Buy rating on JSW steel; Volumes help JSW Steel spring a surprise

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Updated: Oct 26, 2015 12:16 AM

Likely fall in iron costs and ramp-up in production bode well for company

Key takeaways:
Q2 Ebitda (earnings before interest taxes depreciation and amortisation) surprised positively due to higher volumes. Margins improved q-o-q (quarter on quarter) despite lower steel prices owing to lower input costs. We cut FY16-17e Ebitda by 6%-1% and PT (price target) to R1,080, as we see low headroom for price hikes in 2H FY16. We believe local iron ore prices may fall further as domestic iron ore supply rises leading to further input cost savings at JSW. Ramp-up of its expansions could drive stronger volumes  in FY17. We maintain our Buy rating.

Q2 Ebitda beat led by higher volumes: Standalone Ebitda was R15.7 bn (4% q-o-q), ahead of our R14.3 bn estimate due to higher volume and slightly lower costs. Consolidated profit was R1.12 bn, well ahead of our R1.9 bn loss estimate due to R2.5 bn decline in depreciation q-o-q owing to change in depreciation norms. Net debt rose to R390 bn (Q1 R379 bn) and net gearing rose to 1.72 (1.66x) in Q2.

Volume better than expected; margins broadly in line: Volume grew 3% q-o-q to 3.19m tonne (6% beat). Ebitda/t was R4908/t (+R80/t q-o-q), slightly ahead of our R4760/t forecast. Realisations fell 5.7% q-o-q as expected, but raw material cost decline (R1830/t q-o-q) was a tad higher than expected.

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Low headroom to lift prices in 2H; scope for further input cost decline: We trim FY16 ASP (average selling price) estimate by 1% as we see low scope for meaningful price hikes in 2H despite the safeguard duty as
(i) recent price hikes (2-5%) after safeguard duty was levied, do not seem to be sticking;
(ii) domestic prices are now in line with import parity despite the duty;
(iii) recent Chinese offers ($265-275/t FoB), imply further pricing pressure. JSW’s margins may still improve in 2H due to lower local iron ore prices. NMDC has cut iron ore prices by Rs 200/tonne recently.

Projects nearing completion, lift FY17 volume forecast: Expansions at Dolvi (1.7mt) and Vijayanagar (2mt) are on track for commissioning in Q4 FY16. Near term output may be affected due to blast furnace shutdowns for expansion, but this is already factored in JSW’s FY16 volume guidance of 12.9m tonne as per management. We lift our volume estimates and forecast volume of 12.8m tonne in FY16 and 14.3m tonne in FY17.

Valuation/Risks: We believe JSW Steel, being a low cost converter, is better positioned vs. Indian peers as lower iron ore costs could cushion steel price fall. Our PT of Rs 1,080 is based on SOTP (sum-of-the-parts) valuation. We value (i) India and overseas units at 6.5x FY17e Ebitda and (ii) invested capital in yet to be commissioned projects at 0.9x.
Key risks: lower steel prices, higher iron ore prices and rise in BS stress.

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