pankaj pandey steel sector -...

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ICICIdirect | Equity Research

May 13, 2009 | Steel Sector

Initiating Coverage

Steel Sector

Steely resistance shown… The steel industry cycle had turned negative during the latter half of 2008 resulting in margin compression for all steel players due to sales volume drop and crash in realisations. Indian steel players have shown signs of resilience after a very bad Q3FY09 and are currently coming back to terms with the changed dynamics of the global and domestic steel industry. With domestic demand normalising in Q4FY09, softening interest rates and raw material costs all set to go down with contract renegotiation nearing completion, we expect Indian steel companies to ride through this tough phase and emerge stronger but believe that upside potential at current levels is capped. We are initiating coverage on the steel sector with a neutral view on SAIL and negative view on Tata Steel.S l

Global steel demand-supply balance to be maintained Global steel production declined by 1.2% YoY in 2008 and by 22.6% YoY during January-March 2009 due to the global financial crisis leading to a sharp drop in demand and deep production cuts enforced by steel makers across the globe. We expect global steel production and consumption to contract by 15% YoY in 2009 and increase by just 3% YoY in 2010. This would help even out the demand-supply mismatch and prevent further price erosion.

Product price correction done, stability expected at current levels Steel product prices have corrected by 55-60% across various categories during the last two quarters. Price of the benchmark HR coil is hovering in the range of US$440-480/tonne. It is expected to remain stable at current levels due to supply side correction, which has been a result of sustained production cuts.

Margin improvement after raw material contract renegotiation The raw material contract prices of iron-ore and coking coal are expected to be settled 30-60% lower post the negotiations, which are currently under way. This drop would help in arresting the decline in margins of various players. Margin pressure is likely to ease henceforth in FY10.

India to log domestic demand growth despite slowdown Demand slowdown due to the global liquidity crunch had hurt India’s steel consumption growth for an interim period. However, it is expected to still log a growth of 5% in next two years on the back of infrastructure growth, strong domestic demand and cooling inflation. India is among the nations with the lowest per capita steel consumption (47 kg) in the world. It has shown robust consumption growth (~11% CAGR) during the last five year, which had turned India into a net importer of steel in 2007.

Recommendation-prefer domestic plays with strong balance sheets We prefer companies with high exposure to domestic markets, low balance sheet risk with less financial leverage and efficient operations. Most of the Indian companies have shown a smart run up recently and upside potential at current levels looks capped. We are initiating coverage on the steel sector with a neutral view on SAIL and negative view on Tata Steel.

Analysts’ Name

Pankaj Pandey [email protected] Goutam Chakraborty [email protected] Abhisar Jain [email protected]

SAIL (SAIL)CMP (Rs) 122TP (Rs) 115Rating Hold

Tata Steel (TISCO)CMP (Rs) 275TP (Rs) 220Rating Underperformer

JSW Steel (JINVIJ)CMP (Rs) 418TP (Rs) 343Rating Underperformer

Steel WPI

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Table of content Page No.

Global Steel Industry- Down but not out 3

Indian Steel Industry- Showing a brave face 18

Valuations& Recommendation 29

Companies- Initiating coverage

Steel Authority of India (SAIL) 33

Tata Steel (TISCO) 49

Company Update

JSW Steel (JINVIJ) 65

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Global steel industry – Down but not out

Global steel demand-supply balance to be maintained Global steel industry growth has remained robust during the last five years marked by an increased consolidation among large players. Steel production and consumption has expanded at a CAGR of 6.5% and 6%, respectively, during 2003-2008. However, the trend has seen a sharp reversal in 2008 with a huge slowdown in both production and consumption in H2CY08. Exhibit 1: World steel production & consumption trend

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Source: IISI, ICICIdirect.com Research

Global steel production declined by 1.2% in 2008 due to the severe downturn during the latter half of 2008. Production during January-March 2009 has dropped by 22.6% due to poor recovery in demand and recessionary environment in developed countries. Quick production cuts enforced by steel makers across the globe have helped attain a supply side correction and, thereby, demand-supply equilibrium. Exhibit 2: Trimmed world steel production

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Global steel production & consumption to decline by 15% in 2009

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With most of the main steel makers across the world operating under production cuts and overall lower world GDP growth forecast for the next two years, we expect global steel production and consumption to contract by 15% YoY in 2009 and increase by just 3% YoY in 2010. This is based on the expectation of negative steel consumption growth from developed economies like the US (expected to be down 40% YoY in CY09) and Europe (expected to be down 35% YoY in CY09) and slower growth from emerging economies as the dust settles on the global financial and liquidity crisis. Reduced production a result of deep production cuts Production cuts to the tune of 25-35% in the US, 30-40% in Europe and 10-20% in Asia have been effected by various steel players across the world after demand shrank dramatically during H2CY08. This is being used as a tool to avoid inventory pile up and prevent free price fall on the part of steel producers around the world. Exhibit 3: Announced production cuts (2008) Annoucement Name Time period %age CutAugust Nanjing Steel from August 10September Anyang Iron & Steel October 20

ArcelorMittal Q3, Q4 15Hebei Iron & Steel Group October 20Shandong Iron & Steel October 20Shougang Group October 20

October Anshan Iron & Steel NA 20ArcelorMittal (Kazakhstan) N/A 25-30ArcelorMittal (Ukraine) NA 10.5Azovstal September 19.3Bhushan Steel NA 5-7.5Cherepovets October 25Corus Q4 20Duferco Q4 30Evraz Group from November 25Magnitogorsk October 15Nanjing Steel 2H of FY08 Another 20Nippon Steel October 30Severstal NA 25-30Shougang Group FY09 10- 20

November ArcelorMitta (Brazil) 4Q 35ArcelorMittal NA 30ArcelorMittal (Romania) NA 30-50ArcelorMittal (Spain) December 35Baosteel Group Until end Q1 2009 3.5Corus 2H of FY08 30JFE from November 10JSW Steel 2H of FY08 20Riva December/January 20Salzgitter NA 30China Steel 2009 10

December Nucor Steel Q4 2008 40-50Mechel 2009 20-25

Source: Company, ICICIdirect.com Research

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The effect of production cuts has been positive for the industry as it has maintained a demand-supply balance. This indicates increased coordination in the global steel industry in a challenging environment. Most of the steel players are still operating under production cuts announced earlier during 2008. Production cuts more severe in developed world Production cuts in the developed world have been in the range of 25-40%, clearly more severe than other parts. This is because the global economic crisis has been felt most severely in the developed world especially US, Japan and Europe. Production in the recent months has been down 45% in EU (27), 50% in the US and 40% in Japan from their peak levels of 2008. Exhibit 4: Developed world monthly production trend

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Our assumption of a 15% drop in total steel production in 2009 would result in a total production cut of 200 MT to 1130 MT in 2009 from 1329 MT in 2008. This would get shared mainly (147.6 MT, being 74% of the total cut) by the developed countries comprising US, EU (27) and Japan. Exhibit 5: Steel production (million tonne)

JFM-2008 JFM-2009 Y-o-Y(%) 2008 2009E (% )DropE Expected CutUS 25.5 12.1 -52.5 91.5 54.9 40.0 36.6EU (27) 53.6 30.2 -43.7 198.5 129.0 35.0 69.5Japan 30.8 17.6 -42.9 118.7 77.2 35.0 41.5Total DW 109.9 59.9 -45.5 408.7 261.1 36.1 147.6World 340.1 262.8 -22.7 1329.7 1130.2 15.0 199.5 JFM=January Feb & March, DW=Developed World comprising US, EU (27) and Japan


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Demand deterioration a result of GDP slowdown, but could recover sharply We expect demand to stage a mild comeback during H2CY09 as global steel demand is expected to toe the overall world GDP growth trend. This is based on our analysis of the correlation between steel demand and GDP growth and present demand erosion. While demand erosion has been quite steep due to a knee-jerk reaction, a similarly relative high fall in GDP for 2009 is not expected (based on IMF estimates of 1.3% drop). This indicates that demand deterioration for the full year 2009 may not be as intense as the present production cut and could stage a comeback during H2CY09. Exhibit 6: GDP v/s Steel consumption (World)

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Source: IMF,IISI, ICICIdirect.com Research

Exhibit 7: World steel consumption to GDP growth relation

YearSteel Consumption

Growth (%)GDP Growth

(%)Consumption/GDP Multiple

2002 6.7 2.8 2.42003 7.0 3.6 1.92004 10.2 4.9 2.12005 5.6 4.4 1.32006 9.0 5.1 1.82007 7.5 5.1 1.52008 -0.9 3.2 -0.3

Average 1.5 Source: IMF,IISI, ICICIdirect.com Research

The average steel consumption to GDP growth multiple for the world has been 1.5 for 2002-08. With world GDP growth expected at -1.3% (IMF estimates) for 2009, the consequent drop in steel consumption should be close to -2% (based on 1.5xGDP growth). However, since the prevailing financial crisis has been aided by a commodity bubble burst and severe liquidity crunch, the consumption drop is expected to be much higher due to the already seen knee-jerk reaction post the global financial and liquidity crisis. Though the production cuts at present range from 15-40% across the world and production drop for January-March 2009 has been 22.7% we

Correlation between GDP growth and steel consumption growth significant

Steel demand expected to recover during the second half of 2009

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expect production and consumption drop for the full year CY09 to be lower than the extent of present production cuts and drop by 15% in 2009. This leads us to believe that demand would recover in H2CY09 based on the positive effects of government stimulus packages, stabilisation of financial systems and return of consumer confidence. Exhibit 8: GDP growth estimates (IMF)

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Product price correction due to demand destruction done Globally, steel prices have seen a sharp correction during the last two quarters due to weakening global demand and commodity bubble burst amid global financial crisis. Prices have corrected by more than 55-60% from their peak levels across all the major product categories. Benchmark HR coil prices have come down to US$440-480/tonne from their peaks of US$1100-1150/tonne in the last six months. The extent of correction in CR coils and wire rod has also been in excess of 55% from peak levels. Exhibit 9: Global steel price trend

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Source: Meps, Bloomberg, ICICIdirect.com Research

Global steel prices have taken a deep hit (55-60%) amid falling commodity prices…

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Exhibit 10: US Midwest market avg. FOB price

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Source: Bloomberg, ICICIdirect.com Research

Exhibit 11: World rebar price

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The HR sheet price in US has shown a decline of more than 60% from the peaks of July 2008 and is currently hovering around $450-480 levels. Rebar price has shown a similar trajectory and is currently down to US$450/tonne. Price erosion may not be function of demand The price erosion that took place during the last six to eight months led to a similar spot raw material price correction. The global commodity bubble burst after the liquidity crisis led to spot prices of key raw materials like coking coal, iron ore, thermal coal and scrap crashing by more than 60% from their highs to current levels where they seem to have found some base finally. Exhibit 12: Raw material spot price correction

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Raw material spot prices have cooled down considerably…

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With the correction in spot prices done, the contracts are set to be negotiated lower (expect 35-40% drop YoY for iron ore and 55-65% for coking coal). This would provide much needed relief to most of the steel makers around the world who depend on contracted raw material procurement by entering into a price agreement every year and help them improve their margins considerably. Exhibit 13: Raw material contract price

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Source: JSW Corp Ppt, ICICIdirect.com Research

Limited product price downside expected from hereon… The price correction in steel products, which started in October 2008, has been too fast and furious. After stabilising for a while during February-March 2009 prices have started falling again and gone below their November 2008 lows. We expect this to be a result of raw material renegotiation process nearing completion and expect limited downside in prices from present levels. We expect global HR prices to recover mildly and remain stable in the range of US$460-520/tonne in CY09/FY10E. Exhibit 14: HR coil price trend

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..and contract prices which are still under negotiation would follow suit soon

We expect global HR prices to remain stable in the range of US$ 460-520/tonne in CY09/FY10E

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…and margins to get a fillip due to lower production cost We expect the global blast furnace cost of production to come down by 40% on an absolute basis (assuming no captive resource used for a steel maker) post the renegotiation of raw material prices as compared to last year. This would help bring down the cost of production of players without captive resources/partly captive resources to US$428/tonne, which is close to the current HR prices. We expect the reduced production cost to help in arresting the fall in margins. Players with better production processes would have decent margins with production cost going down post contract negotiation completion. Exhibit 15: Global BF steel production cost (US$/tonne)

Particulars I/P Reqd/tonne Cost/unit Cost Cost/unit CostIron Ore 1.8 95 171 60 108Coking Coal 1 300 300 130 130Coke Conversion 1 40 40 40 40Power (KwH) 400 0.075 30 0.075 30Gas (mmbtu) 5 8 40 6 30Scrap 0.1 350 35 250 25Other Raw Material 1 30 30 20 20Transport & Others 1 30 30 20 20Labour 1 25 25 25 25Total Cost/Tonne 701 428

Old Contract Price New Contract Price


Leading to recovery of global steel industry in H2CY09 We expect the overall recovery of the battered global steel industry to start from H2CY09. Raw material renegotiation would be done by then. Also, the various stimulus packages announced by governments across the world would start boosting the infrastructure spend. This is expected to revive steel demand. Product prices are expected to remain at levels above the global production cost of US$430/tonne post raw material re-negotiation. This, in turn, would help steel makers operate at a decent margin. There may, however, be a very slow recovery in some of the developed countries of Europe as well as US due to the advent of a deep recession. Spokes in the wheel Looking at the recent trends in major steel consuming sectors like construction and auto in the developed as well as developing countries we find that the gloomy scenario is still persistent in the developed world (mainly US and EU). However, there have been signs of a recovery in developing nations (mainly China). Demand destruction in US, EU affected by massive persistent slowdown There has been a massive slowdown in steel demand after the global financial crisis resulted into an economic slowdown in all the major developed economies of the world. US and Europe were worst affected by the same. The impact of the economic slowdown in these two economies is prominently visible in the construction and automobile sectors leading to low steel demand.

