We value SAIL at a discount to Tata Steel, given Tata Steel's raw material advantage and better product mix. Key risks include slowing domestic demand, further delays in capex projects and/or decline in spot iron ore prices, sharp decline in steel demand and large imports. Other risks are decline in coking coal prices and improvement in demand in the domestic market.
Our rating upgrade is driven by near-term improvement in Asian steel environment and the flow through for steel equities; coking coal price decline; lower coke purchases; and volume growth from FY14e from new projects. JPMorgan's Asian Steel analyst Daniel Kang, in his recent update on Asian Steel, highlighted that as the steel cycle begins to show signs of bottoming out, we move to a positive stance on the Asian steel sector. Daniel views output cuts from Chinese mills as a positive catalyst for the sector and notes a recent pickup in sentiment from Chinese mills and traders, which along with fourth quarter seasonal demand, may support near-term restocking.
SAIL is trading below its historical averages of P/B and EV/ebitda as the market essentially gives zero value to the ~$7 billion invested in new projects over the last four years. We view this as an option available to investors at little cost and expect positive news flow on the projects to start coming through. SAILs balance sheet is impressive among its peer group, with net debt/equity at only 0.06x and we expect it to peak out at 0.15x in FY15e before coming off as cash generation picks up from new projects.
SAIL, in our view, offers a pure India play. SAIL's reliance on imported coking coal and the recent decline in coking coal prices are likely a big positive for the company.
As the captive coke oven batteries get commissioned, we expect external coke purchases to reduce. Finally, the much-delayed expansion should start flowing through the P&L in the next few quarters. Foreign ownership, as of the June quarter, stood at 3.15%, the lowest since 2005.