SAIL OFS: Only long-term investors should apply

Demand slump, price outlook will keep growth rates in check

Don't want to miss the best from Business Standard?

Steel Authority of India (SAIL)’s offer for sale (OFS) comes at a time when the demand and pricing environment for steel is subdued, both in India and globally. Plus, domestic supplies are expected to increase faster than demand over the next 12-18 months.

For instance, five million tonnes per annum (mtpa) of saleable steel capacity (including SAIL’s two mtpa) is expected to come up in FY16. “Given the six-seven per cent increase in industry’s capacities, demand has to grow by eight-nine per cent compared with about one per cent now to meet the increased supplies. So, pressure on local steel prices should remain,” says an analyst with a domestic brokerage. With global environment also subdued, it will be difficult for any company to surprise, unless the Indian government takes measures such as imposing anti-dumping duties, he adds.

SAIL posted better-than-expected results for the quarter ending September 2014 with earnings before interest, taxes, depreciation, and amortisation (Ebitda) up 54 per cent at Rs 1,336 crore (led by lower costs) and pre-tax profit up 86 per cent at Rs 751 crore compared with the year-ago period, on a one per cent rise in revenues to Rs 11,679 crore. Ebitda margins jumped 393 basis points (bps) year-on-year (149 bps sequentially) to 11.4 per cent, led by lower costs of iron ore and coal and employee expenses. And this trend is expected to sustain. Analysts expect SAIL’s Ebitda margins to rise 100 bps in FY16 and 150 bps in FY17.

Much of this is factored in the stock’s valuations, which is on the higher side with price-to-earnings of 10 times FY16 estimated earnings versus 6.5-8.5 times for its peers. On an enterprise value/Ebitda basis, too, it is quoting at nine time one-year forward earnings. These valuations are higher than Tata Steel’s 5.2 times and JSW Steel’s 4.8 times, according to a December 2 report by Emkay.

The stock has fallen five per cent following Wednesday’s OFS news. The stock is likely to remain under check till Friday, the only day SAIL’s OFS will open for subscription. While a five per cent discount to retail investors sounds good, according to Bloomberg poll (since November 24), half of the 26 analysts have a ‘sell’, eight a ‘hold’ and just five have a ‘buy’ rating on the stock with an average one-year target price of Rs 81.

Long-term investors could, however, consider it on declines or apply around the floor price of Rs 83 (excluding discount) given that SAIL has already completed most of its capex, which will take its saleable steel output from 12.5 mtpa to 19 mtpa in the next four-five years.