Global steel production cost to go down by 40% post raw material contract renegotiation

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Exhibit 16: US construction spending growth (MoM)

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US construction spending growth has slowed down in the last six to eight months. Car sales have gone down to their lowest levels in six years. Recovery is taking place very slowly. Similar trends are observed in Europe with passenger car registrations index at its lowest level and construction confidence indicator deep in the red and showing little signs of any immediate recovery. Exhibit 17: US car sales

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US construction spending growth is at its lowest level in six years

Car sales in US witnessing a huge drop indicating slowing steel demand from auto sector

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Exhibit 18: EU sales passenger car registrations index

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Exhibit 19: Construction confidence indicator Euro zone

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Apparent steel consumption to slide in US & Europe Steel demand had softened in the US during 2007 itself after the commencement of the sub-prime crisis. With a severe liquidity crunch having gripped its economy, steel demand is expected to remain negative as construction activity and infrastructure investment has been severely affected. In the EU comprising 27 countries, steel use has increased at a CAGR of 5% during 2003-07. However, with the ensuing slowdown and liquidity crunch having spread to Europe also, we expect the steel demand in the EU and US to contract by 30% and 35% YoY, respectively, in 2009 and improve slightly by 5% YoY in 2010 once the economic situation improves.

Car sales in EU too show a grim trend

Construction confidence indicator in Euro zone has plunged indicating massive slowdown in housing activities

Steel consumption to decline by 30% in EU and 35% in US in 2009…

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Exhibit 20: Apparent steel consumption

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Chinese steel industry — End of dream run The Chinese steel industry has ended its golden period (2003-2007) of supernormal growth with production and consumption in 2008 remaining at almost the same levels as that of 2007. Exhibit 21: China steel statistics

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The Chinese steel industry has seen a production CAGR of 22% and consumption CAGR of 14% during 2003-2007 turning China into a major net exporter by the end of 2007. With the advent of the global economic slowdown, we forecast a drop of production and consumption by 5% in China in 2009 despite plans of huge government spending through stimulus packages. Catching the breath amid slowdown With the recent global slowdown having an effect on China as well, demand has reduced considerably. Many domestic players have announced production cuts to maintain demand-supply match. Increased consolidation talks are taking place in China to eliminate excess capacities

Chinese steel production & consumption to drop by 5% in 2009

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and maintain competitiveness. The Chinese government has been proactive in maintaining growth and has announced a stimulus package of $586 billion in early November to sustain its economy by spending in infrastructure and other sectors. However, even with reducing interest rates and stimulus package led demand, we feel the global slowdown will take its toll on China. Both production and consumption would go down by 5% in 2009E and 2% in 2010E due to the strong base effect of 2008 production and consumption levels. Slowdown in construction continues but auto shows recovery China has witnessed a slowdown in major steel consumption industries like auto and construction. Car sales, after being down 9% YoY, in Q4CY08 have shown a smart recovery in Q1CY09. However, construction activities remained subdued while the property price index has shown only a slight recovery after plunging. Exhibit 22: China passenger car sales

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Auto sales have increased during the last few months indicating a comeback in steel demand from the auto sector

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Construction accounts for 64% of steel demand in China China’s strong demand for steel had been supported by robust GDP growth aided by massive construction activities and infrastructure improvements in the last five years. Apart from construction and infrastructure, which accounts for more than 64% steel demand, the other major consumers of steel in China are automobiles and machinery. Exhibit 24: Steel consumption pattern — China

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Source: Industry Data, ICICIdirect.com Research

Construction confidence index plunges due to slowdown… The construction industry in China has seen a slowdown in recent quarters amid a global slowdown and liquidity crunch. The construction confidence indicator has taken a sharp dive falling to four year low levels. Exhibit 25: Worsening construction confidence index

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64% of steel demand in China is accounted for by construction activities

Construction activities have slowed down

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…forcing Chinese government to announce stimulus packages… The Chinese government has been proactive in maintaining its high growth and immediately announced a stimulus package totalling US$586 billion when it felt the adverse effects of the global financial crisis on its economic growth. The package announced is indicated to be spent mainly on upgrading infrastructure (approximately 54% of total US$586 billion to be spent on infrastructure) particularly roads, railways and ports. This, in turn would spur steel demand. Exhibit 26: Break-up of Chinese stimulus package

Spending(US$ bn) % Share

Housing 41 7Rural Infrastructure 54 9Urban Infrastructure (Roads, Railways, Airports & Power) 264 45Medical Insurance & Education 6 1Environmental Protection 51 9R&D 23 4Disaster Relief 147 25Total 586

Source: Industry, ICICIdirect.com Research

…thereby providing a silver lining to Chinese steel industry… With the help of various spending measures taken by China and robust expenditure outlined in its Eleventh Plan, there is an expectation of creation of incremental steel demand totalling 40 million tonne (MT). This would cap the negative growth in production and consumption of China in 2009. Also, the total spend on infrastructure by China during the Eleventh Plan is expected to jump by 30% to US$1050 billion after the announcement of the stimulus package to boost the economy. Exhibit 27: Infrastructure spending — China

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Source: Industry data, ICICIdirect.com Research

Stimulus package has been announced to boost infrastructure spending and spur construction activities

Infrastructure spending to increase by 30% with new stimulus

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Excess steel capacities are slowly being consolidated in China. We expect steel demand to stabilise on the back of huge construction project demand of up to US$1 trillion, large scale urbanisation with approximately 15 million people moving to cities annually, increased demand from the growing middle class and robust infrastructure spend by the government. Overall, we remain cautiously optimistic on the prospects of the Chinese steel industry on the whole in the medium to long-term. Steel prices in China Exhibit 28: China rebar & wire rod price trend

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800

900

Dec-07 Feb-08 Apr-08 Jun-08 Aug-08 Oct-08 Dec-08 Feb-09 Apr-09

(US$

/tonn

e)

Rebar Wire Rod


Exhibit 29: China HR & CR coil price trend

300

500

700

900

1100

Dec-07 Feb-08 Apr-08 Jun-08 Aug-08 Oct-08 Dec-08 Feb-09 Apr-09

(US$

/tonn

e)

HR Coil CR Coil


1 8 | P a g e

Indian steel industry – Showing a brave face

Growth stalled but stability coming in… We expect the Indian steel industry to register a production and consumption growth of 5% in FY10-11E. The Indian steel industry has witnessed a period of strong growth with production and consumption increasing at a CAGR of 13% and 11%, respectively, during 2003-07. With the advent of the global financial crisis during the last nine months and the ensuing liquidity crunch, domestic steel production and consumption remained flat in FY09 due to the sharp slide witnessed in Q3FY09. However, with the recent demand pick-up, cooling inflation and softening interest rates there has been some stability in prices and sales volume. Exhibit 30: Indian finished steel statistics

44.5

52.556.0 56.4

59.262.2

54.457.1

51.851.5

46.8

39.2

25

30

35

40

45

50

55

60

65

FY06 FY07 FY08 FY09 FY10E FY11E

(In m

illion

tonn

e)

Production Real Consumption

Source: JPC, ICICIdirect.com Research

Due to pick up in consumption… The apparent consumption of finished steel has picked up after seeing a trough in October and is currently showing signs of stability with significant demand revival from the construction and auto sectors. Exhibit 31: Steel consumption trend

3.6

4.14.4 4.4 4.3

4.6

3.7

4.7

4.14.4 4.5

5.1

2.5

3.0

3.5

4.0

4.5

5.0

5.5

Apr-0

8

May

-08

Jun-

08

Jul-0

8

Aug-

08

Sep-

08

Oct-0

8

Nov

-08

Dec-

08

Jan-

09

Feb-

09

Mar

-09

(Mill

ion

tonn

e)

Signs of stability


Steel production and consumption to show just marginal growth

Monthly steel consumption has shown signs of stability

1 9 | P a g e

…and reduction in imports Imports have fallen sharply after the government imposed 5% import duty on all steel products and put restrictions on imports of certain steel products. This has been a positive for domestic steel makers and provided them with an opportunity to replace domestic import demand through their own supplies. Exhibit 32: Steel import trend

0.4

0.50.5

0.60.5

0.6

0.4

0.8

0.3

0.5

0.30.4

0.2

0.3

0.4

0.5

0.6

0.7

0.8

0.9

Apr-0

8

May

-08

Jun-

08

Jul-0

8

Aug-

08

Sep-

08

Oct-0

8

Nov

-08

Dec-

08

Jan-

09

Feb-

09

Mar

-09

(Milli

on to

nne)


Leading to increased capacity utilisation… The capacity utilisation has increased during the last few months even though additional capacity of 3-4 MT has been added through expansion of JSW Steel and Tata Steel via the brownfield route. This indicates stabilisation in domestic demand. With no major capacity addition to come in the next two years we expect capacity utilisation to remain in the range of 92-95% in FY10-11E. Exhibit 33: Indian steel industry capacity utilisation (%)

93.1

88.8

91.6

89.788.7

94.3

87.8

93.1

88.8

84.6

85

84.3

98.7

91.292.3

95.6

92.3

92.8

86.8

89.2

85.184.6

87.6

84.8

75

80

85

90

95

100

Apr-0

7M

ay-0

7Ju

n-07

Jul-0

7Au

g-07

Sep-

07Oc

t-07

Nov

-07

Dec-

07Ja

n-08

Feb-

08M

ar-0

8Ap

r-08

May

-08

Jun-

08Ju

l-08

Aug-

08Se

p-08

Oct-0

8N

ov-0

8De

c-08

Jan-

09Fe

b-09

Mar

-09

(%)


Imports have gone down after imposition of 5% duty

2 0 | P a g e

Government initiatives providing much needed help The government has been providing support to the steel industry of late by announcing various measures related to duties and imports aimed at benefiting local steel manufacturers. Exhibit 34: Positive government initiatives (Q3FY09)

Measure Action TakenExport Duty Export duty on all steel products removedImport Duty Import duty of 5% re-imposed on steel productsCountervailing Duty CVD reintroduced on certain productsDEPB DEPB on steel items reintroducedImport Restriction Import of certain steel products on restricted listAntidumping Antidumping enquiry initiated


Demand driven by construction and automobile Steel demand in India depends mainly on the construction sector, which consumes close to 60% of the total steel consumed in the country with automobile contributing 11%. The construction and auto sector have shown phenomenal growth over the last few years and were on an upswing till mid 2008 before the global liquidity crunch showed its effects and led to a massive slowdown in these two sectors causing steel demand to slacken. The recent pick up in both these sectors has helped steel demand to bounce back sharply. Exhibit 35: Steel demand break-up

59%

13%

11%

17%

Construction Manufacturing Automobile Others


Infrastructure spend to boost construction activities There has been a pick up in steel demand from both the auto and construction sectors in recent months. The situation seems to be stabilising. We expect steel demand to remain robust and show 5% growth in FY10 on the back of falling interest rates, cooling inflation, return of consumer confidence with infrastructure spend in the Eleventh Plan giving a boost to the construction sector. We expect 7 MT of incremental steel demand per annum from the planned infrastructure spending programme of the government during the Eleventh Plan.

Government steps have been positive for the industry

Construction accounts for close to 60% of total steel demand

Robust infrastructure spending in Eleventh Plan to boost construction activities

2 1 | P a g e

Exhibit 36: Estimated steel demand from infrastructure sector 11th Five year Plan Roads/ Railways Urban Irrigation Airports Telecom Power

Bridges Infra PortsInvestment expected from 11th Plan (Rs. Bn) 3142 2618 1829 2533 1190 2548 6665Assuming that 70% will be spent 2199 1833 1280 1773 833 1784 4666Civil Construction (%) 100 40 60 50 40 15 25Steel Component(%) 14 25 18 15 25 20 15Total Steel (Rs. Bn) 308 183 138 133 83 54 175Steel Prices Rs/Tonne 32000 32000 32000 32000 32000 32000 32000Total steel required (Mn Tonnes) 10 6 4 4 3 2 5Total steel for 11th Five year Plan (Mn Tonnes) 34Average annual steel consumption (Mn Tonnes) 7

Source: Planning Commission, steelworld.com, ICICIdirect.com Research

Exhibit 37: Year wise planned infrastructure investment

270.3321.6

389.3

479.1

595.9

6.06.5

7.3

8.2

9.3

200

300

400

500

600

700

FY08 FY09 FY10 FY11 FY12

(In '0

00 c

rore

)

4.0

5.0

6.0

7.0

8.0

9.0

10.0

(%)

Investment in infrastructure Investment as % of GDP (RHS)

Source: Planning commission, ICICIdirect.com Research

With per capita steel consumption expected to improve Exhibit 38: Per capita steel consumption

627

464

358

182

309

11647

0

100

200

300

400

500

600

700

Japan Germany US World China Brazil India

(In K

gs)

Developed Economies

Emerging Economies

Source: JSW Steel Annual Report,ICICIdirect.com Research

With low per capita steel consumption at present, scope for improvement exists

2 2 | P a g e

India’ per capita steel consumption is a dismal 47 kg at present. It ranks bottom among all developing nations with rural per capita steel consumption as low as 3 kg. India compares poorly with world average per capita steel consumption of 180 kg and other developing countries like China (310 kg) and Brazil (120 kg). With huge infrastructure spending committed by the government in the Eleventh Plan, falling interest rates and steel use being promoted increasingly, demand is expected to pick up after the recent slowdown and remain robust, going forward. This should help India improve its per capita steel consumption. We expect India to remain a net importer of steel till 2012 on the back of increased demand and slow capacity addition to meet the demand as greenfield projects get delayed due to approval hurdles at the state and centre level. Also, most of the planned capacity additions are slated to come on stream only from 2011 onwards. This will keep domestic steel supply in check. Imports would be required on a continuous basis. India least vulnerable to demand erosion Steel consumption growth in India has traditionally shown a direct relation to IIP and GDP growth. Average steel consumption to GDP growth multiple has been 1.4x for 2000-08 while average steel consumption to IIP multiple has been 1.3x for the same period. With India’s FY10 GDP growth estimated at above 5% by various government and other agencies, steel consumption growth could be a healthy 7% in FY10 (based on 1.4xGDP growth). We expect a steel consumption CAGR of 5% in India in FY10-11E. We believe that unlike the developed countries that are faced with negative GDP growth, India with a positive expected GDP growth is least vulnerable to demand erosion in steel. Exhibit 39: Steel consumption growth relation to GDP & IIP — India

GDP Growth(%)

IIP Growth(%)

ConsumptionGrowth (%)

Consumption toGDP Multiple

Consumptionto IIP Multiple

FY00 6.4 6.7 8.0 1.2 1.2FY01 4.4 5.0 7.4 1.7 1.5FY02 5.5 2.7 1.8 0.3 0.7FY03 3.8 5.7 5.7 1.5 1.0FY04 8.5 7.0 7.9 0.9 1.1FY05 7.5 8.4 10.3 1.4 1.2FY06 9.5 8.2 10.9 1.1 1.3FY07 9.4 11.6 30.5 3.2 2.6FY08 9.0 8.5 9.7 1.1 1.2Average 7.1 7.1 10.3 1.4 1.3

