>BHUSHAN STEEL: Initiate at Sell: Strong Business; But Leveraged and Expensive

■  Outperformer, TP Rs310 — We initiate coverage of Bhushan Steel (BSL) at Sell. BSL has
outperformed the Sensex (+19%) & our metal index (+26%) over the past six months, and
now appears expensive at 8.5x Sep13 EV/EBITDA (domestic peers at 5-6x). We believe
historical premium (40-55%) vs. peers should moderate 1) as BSL transforms from being a
steel processor to a steel producer; 2) earnings growth at 8% in FY11-14 is more tepid vs.
33% in FY08-11 & EBITDA/t is range bound; & 3) potential value for captive raw material assets may be overdone given socio/political risks. A premium should remain, but with the convergence of business model, net D/E at 3x & a muted steel outlook, we expect it to narrow.


■  We like model, but in the price — 1) Strong EBITDA ($250-275/t) despite no captive
raw material currently is buoyed by BSL’s value chain: slabs/HR/CR/ galvanized/color
coated (and more); 2) European HR prices have risen 12% in 3m; Indian prices are up
5-10%. Stable/strong prices, improving domestic demand augur well as BSL is more
than doubling capacity to 4.7mtpa by 2HFY13; 3) It has captive iron ore (70mt) and
thermal coal (325mt), both to start in 2yrs and 89% in Bowen Energy, Australia (coking
coal in 4-5yrs); making it a more conventional play with raw material security.


■  Valuation — We value Bhushan Steel at 7x EV/EBITDA at a discount to its 5-yr trading
average of 11x – in line with domestic peers’ 5-yr average of 7-8x. We think the market
is overestimating earnings growth from capacity additions and raw material integration.
We assume expansion by Dec12 and ascribe 7x multiple on FY14 EBITDA (capture
both EBITDA and project related debt) and discount the resulting equity value @ 15%
to Sep13 to arrive at a TP of Rs310. At our TP, BSL would trade at 6x Sep13 PE.


■  Muted steel outlook — Despite stable prices and rising margins, we have a muted
outlook. Chinese steel production started the year on a weak note, implying 600-620mt
of annual production. CISA data for 10 days of March suggest a yearly production of
693mt, +1% yoy. To be more positive, it is vital to see a U-turn in Chinese construction.
European auto demand fell in Jan12 and construction is only likely to recover in 2013.


■ Upside risks — Higher volumes/steel prices, faster raw material integration, FX gains.


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