Thursday, January 12, 2012


Following significant underperformance of companies in the ferrous sector to the tune of 23% in the past six months compared to the Sensex, we remain negative on the sector. Although steel companies may benefit because of lower raw material prices, particularly coking coal, the rupee depreciation has offset entire gains. Steel prices may not rise significantly because of correction in international markets and deteriorating economic conditions in India and in fact are likely to quote at a discount to global prices. We continue to retain our Sell rating on the sector

JSW Steel: We have cut our FY13 EBITDA and PAT estimates by 10% and 25%, respectively, driven largely by higher costs because of substantially weaker rupee-US dollar assumption at Rs54/$ for FY13 and losses at Ispat Industries. We continue to retain our Sell rating on the stock with a revised target price of Rs500 (down 8% from our earlier TP of Rs545). We have marginally lowered our FY12 volume assumption by 1.2%, but we have kept our volume assumption constant for FY13. We have increased our target multiple from 3.5x to 4.0x FY13 EV/EVITDA considering the time series. Our revised TP is 12% below the CMP.

NMDC: We continue to retain our Sell rating on NMDC with a revised TP of Rs154 (down 31% from our earlier TP of Rs222). We have cut our EBITDA estimates by 1% and 9% for FY12 and FY13, respectively. PAT estimate for FY12 has been revised upwards by 3% due to higher other income, although it has been revised downwards by 7% for FY13. We have also revised our valuation multiple assumption from 6.0x to 4.0x in view of deteriorating economic conditions in India and an overall bear cycle in iron ore. Besides this, we are even assigning a 25% discount to the CWIP as the deteriorating environment for commodities will lower the returns from projects. We are also assigning a 10% discount to the cash surplus as we remain cautious about fund utilisation in the wake of the new disinvestment policy, which entails cross-holding in other state-owned companies. Our revised TP is 11% below the CMP.

Steel Authority of India: We have cut our FY13 EBITDA and PAT estimates by 1% and 3%, respectively, after factoring in rupee depreciation. We retain our Sell rating on the stock with a revised TP of Rs76 (down 16% compared to our earlier TP of Rs90). Our TP cut is steeper that the reduction in earnings, driven largely by the change in valuation of CWIP. We are now assigning a 20% discount to CWIP compared to zero discount earlier, as we expect the prolonged economic slowdown in India to result in higher single-digit RoCE and RoE for new projects. At an EBITDA of Rs7,000/tonne also, the new projects are likely to generate RoCE and RoE of 8.3% and 10.6%, respectively. Our revised TP is 10% below the CMP.

Tata Steel: Tata Steel’s FY13 consolidated EBITDA and PAT estimates have been cut by 12% and 27%, respectively, because of factors like higher cost of domestic operations due to rupee depreciation, lower steel prices in Europe because of demand slowdown and a marginal drop in volumes in Europe as well as India. We retain our Sell rating on the stock with a revised TP of Rs341 (down 5% from our earlier TP of Rs358). However, we have increased our target multiple from 3.5x to 4.0x FY13 EV/EBITDA considering the time series. Our revised TP is 6% below the CMP.



From our mid-cap universe, we expect only Bata India to report a strong set of numbers for 3QFY12. After strong 23.7% growth in revenue in 1HFY12, Sintex Industries is likely to witness poor project execution and this coupled with higher MTM (mark-to-market) FCCB losses will exert pressure on valuation. We expect BGR Energy to continue to report weak performance, while JBF Industries’ profitability may stabilise at a lower level.

BGR Energy: BGR reported all-round de-growth in 1HFY12 due to slowing project execution and a higher base of FY11. We expect this deceleration to continue in 3QFY12 as well. Revenue may witness 23.4% YoY decline to Rs9.6bn. The three BoP projects - Marwa, Chandrapur & Krishnapatnam - are likely to account for a major portion of its revenue. The NTPC bulk tender won by BGR will not impact FY12 financials as the project is yet to be awarded. On the order inflow front, BGR has won a 2x300MW EPC contract from TRN Energy worth Rs17bn during the quarter.We expect operating margin of 13% during 3QFY12, up 130bps YoY, as the revenue composition is likely to comprise a bigger share of high-margin BoP contracts compared to 3QFY11. However, on sequential basis, we expect EBITDA margin to fall 130bps. Our EBITDA/PAT estimates are at Rs1.25bn and Rs595mn, resulting in YoY decline of 15% and 32%, respectively.