Steel

Source: IISI, Mospi, IMF, ICICIdirect.com Research

No major capacity addition for next two years

2 3 | P a g e

Price erosion stays a concern with domestic HR prices above global prices Domestic steel prices are hovering in the range of US$480-520/tonne currently and are above global prices. Domestic prices have seen a correction of 40-45% during Q3FY09. However, they have shown signs of stability since January 2009 due to recovery in domestic demand (especially rural steel demand) and imposition of import duty making imports costlier. Exhibit 40: HRC price trend comparison

300

400

500

600

700

800

900

HRC World ExportPrice

HRC Ex. Mill US HRC Ex. Mill China Domestic HR Price

($/to

nne)

Oct'08 Nov'08 Dec'08 Jan'09 Feb'09 Mar'09 Apr'09


The domestic price of HR coils is currently ruling 7-8% higher than the landed cost of imported HR and there remains scope for correction. We believe that though concerns remain on the price erosion front in the domestic market, stable domestic demand and increased support from the government’s favourable policies would help keep prices stable at current levels. Exhibit 41: HR coils price trend

0

10,000

20,000

30,000

40,000

50,000

60,000

70,000

Apr-97

Apr-98

Apr-99

Apr-00

Apr-01

Apr-02

Apr-03

Apr-04

Apr-05

Apr-06

Apr-07

Apr-08

Apr-09

(Rs/

tonn

e)

Domestic Price Landed Cost

Source: Crisinfac, ICICIdirect.com Research

HR prices have stabilised in domestic markets in tandem with global prices

2 4 | P a g e

Raw material scenario – Sufficient iron-ore, shortage of coking coal India finds itself in a position of being partially self-sufficient in terms of raw material availability with large reserves and production of iron-ore and thermal coal but very little reserves and production of coking coal of high quality. Exhibit 42: Raw material reserves

ParticularsTotal Reseves

(bn tonne)Annual Production

(mn tonne) Remarks

Iron Ore 25 207

13 bn tonnes reserve are mineable and suitable for steel making, Captive blocks allotted to main players

Thermal Coal 258 425Captive Coal blocks allotted to most players

Coking Coal 32 20Most of the reserves of high ash content/not of much use


Exhibit 43: Raw material requirement Pariculars (Mn Tonne) 2007-08 2011-12E Remarks

Steel Production 55 90Likely to fall short of target due to demand and capacity addition slowdown

Iron Ore Reqd. 90 155 Self Sufficient through reservesCoking Coal Reqd. 50 90 Dependent on imports

Equivalent Coke Reqd. 28 60Dependent on imports, conversion from coking coal


Cost pressure subsiding leading to margin improvement Cost pressure for the industry has subsided to a great extent with a deep correction in spot raw material prices (this accounts for a total of 60-65% of total production cost) already done. The final easing would occur once the raw material contract prices, which are still under negotiation, get settled at lower prices (we expect a 40% drop in iron ore prices and 60% in coking coal prices). This is due to the fact that domestic steel makers depend on procurement of key raw materials like coking coal through contract agreements. Exhibit 44: Indian steel players — Raw material procurement

CompanyReserves

(MT) Start dateCurrent captiveavailability (%)

Reserves(MT) Start date

Current captiveavailability (%)

Reserves(MT) Start date

Current captiveavailability (%)

SAIL 2000 Operational 100 60 Operational 100 200 5% Operational 30

JSW Steel 720Partly operational &

partly by FY11 20 290 FY11-12 0 275 FY11-12 0

Tata Steel -India 600 Operational 100 240 Operational 60

Thermal CoalIron-Ore Coking Coal


2 5 | P a g e

There has been a correction of 50-60% in spot prices of various raw materials, which has led to lower production cost for steel makers. Iron ore, coal and coke have all fallen by 65% or more in the spot market from their 2008 peak levels whereas coke has fallen by 45% over its 2008 peak level of US$715/tonne. Exhibit 45: Global raw material price

180 208

400

715645

120

400

210

6260

0

100

200

300

400

500

600

700

800

Thermal Coal-FOB(Newcastle)

Iron-Ore FinesCFR(India-China)

Coking Coal-FOB(Australia)

Export Coke-FOB(China)

H1 Melting Scrap-FOB (US)

(US$

/tonn

e)

2008-Peak Apr'09

67% 65%

65%

45%

65%


Exhibit 46: Domestic raw material price

32000

28000

16000 17000

0

5000

10000

15000

20000

25000

30000

35000

Domestic Coke Domestic Melting Scrap

(Rs/

tonn

e)

2008-Peak Apr'09

50%40%


2 6 | P a g e

Major steel players – Strong profile & expansion plans Major steel makers in India include SAIL, Tata Steel and JSW Steel who together control close to 45% of steel making capacity in the country. All these players fall into the category of main steel producers. Among them, SAIL and Tata Steel have both backward and forward integration to a large extent and are low cost manufacturers of steel. Also, all the main producers have aggressive expansion plans through the brownfield and greenfield route lined up for the next five to 10 years to increase capacity and meet demand. Exhibit 47: Indian steel players

Company Profile Production Capacity (MT) Expansion Plans

SAILIntegrated steel manufacturerLargest producer of steel in IndiaProduces steel through blast furnace

1423 MT by 2011 mainly through brownfield route

TATA Steel (India)

Oldest and second largest playerAmong the lowest cost manufacturer in the worlddue to strong integrationProduces steel through blast furnace route

6.6

10 MT by 2011 through brownfield route

JSW Steel

Integrated player with focus on flat productsEfficient manufacturing processUses corex and blast furnace route tomanufacture steel

7.8

10 MT by 2011 through brownfield route


Exhibit 48: Average blended realisations/tonne movement

20000

30000

40000

50000

60000

FY08 Q1FY09 Q2FY09 Q3FY09

(Rs/

tonn

e)

Tata Steel-Standalone SAIL JSW Tata Steel-Consolidated


Tata Steel leads the pack in terms of average blended realisations/tonne due to its rich product mix consisting of branded value-added products and higher percentage of sales done through long-term contracts in the domestic market. However, going forward, average blended realisations for Tata Steel on a consolidated basis could be sharply lower due to lower realisations at Corus. Consolidated realisations of Tata Steel were higher in Q3FY09 due to very high realisations at Corus (US$1250/tonne due to existing long-term contracts).

2 7 | P a g e

Exhibit 49: Q3FY09 cost structure

-20000

-10000

0

10000

20000

30000

40000

50000

60000

Tata Steel-Standalone

SAIL JSW Tata Steel-Consolidated

(Rs/

tonn

e)

Stock Adj. Raw Material Employee expenses Power & Fuel Other expenses


Tata Steel ranked lowest on the cost of production front on a standalone basis in Q3FY09 but was highest on a consolidated basis due to high cost of production at its subsidiaries (mainly Corus), which does not have captive raw material sources. A similar trend exists for EBITDA/tonne. EBITDA/tonne for all players has taken a sharp hit in Q3FY09 due to a fall in blended realisations and higher contract raw material costs resulting in high production cost. EBITDA/tonne for Tata Steel has fallen to Rs 13869 in Q3FY09 from Rs 28043 in Q2FY09. SAIL and JSW Steel have witnessed a QoQ drop of 55% and 50% in EBITDA/tonne in Q3FY09, respectively. Exhibit 50: EBITDA/tonne movement

0

5000

10000

15000

20000

25000

30000

Tata Steel-Standalone

SAIL JSW Tata Steel-Consolidated

(Rs/

tonn

e)

FY08 Q1FY09 Q2FY09 Q3FY09


2 8 | P a g e

Production cost analysis – Tata Steel India leads the way Indian steel players enjoy a competitive advantage over their global peers in terms of cost of production due to availability of captive resources like iron ore and thermal coal. The only laggard is the unavailability of good quality coking coal because of which the current production cost is relatively higher. Tata Steel is the lowest cost producer of steel in India (with 100% captive iron ore access and 60% captive coking coal) followed by SAIL (100% captive iron ore, but only 30% coking coal). Exhibit 51: Current cost of production comparison

0

100

200

300

400

500

600

SAIL Tata Steel-India JSW

(US$

/tonn

e)

Iron-Ore Coking Coal+Coke ConversionPower & Fuel Scrap/FluxesLabour Other Operational


Difference to go down post contract renegotiation The difference between costs of production for various players would be reduced after contract prices for raw materials like iron ore and coking coal are renegotiated at a significantly lower prices in the coming weeks. The biggest beneficiaries would be SAIL and JSW Steel and it would bring their cost of production close to Tata Steel and also provide strong headroom for making decent margins even at HR sales realisations of US$450-500/tonne. Exhibit 52: Production cost reduction comparison

516

409

475

373

336360

300

350

400

450

500

550

SAIL TATA Steel-India JSW Steel

($/to

nne)

Current Expected-Post contract negotiation

20%

24%28%


Tata Steel India has lowest cost of production

2 9 | P a g e

Valuations & Recommendation Most of the steel stocks that had seen huge de-rating after announcement of bad results for Q3FY09/Q4CY08 due to severe demand erosion, steep fall in product prices and drastic fall in profitability, have seen a smart run-up during the last few weeks. This has been the result of swift recovery in domestic demand and stabilisation of steel prices in the domestic market. Also, a drop in raw material prices at the spot level and expectation of a consequent drop in raw material contract prices have eased concerns over margins, going forward. However, players with large quantities of debt and high dependence on developed markets are not out of the woods completely and we believe that significant downside exists for these players from current levels. We believe the fundamentals of the Indian steel industry continue to remain strong and prefer players with strong business model, strong domestic supply network, low balance sheet risk and efficient operations. We believe that upside potential at current levels is capped and are initiating coverage on the steel sector with a neutral view on SAIL and negative view on Tata Steel. We have valued the stocks on the basis of P/BV and EV/EBITDA and assigned a multiple taking into account the rating for a particular stock, which we have decided by ranking the company on various attributes (both qualitative and financial). We have used future volume growth, debt/EBITDA, product/geographical diversification, return ratios (ROCE & RONW), backward integration and cash/share as the attributes for ranking the companies. We find that SAIL and Tata Steel — India rank high in our rating whereas Corus and Tata Steel – Consolidated come towards the lower end. Exhibit 53: Rating parameters & attributes

Rating ScaleFuture Volume Growth(CAGR) Debt/EBITDA

Product/Geographical Diversification

Backward Integration Cash/Share

Return Ratios (ROCE, RONW)

1 <2% >3 Very Low <20% <20% CMP RR<=10%2 2-5% 2-3 Low 20-40% 20-30% CMP RR>10% & <=15%3 5-10% 1.5-2 Medium 40-60% 30-40% CMP RR>15% & <=20%4 10-15% 1-1.5 High 60-80% 40-50% CMP RR>20% & <=25%5 >15% <1 Very High 80-100% >50% CMP RR>25%

Atrributes


Lowest Rating=1, Highest rating=5 , CMP=Current market price, RR=Return ratios

Exhibit 54: Player ratings

CompanyFuture Volume Growth(CAGR) Debt/EBITDA

Product/Geographical Diversification

Backward Integration Cash/Share

Return Ratios(ROCE,& RONW)

Average Rating P/BV EV/EBITDA

SAIL 3 5 3 3 3 4 3.5 1.5 4JSW Steel 5 1 4 2 1 2 2.5 0.65 NATata Steel India 5 2 4 4 2 4 3.5 NA 4.5Corus 1 2 4 1 1 1 1.7 NA 3Tata Steel Cons 2 2 4 2 2 2 2.3 0.65 NA

Rating on attributes Multiple Given by us


3 0 | P a g e

Exhibit 55: EPS CAGR vs. P/E

-50

-40

-30

-20

-10

0

2 4 6 8 10

PE (FY10E)

EPS

CAGR

(FY0

8-10

E)

SAIL JSW Tata Steel


Exhibit 56: EBITDA CAGR vs. EV/EBITDA

-20

-10

0

10

20

2 3 4 5 6

EV/EBITDA (FY10E)

EBIT

DA C

AGR

(FY0

8-10

E)

SAIL JSW Tata Steel


Exhibit 57: Normalised P/E vs. normalised RONW

0

2

4

6

8

10

10 14 18 22 26

Normalized RONW FY10E

Nor

mal

ized

PE F

Y10E

SAIL JSW Tata Steel


3 1 | P a g e

We have also factored historical valuations, particularly those given during the trough period of 1999-2003 (when steel industry was making loss at PAT level) and the current global valuations in deciding the P/BV and EV/EBITDA multiple for Indian steel companies. We believe the business models of Indian steel companies are stronger than in the trough period (1999-2003) and have valued the various companies factoring in their current financial position as compared to that during the trough period. Exhibit 58: Historical valuations P/BV FY97 FY98 FY99 FY00 FY01 FY02 FY03 FY04 FY05 FY06 FY07 FY08Tata Steel 1.5 1.4 0.9 1.0 1.0 1.0 1.6 3.1 3.1 3.0 1.9 2.3SAIL 0.9 0.5 0.4 0.6 0.5 0.7 1.4 2.7 2.5 2.7 2.7 3.3JSW Steel 0.5 0.5 0.4 0.6 0.6 0.3 0.8 0.9 2.4 1.6 2.1 2.8

EV/EBITDA FY97 FY98 FY99 FY00 FY01 FY02 FY03 FY04 FY05 FY06 FY07 FY08Tata Steel 7.7 9.4 8.0 7.0 5.9 6.9 4.1 4.9 4.0 5.2 3.8 7.7SAIL 10.2 9.4 15.4 14.9 7.3 15.0 7.3 4.3 2.3 4.4 3.8 5.1JSW Steel 0.0 82.8 45.9 35.6 25.3 27.2 14.6 4.1 3.6 4.2 4.2 6.2

