Stock Review: JSW STEEL

JSW Steel's offer to acquire 41% stake in Ispat Industries through the preferred share route will benefit the company in the long run. The deal is not expensive, but there can be some concerns over Ispat's operation efficiency in the short-term. JSW's offer values Ispat at . 4,800 crore, marginally lower than the . 5,000 crore replacement cost of Ispat's assets net of debt. JSW has paid around $130 per tonne for Ispat's production capacity. It is cheaper than the $780 per tonne cost for JSW's own green field capacities. This makes the deal lucrative for JSW's shareholders. The additional capacity comes with Ispat's fat debt burden of over . 7,000 crore. The JSW management plans to restructure the entire debt, which would reduce the cost of debt by 3-4%. Ispat's shareholders on the other hand will have to settle for an offer price of . 19.9 per share, which was at least 30% lower than the Street's expectation. The stock fell by 15% after the announcement of the deal. But, in the long term, they can expect higher operating efficiency given the experience of JSW's management. Also, a reduced debt burden after the financial restructuring will help in reducing interest costs, supporting profitability.

   During the September 2010 quarter, Ispat reported a loss of . 330 crore due to higher raw material prices and delay in its plans to reduce input costs through backward integration. JSW's management has stated that it would pursue the ongoing plans of Ispat to improve efficiencies. One of the projects is the 110mw power plant at Dolvi, Maharastra. Once commissioned, it would bring down Ispat's power cost by 40%.

   JSW Steel uses iron ore beneficiation model wherein low-grade iron is processed to increase iron content. It is cost-effective since low-grade iron ore is cheaper. The same model can be replicated to improve Ispat's profitability. JSW also plans to restart Ispat's 3.3-million tonne steel plant in Maharashtra, which was closed due to working capital problems.

   Ispat's investors may have to wait for four more quarters to see the benefits of the restructuring. The deal is expected to turn the company around into a leaner and more efficient steel maker. While its stock may see some selling pressure in the near term, its long-term outlook is promising.