JSW Steel: Lacking fundamental support

Higher valuations, lower capacity utilisation and a possible production cut do not warrant recent share price rise, say analysts

Despite the negatives over ban on iron ore mining, lower capacity utilisation, falling steel prices and low demand, JSW Steel shares have delivered 64 per cent returns in the last one year. The outperformance is even more striking when compared to its peers like Tata Steel which delivered a 17 per cent return over the year and SAIL generating a 19 per cent return. Analysts, however, feel apart from structural issues like iron ore availability and realisations, the stock will face headwinds of high valuations. Jatin Damania of SBICAP Securities opines “At these prices the stock looks expensive. I do not think there is upside from here. Even if we assume that there could be availability of iron ore over the next two quarters, in that case too, valuations are on the upper side.”

At the current share price of Rs 806, it is valued eight times enterprise value (EV) to operating profit (Ebitda) its FY14 numbers as compared to 6.8 times for Tata Steel. Analysts believe the stock benefited from a recovery in the markets and on news of a joint agreement with Japanese firm JFE Steel Corporation which is a technical collaboration. “I do not think the JFE will have material impact on financials in the near term. The rise in share prices is without any fundamental support, which is partly due to the high beta nature of the stock,” says Ashish Kejriwal at Elara Securities.

Fundamentally speaking, the biggest issue is iron ore availability. “We are currently purchasing iron ore from e-auctions, which is sufficient for the month of December. We operated at 69 per cent of our capacity in November, compared to 80 per cent in October this year. If the supply situation does not improve, we may have to take further cuts in the coming months," said Seshagiri Rao MVS, joint managing director & group chief financial officer, JSW Steel Limited.

To achieve the target steel output of 8.5 million tonne in the current fiscal, utilisation should be in the region of 77 per cent for the remaining months. Till November 2012, the company has produced around 5.7 million tonnes, which is in the vicinity of the target. Some analysts have already cut their estimates of production from 8.5 million tonnes to 8.3 million tonnes in FY13 accompanied by lower earnings expectations.

In the next financial year, too, JSW Steel continues to face challenges. “In financial year 2014, the company will require 16-17 million tonnes of iron ore and, if, mining ban remains there is going to be challenges on the utilisation front. If the company buys through e-auction and spot market its margin will be under pressure. Even if the mining ban is lifted, which we think could be resolved in the next two quarters (six months), procuring such huge quantity of iron ore will be difficult. On top of it there is going to be supply pressure because the other steel manufacturers will also ramp up their production as a result of availability of iron ore,” says Ashish Kejriwal.