Source: Capitaline, ICICIdirect.com Research

Exhibit 59: Valuation matrix

FY08 FY09 FY10 FY08 FY09 FY10 FY08 FY09 FY10 FY08 FY09 FY10 FY08 FY09 FY10Tata Steel 177.0 117.9 56.7 1.6 2.3 4.9 3.5 3.5 3.5 35.9 20.7 10.3 15.6 15.3 10.0SAIL 18.2 13.4 13.2 6.7 9.1 9.2 3.0 3.9 4.4 32.7 20.3 17.3 42.3 24.5 20.5JSW Steel 87.7 14.7 54.4 4.8 28.8 7.8 5.7 7.7 6.3 21.3 3.0 10.3 15.1 9.1 10.8

ROCE (%)EPS (Rs) P/E EV/EBITDA RONW (%)


3 2 | P a g e

Exhibit 60: Global valuations

FY09 FY10 FY09 FY10 FY09 FY10USArcelor Mittal 116 0.7 0.7 57.0 10.7 10.1 6.1 69687 6.3 0.8 600.8US Steel 22 0.9 0.9 NA 17.0 NA 6.3 6403 2.4 0.8 291.0Nucor 20 1.9 1.8 NA 15.2 74.9 7.2 14909 9.7 1.8 745.5

ChinaBaoshan Iron & Steel 28 1.2 1.1 18.0 12.8 6.7 5.2 23218 47.6 1.2 829.2Wuhan Iron & Steel 20 1.7 1.6 13.7 11.0 7.6 5.9 12386 16.7 2.0 619.3Angang Steel 16 1.4 1.3 28.8 17.0 10.1 7.3 10654 24.5 1.4 665.9

JapanNippon Steel 35 1.3 1.4 13.9 NA 6.9 16.8 43539 14.6 1.4 1244.0JFE Holdings 28 1.1 1.2 12.2 57.8 6.1 11.6 34600 8.3 1.2 1235.7POSCO-Korea 31 1.2 1.1 13.2 9.4 7.3 5.5 30869 NA NA 995.8

RussiaSeverstal 17 0.4 0.4 21.5 5.1 4.7 3.7 9156 2.0 0.4 538.6Evraz 16 0.6 0.5 8.5 3.5 NA NA 15047 1.2 0.4 940.4

BrazilGerdau 19 1.2 0.8 14.9 8.3 7.8 5.9 20875 8.3 1.3 1098.7Usinas Siderugicas De Minas 9 1.2 1.0 13.4 8.8 6.0 4.6 10274 5.5 1.2 1141.6

Global Average 1.1 1.0 19.6 14.7 13.5 7.2 12.3 1.1 842.0

Forward Consensus Estimates Current ValuationProduction Capacity

(MT) EV (Mn $) P/E P/BVEV/tonne

($)P/BV P/E EV/EBITDA


3 3 | P a g e


Analysts’ Name


Sales & EPS trend

10000

20000

30000

40000

50000

FY07 FY08 FY09EFY10EFY11E

(Rs

Cror

e

4

8

12

16

20

(Rs

Sales EPS

Stock Metrics

Bloomberg Code SAIL INReuters Code SAIL.BOFace value (Rs) 10Promoters Holding (%) 86Market Cap (Rs cr) 5039152 week H/L (Rs) 191.0/55.2Sensex 12158Average volumes 2950446 Comparative return metrics

Stock return (%) 3M 6M 12MSAIL 42 48 -26Tata Steel 52 49 -67JSW Steel 95 44 -54

Price Trend

50

80

110

140

170

200

Apr-08 Jul-08 Oct-08 Jan-09 Apr-09

Close Price Absolute BuyAbsolute Sell Target Price

May 13, 2009 | Metals and Mining

Initiating Coverage

Steel Authority of India (SAIL)

Upside capped… With a production capacity of 13 million tonnes (MT), SAIL is the largest domestic steel player enjoying a market share of ~20%. With no dependence on exports, a strong balance sheet and the advantage of being a government entity, SAIL is expected to continue its strong performance and register revenue CAGR of 15% during FY09-11E in a tough economic situation. Strong backward and forward integration coupled with an expected significant drop in coking coal costs and improving product mix, going forward, would help the company to ride through the difficult times. We believe the upside is capped at current valuations and initiate coverage on SAIL with a HOLD rating.

Modernisation & expansion to fuel growth SAIL plans to boost its production capacity to 23 MT by FY12E but the saleable steel volume is expected to grow at a CAGR of 1.6% during FY08-FY11E due to capacity additions coming only in FY12. This would enable the revenue to rise at a CAGR of 4.7% during FY08-FY11E. Due to modernisation and cost saving measures the operational EBITDA is likely to grow by 0.4% CAGR during FY08-11E despite lower average realisations.

Robust domestic demand advantage Domestic steel demand is likely to grow at a CAGR of 5% over FY09-11E. With more than 95% of SAIL’s output sold in the domestic market, this gives it a distinct advantage over Tata Steel and JSW Steel, that have partial dependence on overseas markets. Being a PSU, SAIL enjoys an exclusive supplier status of special steel products to sectors like railways, infrastructure and defence. This helps the company to achieve stable demand for its products.

Valuations The company has a leadership position in the industry and strong balance sheet with cash/share ~Rs 40. We have valued the company at 4x FY10E EV/EBITDA to arrive at a target price of Rs 112.74/share. Valuing the company at 1.5x BV of FY10E gives us a fair value of Rs 114.48. We are initiating coverage on SAIL with a HOLD rating and assigning a target price of Rs 115 to the stock.

Current Price Rs 122

Target Price Rs 115

Potential upside -6%

Time Frame 12-15 months

HOLD

Exhibit 1: Key Financials FY07 FY08 FY09E FY10E FY11E

Net Profit (Rs Crore) 6202.3 7536.8 5544.5 5454.8 6155.1EPS (Rs) 15.0 18.2 13.4 13.2 14.9% Growth 21.5 -26.4 -1.6 12.8P/E (x) 8.1 6.7 9.1 9.2 8.2P/BV (x) 2.9 2.2 1.8 1.6 1.4EV/EBITDA (x) 4.1 3.0 3.9 4.4 4.6OPM % 32.3 32.8 23.8 26.5 28.9NPM % 18.3 19.1 13.1 13.3 13.6RONW % 35.8 32.7 20.3 17.3 16.9ROCE % 42.6 42.3 24.5 20.5 18.7


3 4 | P a g e

Company background

SAIL, the Navratna PSU, is the largest steel making company in India with strong backward and forward integration. The company produces both basic and special steel products for sectors like construction engineering, railways, automobile and defence. The company has five main integrated steel plants in addition to three special steel plants and boasts of a four decade history of technical, managerial and other know-how in steel making. SAIL manufactures and sells a broad range of steel products in both flats and longs category, which include HR/CR coils, galvanised products, railway products, bars & rods, structurals and other alloy steels. The company has the distinction of being India’s largest producer of iron ore after NMDC and owning the country’s second largest mines network. This gives SAIL a competitive edge in terms of captive availability of iron ore, limestone and dolomite, which are key inputs for steel making. Exhibit 2: Company structure


Shareholding pattern (Q3FY09)

Shareholder % holdingPromoters 85.8Institutional investors 11.1Other investors 0.9General public 2.2 Promoter & institutional holding trend (%)

85.8 85.8 85.8 85.8

11.111.411.311.7

0.0

20.0

40.0

60.0

80.0

100.0

Q4 Q1 Q2 Q3

(%)

Promoter Holding Institutional Holding

SAIL

Main Integrated Steel Plants

Alloy & Special Steel Plants

Subsidiaries

Bhilai Steel Plant (BSP)

Bokaro Steel Plant (BSL)

Durgapur Steel Plant (DSP)

Rourkela Steel Plant (RSP)

IISCO Steel Plant (ISP)

Alloy Steel Plant (ASP)

Salem Steel Plant (SSM)

Visvesvaraya Steel Plant (VSP)

Maharashtra Electrosmelt Ltd (MEL)

3 5 | P a g e

Exhibit 3: Product details

Type Products % Share (FY08)

FlatsPlates,coils & sheets (HR,CR,GP/GC) 55

LongsAngles,Channel,Wire rods, structural 27

Semis Pig Iron etc 18


SWOT analysis

Threats • Government policies related to import & export of steel products • Sharp fluctuations in finished product prices • High coking coal contract rates as compared to spot prices • Increased competition from China, Thailand & Ukraine – Chinese exports into India could rise • Slowdown in demand on account of slow economic growth

Opportunities • Increasing per capita steel consumption in India • Huge investments lined up by the government for sectors that consume steel • Niche product line under huge domestic demand – Long products for their size range & quality – HR coils for tube making sector – Plates for project customers • Driving demand from increased dealer network (PAN India) coverage • Increase in productivity with expansion & modernisation plan implementation

Weakness • Dependence on purchase of coal (non captive) – 70% Coking coal obtained under long term contracts – Thermal coal procured from domestic suppliers • Very high manpower costs • Technological improvements required at various plants • High government control at times restricting better realisations & profitability

Strengths • Largest steel company in India with more than 20% market share in total steel production • Access to captive resources – 100% iron ore – 60% power • Largest distribution network covering all districts in India • Wide range of product mix • Healthy balance sheet with low debt equity ratio • Existing infrastructure for brown-field expansion

700045

700045

700045

700045

3 6 | P a g e

Investment rationale

Long-term growth through expansion plan In order to achieve long term sales volume growth, SAIL is currently implementing a modernisation and expansion plan through the brownfield route to expand its capacity of saleable steel to over 23 MT from the base level of around 13 MT by 2011-12. Since most of the additional capacity is slated to be onstream only by late FY11, we expect the sales volume to grow at a CAGR of 1.6% to 13.2 MT in FY11 from 12.6 MT in FY08.

Exhibit 4: Capacity expansion

3.94.43

1.72 2.07

0.41

2.632.1

1.11

1.81

1.96

0

1

2

3

4

5

6

7

Bokaro Bhilai Durgapur Rourkela IISCO

Capa

city

(In

Milli

on T

onne

)

Production 2007-08 Planned Increase

6.53

2.83

3.88

2.3

6.53


Strong book to support huge capex The company expects to spend close to Rs 54000 crore (US$12.6 billion) to complete the planned modernisation and expansion plan and has a strong balance sheet to support the same.

Exhibit 5: Strong balance sheet

5770

4298

4181

3045 63

71

4659

1001

1

1238

6 1718

4

2720

0

1780

5670

5645 90

34

1313

6

1612

6

8690

2300

4

0

5000

10000

15000

20000

25000

30000

FY04 FY05 FY06 FY07 FY08 Q3FY09

(Rs

Cror

e)

Debt Net Worth Term Deposits


Saleable steel production capacity to rise to 23 MT by FY12

Balance sheet is strong with robust term deposits/liquid investments and low debt

3 7 | P a g e

SAIL plans to fund the investment amount required in such a manner that keeps its debt-equity ratio below 1. It has cash on books exceeding Rs 16000 crore and low debt-equity ratio of 0.24:1 at the end of December 2008. We do not expect any funding related issues and expect a major portion (~60%) of expansion funding to come from strong internal accruals and cash balance in FY10-11.

Higher productivity through operational improvements We expect the modernisation of plants to help SAIL in achieving the technological shift, which will lead to improved production processes, high manpower productivity, reduced coke rate and energy consumption leading to overall cost savings of Rs 2500/tonne.

Exhibit 6: Technology enhancement measures Technology Current Status (%) Post Expansion (%) Benefits

BOF Steel making 100 100 Improvement in operational productivityConCast Route 100 100 Increase in productivity & cost savingsPelletisation & Beneficiation Plant No Yes Cost saving through fines usageCoke Dry Quenching No Yes Increase in BF efficiencyTop Pressure Recovery Turbine No Yes Increase in BF efficiencyAuxiliary Fuel Injection in BF Partial coverage Full coverage Increase in BF efficiencyDesulphurization of Hot Metal Partly 100 Quality improvementThin Slab Casting - Compact Strip Mill No Yes Product improvement


Exhibit 7: Expected savings through operational improvements Improvement Expected Cost Saving/tonne (Rs)Reduction in Coke Rate 1150Manpower Productivity Improvement 1100Reduced Energy Consumption 350Total Operational Savings 2500 Source: Company, ICICIdirect.com Research

Exhibit 8: Manpower productivity improvement

156719

137496

126857

132973127000

100000

14

23

13.512.1

11.310.54

80000

100000

120000

140000

160000

180000

FY01 FY03 FY05 FY07 FY09 FY12E

Man

pow

er(n

os)

8

12

16

20

24

28

Prod

uctio

n (M

illion

tonn

es)

Manpower Production


3 8 | P a g e

Exhibit 9: Coke rate

Coke Rate (Kg/THM)

543 541533

450

400

440

480

520

560

FY06 FY07 FY08 FY11E


Exhibit 10: Energy consumption

Energy Consumption (Gcal/TCS)

7.2 7.2

7.0

5.8

5.5

6.0

6.5

7.0

7.5

FY06 FY07 FY08 FY11E


Product mix change to achieve better realisations SAIL has planned a substantial shift in its product mix with complete elimination of semi-finished steel by FY11 (semis component already reduced to 8% from 15% of total saleable steel at five integrated steel plants {ISPs}). We expect elimination of semi-finished steel by FY11-12E, which would result in better blended realisations resulting from a premium for finished steel.

Exhibit 11: Product mix-FY08

FY08

Rounds/Bars, 10.2%

Coated Products,

2.8%CR

Coils/Sheets, 8.7%

Structurals, 5.2%

Railway Materials,

8.0%HR

Coils/Sheets, 24.1%

Semis, 17.9%

Pipes, 0.5%

Plates, 21.2%


Exhibit 12: Expected product mix-FY11E

FY11E

Plates, 16.4%Pipes, 0.6%

Rounds/Bars, 23.3%

Coated Products,

4.8%

CR Coils/Sheets,

10.4%

Structurals, 15.0%

Railway Materials,

7.4%

HR Coils/Sheets,

22.1%


The company has also been increasing the share of value-added products in the overall product mix to improve realisations (value-added products are sold at a premium of 5-15%). We expect the value-added steel products share to rise to 40% in FY10-11E in the overall product mix. This would increase blended realisations by 3-5% with respect to normal saleable steel realisations.

