Stock Review: JSW Steel

JSW Steel has been in the news in the last fortnight for various reasons, including its tie-up with JFE Corporation of Japan, the June quarter results and, now, its July numbers. The June quarter numbers were good and largely in line with expectations and the rise in July month's output looks impressive given that the global demand is subdued.

What's encouraging is that the domestic demand, led by automobile and consumer durable sectors consuming flat steel, remains robust, which benefits JSW. Higher volumes apart, better product mix and enhanced raw material security make JSW a good pick. New capacities

Capacity expansions at JSW are progressing on schedule. While its steel capacities increased three times over last four years to 7.8 million tonnes (mt) a year, these will increase to 11 mt by the end of 2010-11 (FY11). The coke oven batteries and 300-Mw thermal power plants associated with expanding blast furnace (by 3.2 mt) are to be commissioned by October, well ahead of schedule.

With its 3.5-mt hot-strip mill starting operations in April, the share of semi's (relatively lower margin product) in the product mix has shrunk from 17 per cent to nine per cent — this will further go down to nil by FY12.

On the other hand, flat steel output jumped 35 per cent to 408,000 tonnes and longs grew by an impressive 43 per cent to 90,000 tonnes.

The change in product mix is estimated to boost earnings before interest, taxes, depreciation and amortisation (Ebitda) by Rs 1,000-1,200 a tonne during FY11.

Going ahead, as coking coal prices move north, shipments from JSW's US coking coal mines (to start from September) should cushion margins. Likewise, its Chile iron ore mines are to further contribute 1.5-1.7 mt of high quality iron ore during FY12. The commissioning of beneficiation plant in December 2009 has also been a huge plus, allowing JSW to use abundantly available low quality iron ore in India.

Investment rationale

The JSW-JFE deal gives JFE a 14.99 per cent stake in JSW for Rs 4,800 crore. The total potential capital infusion, though, stands at Rs 5,700 crore. The fund infusion will deleverage JSW's balance sheet, while providing it technological access to growing high-end auto-segment.

In the interim, while some stress due to increased raw material prices continues, further downside to steel prices is limited. For JSW, its new capacities, changing product mix and enhanced raw material security will help drive sales and profits over the next two years. Analysts at IIFL estimate JSW's volumes to grow at a compounded annual growth rate (CAGR) of 25 per cent over FY10-12, operating profits by 33 per cent and net profits by 43.3 per cent.

At Rs 1,132, the stock trades at 16.5 times and 9.5 times its estimated 2010-11 and 2011-12 earnings, and can be bought with a medium-term perspective.