FY22/23e Ebitda up 34/37%; TP revised to Rs 104; valuations attractive; ‘Buy’ retained
We see Steel Authority of India (SAIL) as the best play on higher steel prices as it: (i) is backward integrated with captive iron ore; (ii) has a higher operating leverage due to high conversion cost; and (iii) has a higher financial leverage. With limited capex, higher pricing should drive significant deleveraging and boost equity value. We estimate net debt to decline by Rs 232 bn (Rs 56/sh, 76% of CMP) over FY20-23E to Rs 305 bn. We also expect higher dividend payouts going forward (implying ~5% yield), supported by strong FCF of Rs 19/sh (25% yield).
We are raising our FY22e/FY23e Ebitda estimate by 34%/37% and TP by 28% on expectation of higher realisation and volumes. The stock trades at 4.2x FY22e EV/Ebitda, a 25-30% discount to peers TATA and JSTL.
Higher realisation and volume growth to drive earnings: Given a strong steel cycle, we expect realisation to remain high in the medium term, which, coupled with an inefficient cost structure (higher conversion cost), should provide disproportionate margin gains to SAIL. Every Rs 1,000/t of higher steel price improves SAIL’s FY22e Ebitda by 11%.
Volume growth is expected to be strong at 9% CAGR over FY21-23e. There is also a likelihood of product mix improvement (higher finished steel sales). We estimate 36% Ebitda CAGR over FY20-23e.
Strong FCF to drive deleveraging and higher dividend yield: We estimate FCF to be strong at Rs 78/86 bn in FY22e/FY23e, implying a FCF yield of 25-28%. Higher FCF should drive significant deleveraging, which should boost its equity value. Net debt has already declined by Rs 94 bn (Rs 23/share) to `443 bn in 9MFY21. As SAIL swings to profit and has limited capex needs, we expect a higher dividend payout going forward. We expect a consistent higher payout of Rs 4-5/sh, implying a yield of 5-7%.
Valuation is attractive: At the CMP, the stock is trading at 4.2x FY22e EV/Ebitda, which is at a 25-30% discount to peers TATA and JSTL. Even on FY22e P/BV, it is trading at an attractive 0.6x, despite an expected strong RoE of 16%. We value the stock at 5x FY22E EV/Ebitda at Rs 104/share, implying a target P/B of 0.8x (historical average of 0.7x). Key risks are lower steel price and higher capex.