3 9 | P a g e

Exhibit 13: Value-added steel share

YearSaleable Steel

production(MT)Value added Steel

production(MT)Value added

products Share(%)FY06 12.1 1.26 10FY07 12.6 1.46 12FY08 13 3.36 26

Q1FY09 2.9 0.9 31Q2FY09 3.2 1.07 33Q3FY09 2.9 0.9 31

FY10E 12.2 488 40FY11E 13.2 528 40


Raw material – Major relief on coking coal front during FY10 SAIL has 100% captive availability of iron ore, which is expected to be maintained post expansion also due to development at various captive mines. However, coking coal is a costly open-ended proposition (captive status of only 30%) for the company accounting for 60% of total raw material cost in FY08 and 71% in FY09E. High contract prices entered for FY09 (with quantity of 11 MT contracted at US$300/tonne) has already affected the profitability to a great extent in FY09 with coking coal cost increasing 72% YoY to Rs 14200 crore in FY09E as compared to Rs 8243 crore in FY08.

Exhibit 14: Coking coal cost metrics

64%

59%

71%

65%

62%

8000

10000

12000

14000

16000

18000

20000

22000

FY07 FY08 FY09E FY10E FY11E

(Rs

Cror

e))

55%

58%

61%

64%

67%

70%

73%

Total RM Cost Coking Coal cost as % to total RM cost


Though expected, lower coking coal contract price for FY10 (down 60% YoY to US$120/tonne) would bring relief to SAIL on the margin front. We expect the benefits of the same to accrue only from mid-Q2FY10 when the previous contracted quantity of coking coal (with contract of SAIL running from July to June) is exhausted. We have factored a drop of 60% in the coking coal contract price to US$120/tonne from Q2FY10 onwards as the previous contract runs till the end of June 2009 (Q1FY10). Overall, we forecast a drop of 7% CAGR in total raw material costs during the next two years due to reduced coking coal contract cost and reduction in overall mining costs.

Coking coal cost overhang remains with contracts running from July to June

Value-added steel products share has been increasing continuously

4 0 | P a g e

Production cost downfall comparison The cost of production for SAIL in H2FY09 has been close to $515/tonne (assuming average coking coal price at US$300/tonne). This can be attributed to the full effect of high coking coal contract price and is expected to come down by 28% post renegotiation of new coking coal contract and commencement of new shipments at lower prices. Also, a fall in other raw material prices, mining costs & transport costs due to lower oil prices would bring down the total production cost to US$373/tonne. This would act as a key for the company in easing margin pressure.

Exhibit 15: Production cost reduction

516

409

475

373

336360

300

350

400

450

500

550

SAIL TATA Steel-India JSW Steel

($/to

nne)

Current Expected-Post contract negotiation

20%

24%28%

Source: ICICIdirect.com Research

SAIL’s production cost to go down 28% post raw material contract renegotiation

4 1 | P a g e

Risks & concerns

Coking coal cost higher than our estimates SAIL procures 70% of its coking coal through imports. Most of it is done through long-term contracts. We have factored in a drop of 60% in coking coal contract cost to US$120/tonne (in line with the initial negotiation between Nippon Steel and BHP-Mitsubishi Alliance) for Q2-Q4 of FY10 as SAIL contracts runs from June-July. The coking coal contracts entered into by SAIL at a price higher than US$120 would result in a drop of earnings from our estimates. Rupee depreciation against dollar Since SAIL makes payments for the bought coal in dollar terms, it exposes it to the adverse rupee movements. A significant depreciation of the Indian rupee against the dollar will increase the rupee bill of imported coal for SAIL and impact its earnings negatively. Higher competition from domestic players and importers SAIL sells more than 95% of its products in the domestic market and is exposed to the risks of adverse effect on its sales volume due to increased competition from domestic players and cheap imports from countries like China, Thailand, Ukraine and Korea. While increased competition from domestic players remains a risk, any negative changes in import duty (currently 5% on all steel products) could increase imports in the country and affect SAIL negatively.

4 2 | P a g e

Financials

Revenues, EPS to remain subdued in FY10 before increasing in FY11 SAIL has put up a strong financial performance during FY06-08 with revenue and EPS growing at a CAGR of 19% and 37%, respectively. Though there would be an absolute rise, the growth rate in revenue is likely to slow down during FY08-11E, a CAGR of 4.7% on account of modest realisation and sales volume growth, a CAGR of 0.8% and 1.6%, respectively, during FY08-11E. The EPS is expected to decline at a CAGR of 6.5% to Rs 14.9 in FY11E from Rs 18.25 in FY08.

Exhibit 16: Sales & EPS trend

10000

20000

30000

40000

50000

FY06 FY07 FY08 FY09E FY10E FY11E

(Rs

Cror

e)

4

8

12

16

20

(Rs)

Sales EPS


Stable sales volume & realisations – Worst seems to be over After witnessing a stable growth in sales volume and high growth in realisations for the past few years, SAIL is expected to see a 13.5% drop in volume in FY09 to 10.9 MT from 12.6 MT in FY08 due to low sales of 2.4 MT in Q3FY09. Average realisations for FY09 are expected to be at Rs 39925, a gain of 16.2% over FY08 due to high realisations in H1FY09 with commodity prices at their peak. After the slump in prices and demand during H2FY09 due to the commodity bubble burst, we see stability going forward due to stabilising of domestic demand and favourable government policies related to customs and safeguard duties. We expect modest realisation and sales volume growth for SAIL, a CAGR of 0.8% and 1.6%, respectively, during FY08-11E. Sales volumes are expected to remain muted as capacity addition is expected only during late FY11 with the IISCO expansion not expected to be on stream before then.

4 3 | P a g e

Exhibit 17: Sales volume & realisations

11.712.3 12.6

10.9

12.2

13.2

5.0

7.0

9.0

11.0

13.0

15.0


(In m

illion

tonn

e)

20000

25000

30000

35000

40000

45000

(R/

)

Saleable Steel Sales Average Realizations


Margin pressure to ease out in H2FY10 SAIL is past its high EBITDA margin period (FY08 and H1FY09) and is currently facing margin compression due to fall in realisations and high raw material cost (due to US$300/tonne coking coal contract). We expect margin compression to be felt till the end of H1FY10 due to the high coking coal contract cost running till June end and the full effect of the new contract cost leading to lower cost of production coming only in H2FY10. We expect a margin improvement in H2FY10. We expect stable margins from then on due to lower raw material costs, improvement in production processes, increased efficiency and stable demand from domestic markets with gradual improvement in the global and domestic economic situation.

Exhibit 18: Easing margin pressure

19925

34600

2342525925

2292520484

3320035242

42213

36480

0

5000

10000

15000

20000

25000

30000

35000

40000

45000

FY08 H1FY09 H2FY09E H1FY10E H2FY10E

(In R

s/to

nne)

Production Cost Avg. Sales Realization

High EBITDA Margin Period

Margin Compression Stable

Margins


Easing of margin pressure expected from H2FY10 onwards

4 4 | P a g e

The OPM and NPM are expected to be at 28.9% and 13.6%, respectively, in FY11E.

Exhibit 19: Margins trend

28.9%26.5%

23.8%

32.8%32.3%

26.5%

13.6%13.3%13.1%

19.1%18.3%

14.4%

5%

10%

15%

20%

25%

30%

35%


OPM NPM


Key assumptions We have made the following assumptions for forecasting earnings for the company.

Exhibit 20: Assumptions - Sales volume & realisations FY07 FY08 FY09E FY10E FY11E

Blended Saleable Steel Realizations (Rs/tonne) 30251 34342 39925 33900 35200Total Sales Volume (Mn tonne) 12.3 12.6 10.9 12.2 13.2


Exhibit 21: Assumptions - Raw material

FY07 FY08 FY09E FY10E FY11EIron-OreQty Consumed (Mn tonne) 24.7 25.4 23.3 23.1 25.1Average Price (Rs/tonne) 604 678 750 700 750Coking CoalQty Consumed (Mn tonne) 13.6 14.0 13.5 13.4 14.5Average Price (Rs/tonne) 6259 5907 10505 7875 7380


4 5 | P a g e

Valuations

We have valued SAIL using the EV/EBITDA and P/BV methodology and arrived at a target price of Rs 115 assigning a HOLD rating to the stock. Valuing the company using FY10E EV/EBITDA multiple of 4x gives us a fair value of Rs 112.74 for the stock. Valuing the company at 1.5x its book value of FY10E we get a fair value of Rs 114.48. EV/EBITDA based valuation of Rs 112.7/share

The company has traded at a forwar d multiple in excess of 4xEV/EBITDA for most of FY08 and is currently trading at a multiple of 4.4xFY10E EV/EBITDA. We have valued the company by applying a multiple of 4x to FY10E EV/EBITDA and arrived at a fair value of Rs 112.74. Exhibit 22: EV/EBITDA chart

0

20000

40000

60000

80000

100000

120000

140000

May

-05

Jul-0

5Se

p-05

Nov

-05

Jan-

06M

ar-0

6M

ay-0

6Ju

l-06

Sep-

06N

ov-0

6Ja

n-07

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-07

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-07

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p-07

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ar-0

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ay-0

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ov-0

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n-09

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-09

(Rs

Cror

e)

EV 10 8 6 4 2


Exhibit 23: EV/EBITDA valuation (Rs Crore) FY09E FY10EEBITDA 10071.7 10893.6Exp EV/EBITDA Multiple 4 4Expected EV 40287.0 43574.6Add Cash 17540.3 13838.0Less Debt 6845.2 10845.2

Mkt Cap Expected 50982.0 46567.4Weight (%) 0.0 100.0

Mkt Cap 46567.4No. of Shares(Cr) 413.0Target Price/Share (Rs) 112.7 Source: Company, ICICIdirect.com Research

4 6 | P a g e

P/BV based valuation of Rs 114.5/share SAIL is currently trading at 1.84x and 1.6x its FY09E BV of Rs 66.18 and FY10E BV of Rs 76.32, respectively. Looking at the historic data of SAIL, we find that SAIL has traded at above 2x its book value since FY04 after going through a trough period in FY1999-FY2003 when it was making losses at the PAT level. Exhibit 24: SAIL historical data

FY94 FY95 FY96 FY97 FY98 FY99 FY00 FY01 FY02 FY03 FY04 FY05 FY06 FY07 FY08PAT Margin(%) 4.6 7.8 8.8 3.6 0.9 -10.5 -10.6 -6.3 -15.2 -2.3 10.4 21.3 12.3 15.7 16.4EBITDA/tonne (Rs) 1668 2197 2485 2180 2215 1274 967 1744 835 1760 3744 8866 5573 8280 9781P/BV 3.5 2.0 1.4 0.9 0.5 0.4 0.6 0.5 0.7 1.4 2.7 2.5 2.7 2.7 3.3

Source: Capitaline, Company, ICICIdirect.com Research

Since we do not forecast that the current situation would turn out to be as bad as that witnessed in 2000-02, we expect SAIL to trade at a premium to its book value. We value the company at 1.5x its book value of FY10E of Rs 76.32 to arrive at a target price of Rs 114.48. Keeping in mind the target prices obtained through the BV and EV/EBITDA valuation methods, we have assigned a target of Rs 115 to the stock. We are initiating coverage on the stock with a HOLD rating. Exhibit 25: P/BV valuation BV10E (Rs) 76.3Exp. P/BV 1.5Fair Value (Rs) 114.5 Source: Company, ICICIdirect.com Research

Exhibit 26: P/BV chart

0

50

100

150

200

250

300

350

May

-05

Jul-0

5

Sep-

05

Nov

-05

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ar-0

6

May

-06

Jul-0

6

Sep-

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-06

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ar-0

7

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-07

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7

Sep-

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-07

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-08

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-08

Jul-0

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Sep-

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-08

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09M

ar-0

9

May

-09

(Rs)

PRICE PBV 4 PBV 2 PBV 1.5 PBV 1 PBV 0.5


4 7 | P a g e

Tables Profit and loss account (Rs Crore)

FY07 FY08 FY09E FY10E FY11ENet Sales 33923.1 39508.5 42270.9 41137.7 45313.1% Growth 16.5 7.0 -2.7 10.1Other Income 2001.0 2382.5 2923.5 2869.2 3156.1Raw Materials 13274.9 13960.1 20042.7 16150.0 17323.8Power & Fuel 2578.8 2825.6 3111.2 2941.8 3243.8Employee Exp. 5087.4 7919.0 8964.6 8000.0 8156.4Sell. & Adm.Exp 2308.4 2554.2 2874.4 2665.5 2925.5Total Exp. 24957.8 28935.8 35122.7 33113.3 35364.5% Growth 15.9 21.4 -5.7 6.8EBITDA 10966.2 12955.2 10071.7 10893.6 13104.7Depreciation 1211.5 1235.5 1305.3 1876.9 2516.9Interest 332.1 250.9 352.5 751.8 1261.8PBT 9422.6 11468.7 8413.9 8264.9 9326.0Tax 3220.3 3932.0 2869.4 2810.1 3170.8

Net Profit 6202.3 7536.8 5544.5 5454.8 6155.1% Growth 21.5 -26.4 -1.6 12.8Equity 4130.4 4130.4 4130.4 4130.4 4130.4Face Value 10.0 10.0 10.0 10.0 10.0Dividend % 31.0 37.0 26.8 26.4 29.8EPS 15.0 18.2 13.4 13.2 14.9

Balance sheet (Rs Crore)

FY07 FY08 FY09E FY10E FY11EShare Capital 4130.4 4130.4 4130.4 4130.4 4130.4Reserves & Sur. 13194.9 18944.5 23202.7 27392.0 32119.2Secured Loans 1556.4 925.3 2925.3 5425.3 9425.3Unsec. Loans 2624.1 2119.9 3919.9 5419.9 9419.9Net Deferred Tax 1412.7 1568.6 1568.6 1568.6 1568.6

Total Liabilities 22918.5 27688.8 35747.0 43936.3 56663.4

Net Block 11502.9 11277.5 13972.2 24095.2 37578.3Capital Work in Progress 1236.0 2389.6 4389.6 7389.6 12389.6Investments 513.8 538.2 538.2 538.2 538.2Inventories 6651.5 6857.2 8711.7 8172.8 8701.2Sundry Debtors 2314.8 3048.1 3484.7 3269.1 3480.5Cash & Bank 9716.8 14064.7 17540.3 13838.0 8489.1Loans & Adv. 1650.0 2379.8 2316.2 2254.1 2482.9Current Assets 20485.6 26622.8 32425.9 28007.1 23726.7CL & Prov. 10949.0 13198.8 15638.3 16153.3 17628.9Net Curr. Assets 9536.6 13424.1 16787.6 11853.8 6097.8

