SAIL: Prospects marred by rising concerns

Decline in operating profits and rising debt on account of expansion, amid weak economic environment, put pressure on share price.

Steel Authority of India (SAIL) has seen its stock fall by half in a year’s time due to deterioration in performance. In fact, it is down 25 per cent since the start of November, against the Sensex’s 11 per cent fal. It hit a 32-month low of Rs 81.75 on Friday and is now at Rs 85.55. SAIL’s performance was impacted in the September quarter as well, due to high raw material costs, increasing interest expenses, volatile steel prices and problems at some manufacturing units.

The benefits of its ongoing capacity expansion are not expected to accrue soon. Analysts remain concerned on the persistent issues related to its Bhilai plant, delays in capacity expansion and rising debt levels. Additionally, wage rises due in January 2012 will push up employee costs further. While the rupee’s depreciation provides some comfort to domestic steel prices (as landed costs of imported steel rises), it also makes import of raw materials expensive (partly offsetting the gains from the recent decline in prices of global coal, an input).

In this backdrop and after the results, analysts have further cut earnings estimates for SAIL, and by Bloomberg data, most are bearish on the stock. A positive outcome on SAIL’s joint bid for iron ore blocks in Afghanistan, though, could provide some relief to its stock.

FUTURE EARNINGS AT RISK
In Rs  crore	FY11	FY12E	FY13E
Net sales	42,750	47,088	51,465
Y-o-Y chg (%)	5.3	10.2	9.3
Ebitda	7,008	6,764	8,706
Ebitda (%)	16.4	14.4	16.9
Net profit	4,938	4,107	4,870
Y-o-Y chg (%)	-27.3	-17.5	18.6
EPS (Rs )	12.0	10.1	11.7
E: Estimates Source: Capitaline Plus, Bloomberg, analyst reports

SUBDUED PERFORMANCE

In the past four quarters, SAIL has been seeing continuous decline in sales from 3.3 million tonnes in the December 2010 quarter to 2.8 mt in the September 2011 quarter, led by stagnant output. The outlook remains sluggish. Car and consumer durable sales are under pressure indicating softening of demand for flat products (about 60 per cent of SAIL’s output), while industrial production and India Inc’s capex plans have also slowed.

Apart from a fall in sales, raw material (coking coal) costs have been a challenge and have impacted performance. The September quarter’s raw material costs per tonne, at Rs 18,340, were up 6.5 per cent year-on-year, while power & fuel and staff costs jumped 37 per cent and 24 per cent, respectively. This offset the nine per cent gain in average realisations and led to Ebitda (earnings before interest, taxes, depreciation and amortisation) dipping to $92 a tonne in the September quarter from $120-123 a tonne during the second half of calendar year 2010.

Though international coking coal prices softened recently and should reflect from the next quarter (say Nomura’s analysts), the rupee’s fall against the dollar has limited the benefits. Seventy-five per cent of SAIL’s coal requirements are met by imports. The rupee depreciation also saw SAIL report a Rs 508 crore forex loss in the quarter, largely due to the $500 million of short-term loans, observe analysts.

The coke oven problems at its Bhilai plant (a fourth of capacity), that had started in the June quarter, continue. Analysts at Credit Suisse say these may take another two quarters to resolve, suppressing SAIL’s core profitability. Analysts at Motilal Oswal Securities, in a recent report, observed that earnings growth may remain lacklustre over FY11-13 despite an eight per cent growth in volumes, due to SAIL’s uncompetitive cost structure and poor operating efficiencies.

CAPACITY, DEBT
SAIL is in the process of expanding and modernising its annual capacity of 12.84 mt to 20 mt. The benefits of its Rs 62,000-crore capital expenditure, however, will start only from 2013-14. Of this, its two mt expansion at the Iisco plant at Burnpur has been delayed by another three months, to June 2012. Analysts at Nomura believe the Burnpur plant will take time to stabilise and significant volume growth may be seen only in FY14.

Analysts at Edelweiss Securities note SAIL has been awarded an iron ore exploration license in Bellary, Karnataka, and plans to set up a 10-mt iron ore beneficiation and four mt pellet plant. SAIL is the second largest producer of the steel making raw material in the country and had produced 24.2 mt in 2010-11. However, the mining issues in Karnataka continue, which may delay its plans and, thus, benefits from captive raw material sources.

SAIL said it had spent Rs 34,045 crore on expansions till September. However, its gross debt had increased to Rs 23,500 crore at the end of the September quarter (net debt at Rs 8,000 crore); interest costs, thus, almost doubled to Rs 200 crore year-on-year in the quarter. With the planned public offer nowhere in sight and expansion being financed mainly by debt, the capex requirement of Rs 22,000 crore for the remaining part of 2011-12 and for 2012-13 will mean its balance sheet will get stretched further (estimated annual cash profit of Rs 6,000 crore), say analysts, and add to SAIL’s interest costs.