JSPL: Don't bottom fish yet

Lack of clarity on long-term coal supplies will keep the stock under pressure

Jindal Steel and Power Ltd (JSPL) has seen its market cap erode by half, thanks to adverse news flow about coal blocks since June this year. From its 52-week high of Rs 350 on June 9, the stock fell to Rs 167.70 intra-day last Friday, and is currently around Rs 177. The worst fears of the investors came true last Thursday, as the Supreme Court de-allocated coal mines, after which the stock is down 18 per cent. But, despite the steep fall, investors should not try to bottom-fish, say analysts, most of whom are neutral on the stock, given the twin risk on profitability and cash outgo. It will also lead to lower return ratios for the company and raises risk to its ratings. Consequently, the stock is expected to remain under stress, at least till there is clarity on long-term coal supplies and profitability.

While analysts estimate the valuation impact of cash outgo at Rs 33 a share, they estimate the steel business’ Ebitda (earnings before interest, tax, depreciation and amortisation) to be impacted to the tune of almost Rs 830 crore, as the company buys coal from the open market.

Analysts at Motilal Oswal Securities (MOSL) believe the merchant power business model at JSPL's Tamnar power plant (1,000Mw) has become unviable, as it was fully dependent on supplies from the Gare Palma mines that will now be de-allocated. JSPL will now have to switch to a model based on power purchase or fuel supply adjustment and/or regain a coal block through aggressive bidding, feel analysts.

The Angul plant in Odisha also sees increased uncertainties on supplies, as the Utkal block has also been de-allocated. Against this backdrop, analysts have tweaked their earnings estimates.

MOSL's analysts have cut their FY16 EPS estimates by 34 per cent and the target price by 50 per cent (to Rs 199).

Due to the expected pressure on earnings, return ratios are also likely to come under pressure. Analysts at Jefferies say the return on capital employed from JSPL's Rs 18,000-crore investments in a 2.5-million-tonne steel plant and 810Mw captive power plant at Angul are likely to be in low single digits, in the absence of captive coal from the Utkal B1 coal block.

ICRA has already lowered Jindal Power’s fund and non-fund based rating by a notch to [ICRA]AA-, and put its short-term loans on a rating watch with negative implications. These could have possible implications on cost of borrowings.

Notably, the steel industry environment has seen weakness recently with demand muted and prices down in the current quarter and year-to-date, which will further add pressure on profitability of steel makers like JSPL.