Total Assets 22918.5 27688.8 35747.0 43936.3 56663.4

4 8 | P a g e

Cash flow statement (Rs Crore)

FY07 FY08 FY09E FY10E FY11EOpening Cash 6172.6 9716.8 14064.7 17540.3 13838.0Profit after Tax 6202.3 7536.8 5544.5 5454.8 6155.1Dividend Paid 1478.4 1787.2 1286.3 1265.5 1428.0Depreciation 1211.5 1235.5 1305.3 1876.9 2516.9Cash Profit 5950.2 7210.7 5563.5 6066.2 7244.1Changes In working CapitalNet Increase in CL 273.7 2249.8 2439.6 515.0 1475.6Net Increase in CA 1310.6 1789.4 2327.4 -716.5 1068.5CF after changes in Working Capital -1036.9 460.4 112.1 1231.5 407.0

Cash Flow from Investing ActivitiesPurchase of FA 1030.4 2163.5 6000.0 15000.0 21000.0

Cash from Financing ActivitesIncrease /(Decrease) in Loan Funds -117.1 -1135.3 3800.0 4000.0 8000.0

Closing Cash 9716.8 14064.7 17540.3 13838.0 8489.1

Ratios

FY07 FY08 FY09E FY10E FY11EEPS (Rs) 15.0 18.2 13.4 13.2 14.9Cash EPS (Rs) 17.9 21.2 16.6 17.8 21.0Book Value (Rs) 41.9 55.9 66.2 76.3 87.8EBITDA/tonne (Rs) 8920.8 10244.0 9278.4 8949.1 9930.1EBIDTA Margin (%) 32.3 32.8 23.8 26.5 28.9

Net Profit Margin (%) 18.3 19.1 13.1 13.3 13.6RONW (%) 35.8 32.7 20.3 17.3 17.0ROCE (%) 42.6 42.3 24.5 20.5 18.7Debt/Equity 0.2 0.1 0.3 0.3 0.5

FA Turnover Ratio 1.1 1.2 1.1 0.8 0.6Enterprise Value (EV) (Rs Crore) 44854.6 39371.5 39695.8 47398.1 60747.0EV/EBIDTA 4.1 3.0 3.9 4.4 4.6Sales to Equity 2.0 1.7 1.5 1.3 1.3Market Cap (Rs Crore) 50390.9 50390.9 50390.9 50390.9 50390.9Market Cap to Sales 1.5 1.3 1.2 1.2 1.1Price to Book Value 2.9 2.2 1.8 1.6 1.4

Du Pont analysis

FY07 FY08 FY09E FY10E FY11EPAT/ PBT 0.7 0.7 0.7 0.7 0.7PBT/ EBIT 1.0 1.0 1.0 0.9 0.9EBIT/ Sales 0.3 0.3 0.2 0.2 0.2Sales / Assets 1.5 1.4 1.2 0.9 0.8Assets / Equity 1.3 1.2 1.3 1.4 1.6ROE (%) 35.8 32.7 20.3 17.3 17.0ROI (%) 27.1 27.2 15.5 12.4 10.9

4 9 | P a g e

Analysts’ Name


Sales & EPS trend (Consolidated)

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Stock Metrics

Bloomberg Code TATA INReuters Code TISC.BOFace value (Rs) 10Promoters Holding (%) 34Market Cap (Rs cr) 2011452 week H/L (Rs) 925.0/146.3Sensex 12158Average volumes 4411999 Comparative return metrics

Stock return (%) 3M 6M 12MTata Steel 52 49 -67SAIL 42 48 -26JSW Steel 95 44 -54

Price Trend

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Apr-08 Jul-08 Oct-08 Jan-09


May 13, 2009 | Metals & Mining

Initiating Coverage

Tata Steel (TISCO)

Low visibility and high risks… Tata Steel, with a consolidated production capacity of 30 million tonnes (MT), is currently facing low global product realisations, lower raw material security (less than 25% captive on a consolidated basis) and high foreign currency debt on its books. With low earnings visibility for key subsidiary, Corus, due to the uncertain environment in Europe (facing recession), we believe significant risks remain on the overall performance of the entity, going forward. We see a decline of 24.4% CAGR in consolidated EPS (FY09-11E). We are initiating coverage on Tata Steel with a target price of Rs 220 assigning an UNDERPERFORMER rating due to low visibility and high risks.

Domestic benefits overshadowed by Corus concerns

Low profitability at Corus (9MFY09 OPM~11%) is overshadowing Tata Steel India’s good show (9MFY09 OPM~44%). Earnings visibility remains low at Corus due to the recessionary environment prevalent in Europe. It is expected to continue to nullify the good performance of Tata Steel India, going forward.

High financial leverage could hurt With the acquisition of Corus (at a cost of US$12.9 billion in 2007), Tata Steel today finds itself in a position of high leverage (cons debt/equity~2). This exposes it to risks in terms of adverse currency movements (with foreign currency loans to the tune of US$7 billion) and pre-payment obligations on breach of debt covenants (which may get triggered due to dipping margins).

Capacity expansion in India but production cuts in Europe Increased capacity (6.8 MT, up 30% YoY) at its India operations would lead to a better standalone performance but continuation of the 40% production cut at Corus would act as a dampener.

Valuations – Downside risks remain At the CMP of Rs 275.5, the stock is trading at 0.8xFY10E BV and 3.8x FY10E EV/EBITDA. We have valued the company using P/BV and EV/EBITDA and are initiating coverage on Tata Steel with a target price of Rs 220 assigning it an UNDERPERFORMER rating.


Target Price Rs 220



UNDERPERFORMER

Exhibit 1: Key Financials (Consolidated)

FY07 FY08 FY09 FY10E FY11ENet Profit (Rs Cr) 4165.6 12321.8 8605.5 4655.2 6805.2EPS (Rs) 64.6 177.0 117.9 56.7 82.9% Growth 1.7 -0.3 -0.5 0.5P/E (x) 4.3 1.6 2.3 4.9 3.3P/BV Adj. (x) 1.2 1.2 0.9 0.8 0.7EV/EBITDA (x) 1.9 3.5 3.1 3.8 3.0OPM % 31.3 14.1 13.5 14.6 15.5NPM % 16.5 9.4 5.8 4.5 5.8RONW % 28.1 35.9 20.1 10.3 13.4ROCE % 16.2 15.6 15.3 9.9 12.7


5 0 | P a g e

Company background

Backed by 100 glorious years of experience in steelmaking, Tata Steel is the world’s sixth largest steel company with an existing annual crude steel production capacity of 30 million tonnes per annum (MTPA). Established in 1907, it was the first integrated steel plant in Asia. The company is now the world’s second most geographically diversified steel producer and a Fortune 500 company with a global presence in over 50 markets.

Tata Steel’s Jamshedpur (India) Works has a crude steel production capacity of 6.8 MTPA, which is slated to increase to 10 MTPA by 2010. The company has proposed three greenfield steel projects in Jharkhand, Orissa and Chhattisgarh with additional capacity of 23 MTPA. Through investments in Corus, Millennium Steel (renamed Tata Steel Thailand) and NatSteel Holdings, Singapore, Tata Steel has created a manufacturing and marketing network in Europe, South East Asia and the Pacific-rim countries.

Exhibit 2: Production capacity break-up

6.8

20

21.7

Tata Steel India Corus UKNatSteel Singapore Tata Steel Thailand


Exhibit 3: Geographical distribution of revenue

32%

37%

12%

15%

5%

EU exclduing UK UKAsia excluding India IndiaRest of World


Products

Exhibit 4: Division wise product details Division Products

IndiaHR coils,CR coils,GP/GC sheets, tubes, wire rods, construction rebars

UKStrip products, long products, distribution and building systems

Thailand Round and deformed bars

Singapore Rebars, cur and bend cages, mesh, PC wire and strands Source: Company, ICICIdirect.com Research

Shareholding pattern (Q4FY09)

Shareholder % holdingPromoters 34.0Institutional investors 38.0Other investors 4.1General public 24.0 Promoter & Institutional holding trend (%)

34.034.033.933.938.038.140.241.9

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5 1 | P a g e

Investment concerns

Despite having a robust business model at its Indian operations (with high backward integration and low production cost resulting in 9MFY09 OPM~44%), Tata Steel finds itself in a position of uncertainty due to concerns over its Corus (9MFY09 OPM~11%) and South East operations (9MFY09 OPM~4%). Corus is expected to continue with its 40% production cut for a longer period of time than previously expected due to the continued recessionary environment in Europe. NatSteel and Tata Steel Thailand are also expected to remain under margin pressure due to low realisations leading to low overall profitability, going forward.

Corus facing strong headwinds Tata Steel’s UK operations (Corus) are currently facing strong headwinds due to the recessionary environment prevalent in Europe leading to low visibility in terms of volume and realisations, going forward. Corus is still operating under a 40% production cut announced last year. With demand still very low, it may continue with a production cut for a longer period of time than anticipated earlier. We expect Corus to achieve sales volume of 20 MT in FY09E (down 13.5% YoY) and 18 MT in FY10E (down 22% from FY08 sales volume of 23.1 MT).

Exhibit 5: Sliding steel production in Europe

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45% correction from peak


Demand in Europe to remain weak, lower realisations, going forward Most of the European economies have slipped into recession (Euro zone Q4CY08 GDP contraction~1.6%) and are expected to remain there for the whole of 2009 (2009E GDP contraction~1.8%). With a high correlation between GDP growth and steel demand, recovery in the battered steel industry in Europe may take a long time. We expect demand for steel products to remain weak in Europe in CY09/FY10. We also expect realisations to remain weak with product prices having dropped 40-50% already across various product categories.

Severe demand destruction in Europe leading to sharp drop in production indicates lower sales volume at Corus, going forward

5 2 | P a g e

We expect Corus’ blended realisations at US$940/tonne compared to US$1251/tonne in Q4FY09, a drop of 25% QoQ (with existing sales contracts of FY09 done earlier at higher rates providing a cushion) and US$780/tonne in FY10, a drop of 35% over the Q3FY09 average realisations of US$1251/tonne. The realisations drop in FY10 could be more if the pricing power and premium for specialised products, which Corus enjoys currently in the Western European markets gets hurt due to increased competition and the recessionary environment.

Exhibit 6: Corus - Volume & realisations

21.623.1

4.3 3.8

1820

11.9

825780

939

12511137

1036968

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) Deliveries Realization/tonne


High leverage & dropping margins — a risk on debt covenants trigger Tata Steel, UK is currently carrying a net debt on its books exceeding US$5 billion (though no debt obligation remains due before December-2009 the management intends to prepay US$450 million in FY10). With operating profits expected to drop, going forward, due to lower sales volume and realisations (with raw material cost dropping due to contract renegotiation mitigating the margin drop to some extent), we see a significant risk on the trigger of debt covenants of Tata Steel, UK in FY10E.

Exhibit 7: Debt covenants - Corus Debt Covenants Trigger Point Trigger Event

EBITDA/Finance charges 2.75 Below trigger pointNet debt/EBITDA 4.25 Above trigger pointCash Flow/Net debt service 1 Below trigger point Source: Company, ICICIdirect.com Research

Exhibit 8: Corus EBITDA ratios NetDebt /EBITDA EBITDA/tonne

H1FY09A 2.7 148.5FY09E 2.2 118FY10E 3.6 65 Source: Company, ICICIdirect.com Research

We expect the EBITDA/tonne to drop to US$65/tonne in FY10E, down 60% from H1FY09A levels due to the expected sharp drop in realisations (down 31% to US$780/tonne in FY10E from US$1137/tonne in H1FY09A) and sales volume (down 10% in FY10E YoY). Though the net debt/EBITDA, a debt covenant attribute, is expected to be at comfortable levels in FY09E due to better-than-expected results of Corus in Q3FY09A with a significant drop in EBITDA in FY10 and indicated repayment of net debt in FY10 only at US$750 million, we expect the net debt/EBITDA to rise to 3.6 in

With product price correction happening in EU, realisations for Corus will be lower, in Q4FY09 and going forward

Debt covenants trigger risk looms in the current adverse environment and dropping margins

5 3 | P a g e

FY10E. This would be close to the covenant trigger level of 4.25. This could further increase with lower debt repayment or lower margins than expected by us in FY10E and pose a further risk to the trigger of debt covenants.

Cost saving initiatives – Positive but not enough The management of Tata Steel has been proactive in reducing cash costs and realising synergy benefits. It has undertaken key initiatives at TS- Europe namely “Weathering the storm” programme and “Fit for future” programme.

Exhibit 9: Cost saving initiatives - Corus Programme Steps to be taken Target Savings

Weathering the StormAligning production with market demandReduction in use of 3rd party servicesReduction in employee and administrative costs

£600 mn in H2FY09

Fit for FutureRestructuring initiatives and sale of unproductive assets £200 mn per annum


While the targeted cost savings would act as a positive for the company we believe it is not enough to mitigate the negatives that would be caused by lower product realisations and sales volume. We expect Corus to witness a drop in its EBITDA/tonne to US$65/tonne in FY10E and US$80/tonne in FY11E.

Exhibit 10: Corus EBITDA/tonne

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South East operations bring no cheer either Apart from Corus, the other two subsidiaries of Tata Steel, NatSteel Asia and Millennium Steel, Thailand had negative EBITDA/tonne in Q3FY09. They are expected to remain under severe pressure on the margin front due to lower realisations and increased competition in Asian markets. With their historical low margins (due to high costs and low integration), the picture looks gloomy for FY10. Both these operations are expected to remain EBITDA negative in FY10 in line with their Q3FY09 results.

Cost saving initiatives expected to provide only marginal relief but would still keep EBITDA of Corus positive

5 4 | P a g e

Exhibit 11: Asian subsidiaries EBITDA/tonne

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8864

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NatSteel - Asia TS-Thailand


Lower raw material costs to bring some relief though With both iron ore and coking coal set to be contracted at a significant discount to last year’s level, Tata Steel’s overseas operations (mainly Corus with low captive raw material resources) would see their raw material costs dropping significantly with indications from the management that further purchases would be made at new contract rates. We have factored in a drop of 35% in benchmark iron-ore price to US$55/tonne and 60% in hard coking coal contract prices to US$120/tonne in our estimates for FY10.

