>INDIAN STEEL SECTOR: Integration Less Significant: Buy JSW Steel, Hold TSL & SAIL (CITI)

■ Prefer steel to ore — We expect HRC prices to average $825/t (+41% yoy) in FY11 vs current $790/t, to partly compensate for the expected near-term rise in coal prices. Spot iron ore prices are ~$160/t but expected to average $130/t in FY11. With steel prices expected to show only a marginal upside and iron ore prices expected to come off, integration becomes less relevant. EBITDA/t rises in FY11 but is flat to lower in FY12. JSTL (Buy) remains our top pick followed by SAIL (raised to Hold) and Tata Steel (Hold).

■ Estimates/TP changes — FY11 estimates change by -28% to +36% on new prices, costs, updated volumes, FX changes and revised tax rates. We maintain our earlier valuation parameters for JSTL (6.5x EV/EBITDA for India) and Tata Steel (7x for India), but hike SAIL’s target EV/EBITDA to 6.5x (in line with JSTL) keeping in mind its largely domestic exposure (safer). We upgrade TPs by 12-55%.

■ JSTL offers many advantages — 1) Strong volumes +18-38% in FY11-12; 2) better product mix (reduction of semi-finished steel volumes from 22% to 2-3% is an EBITDA driver); 3) 15% captive coking coal by FY11, >40% by FY13; 4) lower costs with iron ore beneficiation; 5) reasonable valuations – 6.1x Jun11 EV/EBITDA. We expect JSTL to report $186/t of EBITDA in FY11-12. Maintain Buy.

■ Tata Steel appears interesting; but Europe could be drag — TSL’s Indian ops have several positives: a 33% jump in EBITDA/t to $420 in FY11 as they have 100% iron ore, 50% coking coal and 7% volume growth. At Corus, FY11 should be better as margins have risen in the past few months − but recent uncertainty in Europe and FX trends with risks of price cuts/lower utilizations makes us more cautious than before. We cut FY11 cons. EBITDA by 6% but PAT by 28% (higher tax). At TP of Rs590, TSL would trade at 6.2x June11 EV/EBITDA and 9.6x PE. Hold.

■ SAIL upgraded to Hold — SAIL has the advantage of largely domestic exposure but offers lower volume growth relative to JSTL until FY12. We expect iron ore prices to fall in 2H (100% is captive) but a rising trend in coking coal (only 5% captive), which does not help SAIL. Stock valuations are relatively rich, and we don’t expect Sensex outperformance. However, the stock has fallen 9% in the past month and with underperformance vs. the broader indices unlikely, we upgrade to Hold. At our TP Rs234 (vs.Rs151), SAIL would trade 11.9x June11 PE.

To read the full report: STEEL SECTOR