SAIL’s Q4 adjusted PAT (profit after tax) of R15bn was 26% lower year-on-year and 4% below our estimate. Ebitda margin (excluding other income) was 19% in Q4 vs. 25% last year, but improved on a sequential basis (Q3FY11 was 16%). The main reasons for the decline in profits and margins on a YoY basis were higher raw material and staff costs, despite the hike in steel prices. Adj. PAT for FY11 was R48.7 bn, 27% lower YoY.

Q4 was hit by costs, particularly for coal. SAIL had to bear higher costs for coking coal in the domestic and international market. International coking coal prices were $225/t in Q4FY11 vs $128/t last year. SAIL has tied up coking coal for Q1FY12 at $330/t. It also has carryover tonnages of coking coal at $305/t and $205-222/t. The lower cost coal will likely be consumed later, indicating that coking coal cost will largely remain around $300-330/t for SAIL in FY12. Staff costs also impacted SAIL. While these are expected to settle around FY11 levels, a wage revision is due on Jan 1, 2012 for non-executive staff (60% of of 111,000 employees).

Sales volumes at 3.14mt were 8% lower YoY and 10% below estimates. The main reason for the fall was lower demand for flat products due to price volatility especially in March. Overall inventories rose by 238,000 tonne to 1.1mt, most of which were flat products. SAIL is giving quantity discounts and higher levels of interest free credit (38 days vs. 30 days earlier) in an effort to boost sales and reduce inventories. Domestic prices have been reduced by giving discounts, and SAIL mentioned that average NSR (net smelter royalty) for Q4FY11 was R35,500/t. Flat products account for 60% of volumes and longs 40%.

We use EV/Ebitda (enterprise value/earnings before interest, taxes, depreciation and amortisation) as our preferred valuation metric for the Indian steel companies. SAIL has traditionally traded at a discount to both TSL and JSTL (Tata Steel & JSW Steel) based on its history, status as a government company and lower rate of volume growth. Our R185 target price is based on FY12e EV/Ebitda of 6.5x, in line with JSTL’s (standalone) target multiple of 6.5x and at a discount to TSL’s target multiple (for Indian operations) of 7.5x. SAIL’s target EV/Ebitda multiple is at a premium to its 3-year average, but lower than its highs of 7-9x since then. At our target price, the stock would trade at a P/E of 11.7x.

We rate SAIL Low Risk. Its exposure to the Indian market, net cash position, and potential for cost cutting, all back up the rating. We rate SAIL as Hold/Low Risk (2L). It has the highest iron ore integration (100%) relative to peers and recent environmental clearance for iron ore mines with 1 bnt of reserves at Chiria helps secure reserves for expansions. SAIL had a marginal net cash position as of Sept-2010 and largely domestic exposure as advantages, but debt to equity is expected to rise in FY12 as it takes on debt to fund expansion.

The government has approved a 20% equity sale in two tranches of 10% each. On completion, share capital will rise to R45.4 bn (from R41.3 bn) and the government stake will fall to 69% (from 86%). However, given the delay in the planned equity issuance, we have not yet incorporated it in our forecasts.

SAIL’s target to raise crude steel capacity, from 13.5m tpa to 21.4m tpa by FY14 should help with: lower average costs (more modernisation), improved labour productivity, higher prices (value-added products, no semis). However, flattish steel prices, falling iron ore prices, likely equity issuance in H1FY12, and lower volume growth, means we don’t expect outperformance vs. Sensex.

SAIL has fallen 23% in the past six months, and with under performance vs the broader indices unlikely, we continue to rate it Hold.