SAIL crosses offer-for-sale hurdle, valuations attractive

While the recent correction has resulted in a truncated offer for sale, analysts suggest investors use the opportunity to buy

The share prices of Steel Authority of India Ltd (SAIL) have been affected on account of various concerns; chief among these being the overhang due to the government’s offer-for-sale (OFS) initiative. As a result, SAIL has lost 35 per cent of its market capitalisation since January this year. However, the good part is that the fall in share prices has made valuations attractive.

The Street believes that the current low price has compelled the government to cut down its original offer size by almost half as it did not want to sell its stake at cheap valuations. Through the OFS, the government intends to raise over Rs 1,500 crore at Rs 63 a share, which is attractive considering that at this price, the price to earnings ratio works out to eight times its FY14 estimated earnings.

Rakesh Arora, head of research, Macquarie Capital Securities, feels SAIL is trading at an attractive valuation and one should invest in the stock with a two-year perspective. He says, “Over the next two years, benefits of its ongoing capacity expansion, for which the company is investing about Rs 70,000 crore, will be fully realised. SAIL is doubling its capacity from the current about 12 million tonnes to 22-23 million tonnes by end-FY14.”

The other big issue that has kept SAIL’s share price under pressure is delay in capacity expansions. The company had announced that it will be doubling its steel capacity and this could be a key trigger for the re-rating of the stock. However, the Street is divided considering that capacity expansions are already delayed and the company has in the past postponed its execution timelines. Analysts are less confident of capacity coming on stream as scheduled.

Its existing capacity of about 12 million tonnes is being fully utilised and hence offers little room for additional volume growth. As a large sum of money is already committed for the expansion capacity, it needs to come on stream fast in order to avoid strain on its financials. “Structural inefficiencies of losing market share, high legacy costs and delayed expansions continue to weigh on operational performance of the company,” says Ashutosh Somani of JM Financial, in a note. Analysts also fear that if the industry outlook remains subdued there would be less scope for volume push on expanded capacity. Apart from domestic issues, SAIL had seen downgrades on account of subdued steel industry outlook and steel prices. Indian long steel prices have dropped from Rs 37,000 a tonne in January 2013 to its current level of Rs 35,200 per tonne.

Against a growth of six to eight per cent in FY12, April-February 2013 has seen demand for steel fall sharply to 2.9 per cent. In its recent report, Barclays Research has cut India’s steel demand forecast for FY13 to 4.1 per cent from 6.8 per cent earlier.

These are issues that are likely to impact it in the near to medium term. However, industry estimates suggest demand growth will return in 2014. Steel prices are also likely to move higher on the back of demand from capex-led sectors.