Lower raw material costs post new contracts the only silver lining in sight

5 5 | P a g e

Tata Steel India – Operationally sound Tata Steel India is one of the most operationally sound companies in India and has always maintained high EBITDA margins (9MFY09 OPM~44%) due to strong backward and forward linkages, good supply contracts in domestic markets and special branded products. The company has recently expanded its production capacity at its Jamshedpur plant through the brownfield route to 6.8 MT in FY09 from 5 MT in FY08. It has achieved a balanced portfolio currently with a mix of 50% each in longs and flats.

Increased volumes to mitigate realisation drop effects Tata Steel India has achieved a balanced portfolio with 50:50 mix in flats and longs post expansion, which was earlier skewed towards flat products. With flat product sales having declined lately and long product demand remaining robust, Tata Steel has been successful in altering its product mix to align with the industry demand. With robust sales volumes in Q4FY09 (1.8 MT, up 64% QoQ) and domestic demand holding up, we expect Tata Steel to achieve 95% capacity utilisation in FY10 on expanded capacity and, thereby, achieve sales of 6.3 MT. This should help the company to mitigate the effects of lower blended sales realisation, which is expected to drop to Rs 38300/tonne in FY10.

Exhibit 12: India operations — Volume & realisations

1.2 1.2 1.1

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5528053170

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Jamshedpur expansion to 9.7 MTPA on track Tata Steel India is on track to expand the capacity further at its Jamshedpur plant to 9.7 MTPA through the brownfield route. It has set December 2010 as the target completion date. The company has planned a capex of Rs 6000 crore in FY10 and expects to spend Rs 2400 crore on the Jamshedpur expansion. It has decided to go slow on its other planned greenfield projects announced earlier as of now due to the uncertain scenario prevalent in the global steel industry.

Sales volume set to increase as domestic demand seems to be holding up

5 6 | P a g e

Lower coking coal costs – positive but limited impact Tata Steel India is 100% captive in terms of iron ore linkages and 65% captive in terms of coking coal linkages. It meets the remaining 35% of its coking coal requirements through long-term contracts, which run from June to July. Since we expect coking coal to be renegotiated at 60% lower levels, the cost pertaining to coking coal would come down (expected savings of Rs 1930 crore). Also, the management has been renegotiating the existing contracts to reduce its raw material costs. We see the reduction in coking coal costs for existing as well as future contracts as a positive for the company. However, we expect the same to have only a limited impact on Tata Steel (as only 35% is sourced from outside) vis-à-vis its peers like SAIL and JSW Steel who do not have major captive resources of coking coal.

EBITDA/tonne to remain highest in the industry Tata Steel India has consistently maintained high operating margins leading to robust EBITDA/tonne. EBITDA/tonne was highest in Q2FY09 at Rs 28043/tonne (up 62% from FY08 level of Rs 17298/tonne) but dropped sharply by 50% to Rs 13869/tonne in Q3FY09 due to lower realisations and higher raw material costs. Going forward, we expect the lower realisations effect on EBITDA/tonne to be mitigated by the drop in other raw material costs. We expect Tata Steel India to maintain EBITDA/tonne at close to Q3FY09 levels in FY10-11E.

Exhibit 13: EBITDA/tonne trend – Tata Steel India

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High captive status translates into limited benefit from contract renegotiation as compared to peers

Lowest cost of production status in Indian steel industry to continue leading to high EBITDA/tonne

5 7 | P a g e

Risks to our call

Coking coal cost lower than our estimates We have factored in a drop of 60% in coking coal contract cost to US$120/tonne from US$300/tonne last year (in line with the initial negotiation between Nippon Steel and BHP-Mitsubishi Alliance). Coking coal contracts entered into at a price lower than US$120 would result in increase of earnings from our estimates. Higher sales volume at Corus We have factored in a drop of 10% in sales volume to 18 MT at Corus in FY10 due to the prevalent adverse environment in Europe and lower demand. A sales volume in excess of 18 MT would result in higher revenues and earnings at Corus and have a large effect on the overall profitability of Tata Steel. Rupee appreciation against dollar A significant appreciation of the rupee against the dollar will decrease the outstanding foreign debt and interest payments of the company and would be positive for the company.

5 8 | P a g e

Financials

Consolidated revenues and EPS set to drop sharply With the advent of the global slowdown in commodities and huge drop in sales volume and realisations, the company’s revenue and EPS is set to drop sharply. We expect the consolidated net sales to drop by 3.9% CAGR to Rs 116754 crore in FY11 from Rs 131536 crore in FY08. The diluted EPS is expected to decline by 21.2% CAGR to Rs 79.78 from Rs 163.06 in FY08.

Exhibit 14: Sales & EPS trend (consolidated)

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Standalone revenues are expected to grow at a CAGR of 10.1% to Rs 26321.74 crore in FY11 from Rs 19693.27 crore in FY08 on account of sales volume CAGR of 15% in the next two years. The standalone EPS is expected to decline at a CAGR of 10.4% to Rs 48.36 in FY11 from Rs 67.18 in FY08 due to the CAGR drop of 5.3% in blended realisation in FY11 from FY08.

Exhibit 15: Sales & EPS trend (standalone)

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5 9 | P a g e

Return ratios to suffer badly We expect Tata Steel’s consolidated return ratios to suffer badly due to reducing profits, continuing capex and expanded equity base. We expect the RONW and ROCE to decline to lower double digits of 13.4% and 12.7% in FY11 from 35.9% and 15.6% in FY08, respectively.

Exhibit 16: RONW & ROCE (Consolidated)

35.9%

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12.7%10.0%15.3%15.6%16.2%

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RONW ROCE


Key assumptions We have made the following assumptions to forecast earnings for the company.

Exhibit 17: Assumptions - Volume & realisations Finished Products FY07 FY08 FY09E FY10E FY11ETata Steel (India)Sales Volume ('000 tons) 4732 4730 5019 6277 6608Blended Realisation (Rs/tonne) 41758 46908 47771 38385 39833

Corus (UK)Sales Volume (Million tons) 21.6 23.1 20 18 20Blended Realisation (USD/tonne) 968 1036 1124 780 825

NatSteel AsiaSales Volume (Million tons) 2.2 2.5 2.5 2.5 2.5Blended Realisation (USD/tonne) 498 769 772 550 600

Tata Steel (Thailand)Sales Volume (Million tons) 1.1 1.4 1.2 1.2 1.4Blended Realisation (USD/tonne) 577 713 701 550 600


6 0 | P a g e

Valuations

We have valued Tata Steel using the EV/EBITDA and P/BV methodology and arrived at a target price of Rs 220 assigning an UNDERPERFORMER rating to the stock. Valuing the company using FY10E EV/EBITDA multiple of 4.5x for its Indian operations and 3x its overseas operations we get a fair value of Rs 225.5 for the stock. Valuing the company at 0.65x its book value (consolidated and adjusted for goodwill) of FY10E, we get a fair value of Rs 214.45. Using the average of the two measures, we assign a target of Rs 220 to the stock and initiate coverage with an UNDERPERFORMER rating. EV/EBITDA based valuation of Rs 225.5/share We value the company by applying a multiple of 4.5x (for Indian operations) and 3x (overseas operations) FY10E EV/EBITDA to arrive at a fair value of Rs 225.5. We have valued the Indian operations at a higher multiple of 4.5x due to robust business model, high margins and domestic demand advantage. We believe that a much lower multiple of 3x is justified for Tata Steel’s overseas subsidiaries (Corus and South East operations) considering the adverse economic environment, low margins and uncertain outlook. Exhibit 18: EV/EBITDA valuation (Rs Crore) FY09E FY10ETata Steel EBITDA 9786.7 8190.6EV/EBITDA(x) 4.5 4.5TISCO EV 44040.3 36857.6

Corus & Subs EBITDA 10167.3 6815.0EV/EBITDA(x) 2.5 3.0Corus & Subs EV 25418.2 20445.0

Total EV 69458.5 57302.6Total Debt 55292.8 51492.8Cash 9198.8 14258.9Pref Capital 5472.5 0.0Minority Interest 832.7 832.7Market Cap 17059.3 19236.1No. of Shares 82.2 85.3

Price per Share (Rs) 207.5 225.5Weight (%) 0.0 100Fair Value (Rs) 225.5 Source: Company, ICICIdirect.com Research

6 1 | P a g e

Exhibit 19: EV/EBITDA chart

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Exhibit 20: Global players consensus valuation

2009 2010 2009 2010Arcelor Mittal 0.7 0.7 10.1 6.1US Steel 0.9 0.9 NA 6.3Severstal 0.4 0.4 4.7 3.7Angang Steel 1.4 1.3 10.1 7.3Gerdau 1.2 0.8 7.8 5.9JFE Holdings 1.1 1.2 6.1 11.6Avearge 0.9 0.9 7.8 6.8

EV/EBITDAP/BVCompany


P/BV based valuation of Rs 214.5/share Tata Steel is currently trading at 0.85x and 0.84x its adjusted consolidated FY09E BV of Rs 321.97 and FY10E BV of Rs 329.93, respectively. The stock has been trading at below its adjusted consolidated BV during recent times due to the tough scenario prevalent in the steel industry, which has resulted in operating losses in Tata Steel’s South East Asian operations and a drop in European operations profitability. Looking at the P/BV valuations (forward consensus estimates) of global steel majors like Arcelor Mittal, US Steel, etc (which are facing production cuts and margin pressure due to sharp realisations drop), we have assigned a multiple of 0.65x to the consolidated adjusted book value of FY10E of Tata Steel (giving a discount of 25% to global 2010 average book value of 0.88) and arrived at a fair value of Rs 214.45. We believe a lower multiple of 0.65x FY10E adjusted consolidated BV is justified considering the exposure of Tata Steel to global steel industry dynamics through Corus and is in line with the current P/BV valuations (on forward BV of 2009 and 2010) of global players like ArcelorMittal who are faced with similar situation globally.

6 2 | P a g e

Exhibit 21: P/BV valuation Adj. BV10E (Rs) 329.9Exp. P/BV 0.7Fair Value (Rs) 214.5 Source: Company, ICICIdirect.com Research

Exhibit 22: P/BV chart

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Exhibit 23: Historical valuations – Tata Steel standalone

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Source: Capitaline, ICICIdirect.com Research

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Tables (Consolidated) Profit and loss account (Rs Crore)

FY07 FY08 FY09E FY10E FY11ENet Sales 25212.4 131535.9 147799.4 102836.3 116753.7% Growth 421.7 12.4 -30.4 13.5Other Income 438.1 574.2 368.6 800.0 800.0Raw Materials 3489.0 33324.6 43539.2 24177.0 28808.4Purchase of Power 1315.4 4929.3 6125.1 5528.1 6030.5Employee Exp. 1885.0 16673.2 18218.6 17235.8 18967.3Freight & Handling 1508.4 6005.2 6029.3 5178.6 5702.3Total Exp. 17762.2 113542.8 128214.0 88630.7 99442.2EBITDA 7888.2 18567.3 19954.0 15005.6 18111.5Depreciation 1011.0 4137.0 4437.1 4924.0 5074.0Interest 411.2 4183.8 3466.4 3551.1 3686.1PBT 6313.0 16371.1 11150.1 6530.5 9351.4Tax 2147.4 4049.3 2544.6 1875.3 2546.2Net Profit 4165.6 12321.8 8605.5 4655.2 6805.2% Growth 195.8 -30.2 -45.9 46.2Equity 646.8 697.7 730.1 821.3 821.3Face Value (Rs) 10.0 10.0 10.0 10.0 10.0Dividend % 22.6 9.7 13.3 19.5 14.6EPS-Basic (Rs) 64.6 177.0 117.9 56.7 82.9EPS-Diluted (Rs) 64.6 163.1 104.9 54.6 79.8

Balance sheet (Rs Crore)

FY07 FY08 FY09E FY10E FY11EShare Capital 580.0 6202.6 6202.6 821.3 821.3Reserves & Sur. 14225.7 28085.4 35354.6 44325.8 49969.2Secured Loans 4961.2 35415.2 36615.2 34315.2 31515.2Unsec. Loans 19964.3 18177.5 18677.5 17177.5 15677.5Net Deferred Tax 785.9 2454.4 2454.4 2454.4 2454.4

Total Liabilities 42398.4 92265.5 101234.6 101024.5 102367.9

Net Block 14220.5 41963.1 43026.0 45102.0 45028.0Capital Work in Progress 3326.4 8896.2 10896.2 11896.2 13896.2Investments 16497.5 3367.4 3367.4 3367.4 3367.4Inventories 3888.1 23064.3 26915.8 19523.4 22136.4Sundry Debtors 1686.5 18696.3 21532.6 15973.7 18111.6Cash & Bank 11218.5 4345.7 9198.8 14258.9 12105.8Loans & Adv. 1980.3 15465.5 17735.9 12340.4 14010.4Current Assets 16794.3 46115.4 57656.2 49765.0 52362.8CL & Prov. 7523.8 32851.5 38756.5 27755.9 30606.4Net Curr. Assets 11250.9 28729.3 36635.6 34349.5 35766.8

Total Assets 42398.4 92265.5 101234.6 101024.5 102367.9

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Cash flow statement (Rs Crore)

FY07 FY08 FY09E FY10E FY11EOpening Cash 776.8 11218.5 4345.7 9198.8 14258.9Profit after Tax 4177.3 12350.0 8605.5 4655.2 6805.2Dividend Paid 1106.3 1397.8 1336.4 1064.8 1161.9Depreciation 1983.4 50849.7 4437.1 4924.0 5074.0Cash Profit 4616.4 66609.4 11706.3 8514.4 10717.3Changes In working CapitalNet Increase in CL 3156.3 25327.7 5905.0 -11000.7 2850.5Net Increase in CA 2424.9 49678.9 8958.2 -18346.8 6421.0CF after changes in Working Capital 731.4 -24351.2 -3053.2 7346.2 -3570.4

Cash Flow from Investing ActivitiesPurchase of FA 5422.1 81715.4 5500.0 7000.0 5000.0

Cash from Financing ActivitesIncrease /(Decrease) in Loan Funds 21548.1 28667.2 1700.0 -3800.0 -4300.0

Closing Cash 11218.5 4345.7 9198.8 14258.9 12105.8

Ratios

FY07 FY08 FY09E FY10E FY11EEPS (Rs) 64.6 177.0 117.9 56.7 82.9Cash EPS (Rs) 80.0 235.9 178.6 116.6 144.6Book Value (Rs) 228.9 491.4 569.2 549.7 618.4Book Value(Adj.) (Rs) 227.5 232.7 322.0 329.9 398.6EBITDA Margin (%) 31.3 14.1 13.5 14.6 15.5

