Near-term worries weigh on SAIL

While commissioning of projects, lower raw material costs and demand outlook are positives, stretched valuations and high debt are concerns

Steel Authority of India (SAIL)’s earnings for the June quarter beat Street expectations, with net profit rising 17.5 per cent year-on-year to Rs 529.88 crore. Profits were boosted by higher other income and lower tax and depreciation, which helped the company beat the consensus estimate of Rs 399 crore.

On Monday, the SAIL stock closed at Rs 83 on the National Stock Exchange, up 2.6 per cent.

Improving steel demand on a year-on-year basis led to SAIL posting volumes of 2.75 million tonnes (mt). Though this was more than in the year-ago period, these were lower compared to the March quarter this year (3.5 mt) and analyst estimates of 2.9 mt. However, due to better realisations, the revenue of Rs 11,341.20 crore was in line with the consensus estimate of Rs 11,382 crore.

While concern on delayed capacity expansion is easing, as many projects are being commissioned, the demand outlook for steel is also improving. Analysts at Motilal Oswal Securities feel there are high chances of strong demand in the second half of this financial year.

SAIL’s profitability is likely to get a further boost from the commissioning of new capacities, as decreasing raw material costs such as those for coal and iron ore provide further respite. Primary steel mills in India are likely to benefit from stable steel pricing and lower coking coal costs, say Motilal Oswal Securities analysts. The commissioning of a basic oxygen furnace at Rourkela in the first half of FY15 is likely to be a key volumes driver, analysts say. SAIL had announced the commissioning of this furnace, along with a new plate mill at its Rourkela steel plant. Commissioning of new blast furnaces at the IISCO and Bhilai plants this financial year is likely to drive volumes from FY16.

Analysts at IL&FS Institutional Equities had said SAIL’s volume growth for FY15–FY17 would beat the growth of its peers.

The company’s profitability is likely to get a boost from new furnaces and systems. Analysts at Prabhudas Lilladher say new blast furnaces will lead to savings of $50 a tonne, as the coke rate per tonne will fall 12 per cent to 450 kg from the current 512 kg after the commissioning of three new blast furnaces, the closure of old blast furnaces across plants and the installation of coal dust injection systems. SAIL is targeting an overall cut of 20 per cent, or $50 a tonne, in energy costs (equivalent to about 10 per cent of current steel prices).

Though this is a positive, there is concern on the high debt and the impact of the iron ore mining ban in Odisha. On July 31, Standard and Poor’s had cut SAIL’s ratings to from ‘BBB-’ to ‘BB+’, citing continued high leverage. The agency said “through the coming 12 months, sizeable capacity add-on will lead to robust volume growth. SAIL is likely to improve its adjusted debt-to-Ebitda (earnings before interest, tax, depreciation and amortisation) ratio to 4-4.5 by 2014-15 from 5.5 in 2013-14. However, this is short of the 3.5 level; above this trigger point is when S&P will consider lowering the rating”.

While the rating agency expects a gradual improvement in SAIL’s business performance after 2-14-15, it feels delays to the rollout of new capacities cannot be ruled out. Considering the near-term cautious view of analysts and the fact that valuations, at current levels, seem stretched, investors with a long-term view could consider the stock on dips.