JSW Steel: A Japanese connection

Since the foreign partner isn’t buying equity in JSW Steel, there’s no reason for a re-rating.

It’s not surprising that the JSW Steel stock closed in the red even after the steel major announced a technical collaboration with JFE Steel, Japan’s second biggest steel producer. Since the foreign partner isn’t picking up an equity stake in the Indian firm, there’s no case for any re-rating.

Also, the agreement with the Japanese steel maker will no doubt help JSW produce top grade steel for the automotive industry, and while there’s no question that demand for value-added steels can only increase, the benefits won’t flow in for a while.

The Japanese firm is understandably looking for a big market to expand and will probably partner JSW its 10 million tonne West Bengal venture.

Before that happens JSW needs to sort out its own problems with the operations in the US which are doing badly but are expected to turn cash positive by March next year. That would be possible because the inventory write-downs are almost complete but the pipe and plate mills are running at less than a fourth of the capacity.

It must also try and deleverage the balance sheet with a consolidated debt of around Rs 16,000 crore. The company is believed to have explored raising funds to the tune of Rs 2,000-3,000 crore, through a placement to institutions, but is yet to go to the market.

JSW has expanded capacity by 3 million tonnes to 8 million tonnes, and by March 2011, the capacity would be 11 million tonnes. Also, once the new hot strip mill is up and running, which is expected by March next year, the share of semi-finished steel sales will be smaller resulting in a better product mix.

Since demand for steel in India is expected to grow 10-12 per cent annually in the next few years, JSW’s volumes should grow at a compounded 20 per cent between 2010 and 2012. Assuming steel prices remain stable, that should fetch it some good profit numbers; on a low base (earnings fell 55 per cent in 2008-09), earnings are expected to grow a compounded 60 per cent over the same period.

For 2010-11, JSW’s revenues are expected to grow Rs 22,500 crore while net profits are estimated to come in at Rs 2,100 crore, an increase of 40 per cent over 2009-10. At the current price of Rs 959, the stock trades 7 times 2010-11 enterprise value to earnings before interest tax and depreciation with little room for upside in the near term.