Net Profit Margin (%) 16.5 9.4 5.8 4.5 5.8RONW (%) 28.1 35.9 20.7 10.3 13.4ROCE (%) 16.2 15.6 15.3 10.0 12.7Debt/Equity 1.7 1.6 1.3 1.1 0.9

FA Turnover Ratio 1.1 1.3 1.3 0.9 1.0Enterprise Value (EV) (Rs Crore) 15028.9 65101.2 62840.8 56493.2 54346.3EV/EBITDA 1.9 3.5 3.1 3.8 3.0Sales to Equity 1.7 3.8 3.6 2.3 2.3Market Cap (Rs Crore) 17819.3 19221.6 20114.3 22626.8 22626.8Market Cap to Sales 0.7 0.1 0.1 0.2 0.2P/E 4.3 1.6 2.3 4.9 3.3Price to Book Value 1.2 0.6 0.5 0.5 0.4P/BV Adj. 1.2 1.2 0.9 0.8 0.7

Du Pont analysis


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Analysts’ Name


Sales & EPS trend

0

5000

10000

15000

20000

25000

FY07 FY08E FY09 FY10E FY11E

Rs C

rr

0

20

40

60

80

100

(Rs)

)

Sales EPS

Stock Metrics

Bloomberg Code JSTL INReuters Code JSTL.BOFace value (Rs) 10Promoters Holding (%) 45Market Cap (Rs cr) 781852 week H/L (Rs) 1203.4/ 161.1Sensex 12158Average volumes 80669 Comparative return metrics

Stock return(%) 3M 6M 12MJSW Steel 95 44 -54Tata Steel 52 49 -67SAIL 42 48 -26 Price Trend

0

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1250

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Jun-08

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Apr-09


May 13, 2009 | Metals and Mining

COMPANY UPDATE

JSW Steel (JINVIJ)

Still under clouds… JSW Steel, with an expanded capacity of 7.8 million tonnes (MT) has become the largest domestic, private steel producer during Q4FY09 on a standalone basis. Sharp fall in steel prices, almost nil captive sources of raw material and huge foreign currency debt along with depreciating INR remain major worries for JSW in the recent period. However, after going through extreme pain during Q3 and early Q4FY09, its efficient cost management, strong volume growth, modification in AS-11 norm, slight recovery in domestic steel demand and its extensive marketing to tap some potential areas like rural India and import substitution have been helping the company to see some positive momentum since the later part of Q4FY09. We, however, remain a little cautious about the near-term future and assign an UNDERPERFORMER rating on the stock.

Capacity expansion to drive revenue growth JSW Steel has successfully commissioned its 3 MT capacity in its Vijaynagar plant during the end of Q4FY09. The commercial production from that unit would be available from FY10. This would help the company to see revenue growth despite weak steel prices. The company has deferred its 11 MT expansion project till the end of FY11 due to bad market conditions.

Demand recovery/cost cutting to help ease margin pressure There has been some recovery in steel demand during Q4FY09, which came mainly from rural markets and in long product segments. The company has also taken significant cost reduction measures, which according to the company would save around Rs 13500/ tonne in the total cost of production. This would help the company to improve or at least maintain its margin despite falling realisation.

Valuation At the current market price (CMP) of Rs 418, the stock is trading at 7.7x its FY10E earning, 6.3x its FY10E EV/EBIDTA and 0.8x its FY10E BV. Taking into account the abovementioned scenario and the current situation that we are in we would like to value the stock in terms of P/BV. Based on the challenging situation ahead we assign the stock P/BV multiple of 0.65 on the FY10 BV, which translates to a target price of Rs 343/ share. At the current market price we rate the stock as UNDERPERFORMER.


Target Price Rs 343



UNDERPERFORMER

Exhibit 1: Key Financials FY07 FY08 FY09E FY10E FY11E

Net Profit (Rs crore) 1303.9 1640.0 274.9 1018.1 1569.1EPS (Rs) 79.5 87.7 14.7 54.4 78.1% Growth 43.1 10.3 -83.2 270.3 43.5P/E (x) 5.3 4.8 28.4 7.7 5.4Price / Book (x) 1.2 1.1 0.9 0.8 0.7EV/EBITDA (x) 4.0 5.7 7.6 6.3 5.1OPM (%) 27.4 31.6 30.0 20.2 22.4NPM (%) 15.1 13.2 1.7 5.3 7.4ROCE (%) 23.7 15.1 9.1 10.8 12.4RoNW (%) 23.3 21.3 3.0 10.3 14.1 Source: ICICIdirect.com Research

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Company Background

JSW Steel Ltd, the flagship company of the JSW group, is a fully integrated steel maker and is ranked second in India in terms of volume. With the commissioning of India’s largest blast furnace (2.8 MT capacity) in February, 2009 JSW Steel became the largest private steel producer in India with a total capacity of 7.8 MT on a standalone basis. JSW Steel is the only company in India to use corex as well as blast furnace technology for steel production. The company’s upstream steel-making facility is located in Vijaynagar, Karnataka, and downstream in Maharashtra. JSW Steel acquired an integrated steel plant in Salem, Tamil Nadu in November, 2004, which primarily produces long category of steel. The company has a presence in the overseas market also mainly with Houston plate and pipe mill in the US, iron ore mine in Chile and coking coal mine in Mozambique. The company’s products range from MS slabs, hot rolled coils to value-added products like galvanised coils/sheets and cold rolled coils/sheets to long products, for example, bars and wire rods. The company is on the verge of further major expansion plan of adding 3.2 million tonnes (MT) to its current capacity of 7.8 MT in India by March 2011, which would take the total capacity to 11 MT. Exhibit 2: Company structure

JSW Steel Ltd.

Subsidiaries Associated Companies

Indian Subsidiaries Overseas Subsidiaries

JSW Bengal Steel Ltd.

JSW Jharkhand Steel Ltd.

JSW Processing Centres ltd.

JSW Energy (Vijaynagar) Ltd.

JSW Panama Holding Corporation & Chilean

Subsidiaries

JSW Steel (UK) Ltd. & Subsidiaries

JSW Steel Holding (USA) Inc. & JSW Steel (USA)

Inc.

JSW Steel (Netherlands) B. V.

JSW Steel Natural Resources Ltd.

Jindal Praxair Oxygen Company Private Ltd.

Vijaynagar Minerals Ltd.

JSW Steel Natural Resources Mozambique

Ltd.


Share holding pattern (Q3FY09)

Shareholder % holdingPromoters 45.0Institutional investors 35.8Other investors 9.3General public 9.8 Promoter & Institutional holding trend (%)

47.0 47.0 45.4 45.034.7 34.1 35.0 35.8

0.0

10.0

20.0

30.0

40.0

50.0

Q1 Q2 Q3 Q4


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Exhibit 3: Saleable steel vs. EBITDA/tonne

0

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400000

600000

800000

1000000

1200000

Q1FY08 Q2FY08 Q3FY08 Q4FY08 Q1FY09 Q2FY09 Q3FY09 Q4FY09

MT

0200040006000800010000120001400016000

Rs/T

onne

))

Saleable steel EBITDA/ Tonne


Exhibit 4: Margin movement

0.00%

5.00%

10.00%

15.00%

20.00%

25.00%

30.00%

35.00%


EBITDA Margin NPM


Exhibit 5: ROCE vs. RONW

0.00

5.00

10.00

15.00

20.00

25.00

FY07 FY08 FY09 FY10E FY11E

ROCE RONW


Exhibit 6: D/E vs. Long term debt gearing (cons.)

0.51

1.52

2.53

3.54

4.55

Q1FY09 Q2FY09 Q3FY09 Q4FY09

D/E Adj. Long-term debt/ EBITDA


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Tables Profit and Loss account (Rs Crore)

FY07 FY08 FY09 FY10E FY11ENet Sales 8554.4 12456.6 16081.4 19093.4 21261.5% Growth 37.6 45.6 29.1 18.7 11.4Other Income 145.2 261.2 128.5 190.9 212.6Raw Materials 4027.0 6244.0 9695.6 10870.2 11673.8Power & Fuel 393.1 575.9 805.7 811.5 850.5Employee Exp. 175.8 392.2 520.0 601.4 669.7Other Expenditure 1290.7 1766.6 2020.5 2720.8 3029.8Total Exp. 5886.6 8978.6 12956.5 15004.0 16223.8% Growth 30.5 52.5 44.3 15.8 8.1EBDITA 2667.8 3478.0 3125.0 4089.5 5037.7Depreciation 498.3 741.9 987.8 1255.6 1380.1Interest 399.5 573.0 1155.6 1505.3 1528.3PBT 1915.2 2424.2 1110.1 1519.5 2341.9Tax 623.3 765.8 72.6 501.4 772.8

Net Profit 1303.9 1640.0 274.9 1018.1 1569.1% Growth 49.5 25.8 -83.2 270.3 54.1Equity 164.0 187.1 187.1 187.1 200.9Face Value 10.0 10.0 10.0 10.0 10.0Dividend % 125.0 140.0 100.0 100.0 100.0EPS 79.5 87.7 14.7 54.4 78.1 Balance Sheet (Rs Crore)

FY07 FY08 FY09E FY10E FY11EShare Capital 525.8 537.0 537.0 537.0 550.9Reserves & Sur. 5080.1 7153.8 8625.5 9319.5 10548.0Secured Loans 3632.5 10083.0 13583.0 16083.0 18083.0Unsec. Loans 540.5 2053.2 2053.2 2053.2 2053.2Minority Interest 0.0 191.9 191.9 191.9 191.9Net Deferred Tax -1012.7 -1251.7 -1251.7 -1251.7 -1251.7Total Liabilities 9779.0 20018.9 24990.6 28184.6 31426.9

Net Block 8189.7 15064.5 19847.6 24971.4 26591.3Capital Work in Progress 2002.9 5770.8 6379.5 3000.0 1000.0Investments 245.0 469.6 517.6 1517.6 2517.6Inventories 1011.4 2181.7 2816.6 3344.1 3723.9Sundry Debtors 245.2 539.1 675.0 809.9 901.8Cash & Bank 296.7 239.8 -380.9 247.7 2899.8Loans & Adv. 542.8 909.8 909.8 909.8 909.8Current Assets 2141.4 3649.2 4420.1 5082.4 5554.1CL & Prov. 2279.0 4706.4 5324.6 6166.0 6667.3Net Curr. Assets -137.6 -1057.2 -904.5 -1083.6 -1113.2Total Assets 9779.0 20018.9 24990.6 28184.6 31426.9

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Cash Flow Statement (Rs Crore)

FY07 FY08E FY09 FY10E FY11EOpening Cash 98.9 296.7 239.8 -380.9 247.7Profit after Tax 1303.9 1640.0 274.9 1018.1 1569.1Dividend Paid 266.4 340.5 324.1 324.1 340.6Depreciation 498.3 741.9 987.8 1255.6 1380.1Cash Profit 1890.6 2642.3 938.6 1949.5 2608.6Changes In working CapitalNet Increase in CL 136.4 2427.4 618.1 841.4 501.3Net Increase in CA -327.6 1507.8 770.9 662.4 471.7CF after changes in Working Capital 464.0 919.6 -152.7 179.1 29.6

Cash Flow from Investing ActivitiesPurchase of FA 2285.9 11359.6 6379.5 3000.0 1000.0Good will 0.0 783.1 0.0 0.0 0.0Cash from Financing ActivitesIncrease /(Decrease) in Loan Funds 77.0 7963.2 3500.0 2500.0 2000.0

Closing Cash 296.7 239.8 -380.9 247.7 2899.8 Ratios

FY07 FY08 FY09E FY10E FY11EEPS 79.5 87.7 14.7 54.4 78.1Cash EPS 34.3 44.4 23.5 42.3 53.5Book Value 341.9 384.4 489.8 526.9 593.4EBIDTA Margin (%) 31.2 27.9 19.4 21.4 23.7

0.0 0.0 0.0 0.0 0.0Net Profit Margin (%) 15.2 13.2 1.7 5.3 7.4RONW (%) 23.3 21.3 3.0 10.3 14.1ROCE (%) 23.7 15.1 9.1 10.8 12.4Debt/Equity 0.7 1.6 1.7 1.8 1.8

FA Turnover Ratio 0.7 0.5 0.5 0.6 0.6Enterprise Value (EV) 10729.9 19714.2 23834.9 25706.2 25633.1EV/EBIDTA 4.0 5.7 7.6 6.3 5.1Sales to Equity 1.5 1.6 1.8 1.9 1.9Market Cap 6853.5 7817.8 7817.8 7817.8 8396.6Market Cap to Sales 0.8 0.6 0.5 0.4 0.4Price to Book Value 1.2 1.1 0.9 0.8 0.7

Avg. Cost of Debt (%) 9.6 4.7 8.3 8.3 7.6 Du Pont Analysis


7 0 | P a g e

RATING RATIONALE ICICIdirect.com endeavours to provide objective opinions and recommendations. ICICIdirect.com assigns ratings to its stocks according to their notional target price vs. current market price and then categorises them as Outperformer, Performer, Hold and Underperformer. The performance horizon is two years unless specified and the notional target price is defined as the analysts' valuation for a stock. Outperformer (OP): 20% or more; Performer (P): Between 10% and 20%; Hold (H): +10% return; Underperformer (UP): -10% or more; Pankaj Pandey Head – Research [email protected]

ICICIdirect.com Research Desk, ICICI Securities Limited, Gr. Floor, Mafatlal House, 163, HT Parekh Marg, Backbay Reclamation Churchgate, Mumbai – 400 020

[email protected]

ANALYST CERTIFICATION We /I, Pankaj Pandey PGDBM Goutam Chakraborty Msc, Ag-Economics Abhisar Jain B.Tech, PGDBM-Finance research analysts, authors and the names subscribed to this report, hereby certify that all of the views expressed in this research report accurately reflect our personal views about any and all of the subject issuer(s) or securities. We also certify that no part of our compensation was, is, or will be directly or indirectly related to the specific recommendation(s) or view(s) in this report. Analysts aren't registered as research analysts by FINRA and might not be an associated person of the ICICI Securities Inc.

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