SAIL: Feeble near-term outlook

Benefits of capacity expansion to accrue soon, but steel demand, realisations will pressure stock in the interim

The share price of Steel Authority of India Limited (SAIL) continues its downtrend, hitting its 52-week low of Rs 46.95 on July 8, the lowest since December 2005. The recent decline in its share price is despite SAIL reporting saleable steel output of 3.2 million tonnes (mt), up six per cent, year-on-year (y-o-y), and three per cent sequentially for the quarter ending June 2013. The concerns on the steel demand and realisations continue to take a toll. Notably, even as the share price has halved in the past six months, analysts do not rule out some more correction.

Giriraj Daga at Nirmal Bang believes the correction is not yet over, as weak demand, slow expansion and languid marketing strategies would ensure a downward revision in consensus earnings estimates for the coming quarters.

According to Bloomberg, of 11 analysts’ recommendations in July 2013, six have ‘sell’ ratings while five have ‘hold’ ratings on the stock. Recent target prices range between Rs 38 and Rs 61 for the stock priced at Rs 48.40.

Weak demand scenario
Though World Steel Association had forecast steel demand in India to grow 5.9 per cent and seven per cent in 2013 and 2014, respectively, the demand growth has been weak. India’s real steel consumption grew a modest 3.3 per cent in FY13, less than half of 6.9 per cent for FY12, due to lower demand from automobiles, consumer durables and others. Against this backdrop, the demand expectation remains soft for 2013 before a possible recovery in 2014, on the back of economic revival and expected infrastructure push by the government.

<B>Realisations under pressure</B><BR>
While iron ore prices have softened considerably and should support margins, the benefits of lower imported coal costs for SAIL has been negated by the rupee depreciation. Also, realisation, flat in FY13, is expected to be lower in FY14. Daga has cut his per tonne steel realisation estimates for SAIL by 10.7 per cent and 11.2 per cent for FY14 and FY15 at $655.3 and $659.9, respectively. Analysts at HSBC estimate FY14 realisations to be lower by 3.9 per cent, compared to FY13.

Expansion gains
Meanwhile, last month, the company was able to commission its coke oven battery at Rourkela Steel Plant. Other expansion projects that have started production include new sinter plant and coke oven at Rourkela, air separation unit of oxygen plant at Bhilai Steel Plant, raw materials handling plant, coke oven, sinter plant and wire rod mill and RHF (rotary hearth furnace) at IISCO Steel Plant. Benefits of all these should start accruing, though larger gains are mostly expected from FY15. Analysts at HSBC see sales increasing to 13 mt and 15 mt in FY14 and FY15, respectively, compared to 12 mt each in FY13 and FY12.

Other concerns
HSBC analysts say large capital spending could incur higher risk, exacerbated by weak demand. They add that after delays in expansion, the rupee depreciation has increased equipment costs. More, with capacity-addition delays, the value-addition capacities would lag crude steel capacity commissioning. As a result, it could lead to the product-mix worsening before it improves. However, if SAIL can manage the costs by reducing employees, fuel and power costs and improve the product-mix, the impact on Ebitda (earnings before interest, taxes, depreciation and amortisation) can be managed well.

While there are challenges on the expenditure front, SAIL has been utilising large parts of its cash on books to fund expansions. This cash and bank balance, which has helped earned other income (equivalent to 20-30 per cent of profit before tax during FY09-12), however, has fallen sharply at March-end 2013 by 36 per cent, y-o-y, to Rs 3,850 crore, leading to a fall in other income.

Also, as Jimesh Sanghvi at Avendus observes, borrowings increased from Rs 16,320 crore in FY12 to Rs 21,600 crore in FY13, as the delay in project commissioning impacted volumes and cash flows. He estimates the net debt to further rise to Rs 30,450 crore in FY15 due to lower cash flows on weak prices and lower volumes. Thus, the net debt to equity is likely to increase from 0.1 times in FY11 to 0.7 times in FY15. Sanghvi has cut his FY14–FY15 revenue estimates by 10.4 per cent on the back of a nine-month delay in project commissioning, lower-than-estimated volumes and weak global prices.