>SAIL (IDFC SSKI)

Estimates changed to factor in concessions to existing raw material contracts :
SAIL’s coking coal contracts typically run from July-June and adjusting for the unlifted quantities, we earlier expected the benefit of lower coking coal prices to accrue only from Q3FY10. However, we believe SAIL has received significant concessions on its existing coking coal contracts that offer flexibility to defer the purchase of unlifted quantity of coking coal over the next few quarters. These concessions, in our view, are now being offered across all Indian steel companies – particularly by one of SAIL’s key supplier. This would translate into an immediate drop in raw material costs, though the difference would be spread over the next few quarters. Hence, we re-evaluate our numbers and account for (a) significantly lower raw material costs in Q4FY09; (b) spillover of unlifted contracted coal volumes leading to higher than- expected costs in FY10; and (c) lower average realisations for FY10.

SAIL’s earnings sensitive to new coking coal prices:
We estimate new iron ore and coking coal contracts to be signed at 33% and 50% lower respectively. This would translate into a substantial US$160/tonne saving in coking coal cost for SAIL. Press reports suggest an even higher drop in coking coal cost to US$100-110/tonne. A further 10% drop in imported coking coal price would prop SAIL’s earnings by 15%.

Though SAIL has 100% backward linkages for iron ore, its operating margins are vulnerable to international coking coal prices and freight rates. SAIL imports 69% of its total coking coal requirement (~10m tonnes – 8.5m tonnes from Australia and 1.5m tonnes from USA), and procures the remaining through coal linkages (via CIL) and captive mines. High dependence on imported coking coal renders SAIL’s earnings highly sensitive to coking coal prices.

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