>JSW STEEL: Lower volumes/higher costs; Delays in captive raw materials; Deterioration of performance in US plates/pipes business; Delays in Ispat cost-cutting

■ Receding uncertainties — We upgrade JSW Steel (JSTL) to Buy from Neutral as: 1) Ore availability should improve gradually on positive Karnataka developments – helping reduce average ore procurement costs; 2) Capacity utilisation should continue the uptrend – helping reduce costs and improve profitability; 3) Falling raw material costs; 4) Better domestic steel demand which has rebounded to 7.7% in 3QFY12. While JSTL has rallied from its bottom, we see further upside from current levels and it is now our Top Pick in the steel space.


■ Earnings revision & increased TP — We raise FY12E/FY13E consolidated PAT 6%/9%, but cut FY14E 21% (mainly due to higher raw material costs & lower profits from subs). We value the India business at 5.5x EV/EBITDA, JSW Ispat at 5x EV/EBITDA, the US business (operating at 15-40% utilization levels) at 1.5x EV/Sales (prev. 3x; higher volumes but continued losses), and Chilean iron ore at 8x PE (prev. 7x; shipping commenced). Roll forward to Mar-13E (prev. Sep-12E) for a TP of Rs920 (prev. Rs631).


■ Expansion: Lower costs & higher value — Current expansion plans will help reduce costs and increase value-add. Cost savings from: 1) Captive power to rise by 300MW to 830MW by Mar-12 (meeting 100% at Vijaynagar); 2) Iron ore beneficiation from 10mtpa to 20mtpa by Sep-12 (more usage of lower quality ore); 3) Own coking coal (10-15% of usage in FY13-14); 4) Own iron ore mine restart (taken at 50% utilisation; upside risk in FY13). Value-add from: 1) Hot rolled coil capacity rising 1.5mtpa to 8.2m tpa by Sep-12; 2) Gain from cold rolled steel capacity rising in stages by end-FY14 (2mtpa to 4.3mtpa).


■ Ore availability to improve — Press articles indicate the CEC has recommended that ~45 mines (of ~166 in Karnataka) be allowed to mine as soon as the mining ban is lifted and some more (~70) after paying penalties. As JSTL has limited captive ore, the Supreme Court decision on re-start of Karnataka mines is key to future output as eauction stocks will soon be exhausted, making alternative ore essential.


■ Downside risks — Lower volumes/higher costs; Delays in captive raw materials; Deterioration of performance in US plates/pipes business; Delays in Ispat cost-cutting.


To read full report: JSW STEEL
RISH TRADER