSW Steel’s EBITDA increased 16 % q-o-q to Rs 30.4 bn, in line with estimates. Steel volumes increased 12% q-o-q led by higher export sales and increased retail sales from steadier markets post GST. High iron ore costs in Karnataka remain an earnings drag but an expected court ruling which would increase the cap on iron-ore mining in the state can reduce costs as well as pave the way for further low cost capacity expansion. We raise target price to Rs 270. ADD.
Sequential increase in sales volumes and lower costs aid improvement in Ebitda
JSTL reported consolidated Ebitda of Rs 30.4 bn (+3% y-o-y, +16% q-o-q), marginally lower than our estimate. Standalone Ebitda increased 33% q-o-q to Rs 29.3 bn led by (i) Ebitda/ton improving to Rs 7,470/ton aided by a decline in input costs (includes coking coal) and (ii) steel volumes increasing to 3.92 million tons. The 12% q-o-q increase in steel deliveries was led by the company liquidating a large part of the steel inventories built during GST implementation in 1QFY18.
The miss in consolidated Ebitda was due to poor performance by its subsidiaries. The Ebitda at subsidiaries declined to Rs 1.1 bn in 2QFY18 from Rs 4.2 bn in 1QFY18 due to lower earnings at JSW Coated, US plate mill. The consolidated net income increased 15% y-o-y to Rs 8.4 bn but was 9% lower than our estimate due to the marginal Ebitda miss and higher tax rate.
Improvement in Karnataka’s iron-ore supply can aid earnings over near and longer term
The management highlighted that the case hearing in the Supreme Court for increasing the iron-ore mining cap in Karnataka beyond 30 mtpa is now complete and the order has been reserved. The increase in Karnataka’s iron ore cap will help JSTL in two ways (i) it would lower iron-ore prices in Karantaka which are now at a premium of close to Rs 1,600/ton when compared to Odisha’s iron-ore, per management, and (ii) it would allow JSTL to pursue capacity expansion at its steel plant in Karnataka; the company has approval to raise capacity up to 16 mtpa from 12 mtpa now. The management stated that in such a case, JSTL can increase steelmaking capacity in Vijaynagar operations by postponing the shutdown of its blast furnace 2 (1.4 mtpa), which is now being replaced by upgrade of BF-3.
We maintain ADD rating and raise TP to Rs 270
JSTL’s Dolvi expansion is on track and will push up volumes over the next three years (commissioning by March 2020) at low capital costs. Besides strong volume growth over FY2018-21E, we expect JSTL’s operating margins to improve led by a better demand-supply balance in the Indian steel industry over the next three to four years given limited capacity additions and likely consolidation of stressed assets. We maintain our positive stance on the stock and revise the target price to Rs 270 (Rs 235 earlier). The increase in the target price is led by rollover to September 2019e financials and ascribing a higher value to Dolvi expansion CWIP.
Changes in our estimates
We cut our FY2018e consolidated Ebitda estimate by 4% due to weaker-than-expected 1HFY18 earnings given weak domestic demand and domestic prices trading at a large discount to import offers. We estimate consolidated Ebitda of Rs 125 bn, Rs 141 bn and Rs 147 bn for FY2018e, FY2019e and FY2020e. We estimate EPS of Rs 15.7, Rs 21.1 and Rs 23.6 for FY2018e, FY2019e and FY2020e. We highlight that EPS can increase sharply in FY2021e from volume led growth at Dolvi expansion. The company’s capacity will increase to 23 mtpa from 18 mtpa post the commissioning; management expects the project to be complete by March 2020. Our target price of Rs 270 is based on 6.5X September 2019 Ebitda. We also ascribe value to capital-work-in-progress for the ongoing 5 mtpa steel expansion at 70% of invested value. This project will increase JSTL’s capacity by 5 mtpa and will have strong returns given its low capital cost.
Realisations were flat, costs declined: The company’s steel realisations were flat
q-o-q. The realisation in the domestic steel markets saw some improvement; however, there were contracted quantities where the pricing was locked in till September—these willcome for renegotiation in 2H. The management also highlighted that certain exports were made on prior bookings which also pulled down the realisations for the quarter. The realisations will likely improve from renegotiation of these contracts, better export prices and increase in spot prices. Also, the long product prices are expected to fare better in 4QFY18.