JBF Industries: With the falling delta margin of its products stabilising at a lower level, we expect the company to report flat operating profit QoQ in 3QFY12 and gradually recover from 4QFY12 onwards. On account of sharp demand-supply mismatch, prices of PET film increased 37% to Rs182/kg in 3QFY11 thereby boosting profitability for the quarter. Hence, YoY comparison is not possible. We expect its RAK subsidiary to account for 44.4% of revenue and 46.7% of EBITDA on account of sharp rupee depreciation that should result in translation gains on consolidation. We expect JBF to report volume growth of 5.1% YoY and 4.9% QoQ for 3QFY12. Higher volume alongwith higher realisation and rupee depreciation would drive consolidated revenue by 13.9% YoY and5.1% QoQ to Rs19,492mn. Delta margins of its various products like chips, POY, films etc were onthe declining mode in 1HFY12. With margins stabilising at a lower level, the company should maintain its operating profit of Rs2,110mn, flat QoQ, but it should improve from 4QFY12 onwards. We, expect JBF to incur exchange loss of Rs635mn (Rs385mn forex loss and Rs250mn MTM loss) which would exert pressure on the bottom line. We expect JBF to report net profit of Rs699mn for 3QFY12, down 8.0% QoQ. Profitability is expected to improve from 4QFY12 and forex losses to decline sharply from August 2012 onwards, which would provide upside trigger for JBF’s valuation.

Bata India: The company’s net sales increased 23.5% during 9MCY11 and we expect it to maintain the growth momentum. Going for aggressive retail expansion, it opened 108/68 stores in CY10/1HCY11, respectively, and supported by a better product mix the net sales should increase 20.8% YoY to Rs4,347mn in 4QCY11 (the company’s financial year ends in December). Bata India has increased outsourcing of products (with partial imports from countries like Taiwan, Korea, Malaysia etc), which accounted for 30.6% of sales in CY10. With the rupee depreciating 18.7% in the past six months, imported goods turned costlier and apart from that lease rental costs remained at an elevated level due to aggressive retail expansion, thereby exerting pressure on operating margin by 27bps YoY to 16.2%. However, with the stabilisation of new retail outlets and a hike in product prices to pass on higher input costs, the margins should bounce back in CY12. As the company is debt-free and depreciation costs would lag operating profit growth, net profit should witness strong growth of 19.9% YoY at Rs412mn in 4QCY11.

Sintex Industries: We expect the company to report subdued 3QFY12 numbers for its core business due to weak project execution by its building products division. However, a depreciating rupee, which increases export revenue and translated revenue gains of overseas subsidiaries, would provide some cushion. MTM losses on FCCBs would add to the pain. Net revenue should register moderate growth of 7% YoY to Rs12,692mn, due to execution delay at monolithic sites and stretched working capital. After witnessing strong 26.9% growth in its building product in 1HFY12, the division is heading for moderation and we expect it to register 3% growth at Rs6.3bn. The company should report EBITDA margin of 16.5% in 3QFY12, lower by 14bps YoY, on account execution delay and higheroverheads. Operating profit should register a growth of 6.1% YoY to Rs2,088mn. Of the FCCB proceeds amounting to US$225mn, Sintex has utilised ~US$112mn until 31 March 2011 and out of the balance ~US$113mn, ~US$25mn is in the form of rupee deposits while ~US$88mn lies in an overseas escrow account.The rupee has depreciated sharply by 8.4% (Rs4.1) from Rs48.97/$ on 30 September 2011 to Rs53.06/$ on 31 December 2011, which should result in MTM losses of ~Rs560mn in 3QFY12 in respect of un-hedged FCCBs (~$137), thereby exerting pressure on profitability. Reported net profit should show a decline of 53.8% to Rs521mn
in 3QFY12. Adjusted net profit should also decline by 4.2% to Rs1,081mn. Following stretched working capital cycle, delay in approval for building project sites and weakness in the US and the EU, we expect execution/growth rate to moderate in 4QFY12/FY13 also and profitability to be under pressure, which should cap valuation.