Stock Review: JSW STEEL

JSW Steel has lost over 10% of its enterprise value (the value of the company's business) following the release of the Karnataka Lokayukta report last Thursday. According to the report, JSW Steel, along with other iron and steel companies, was accused of illicit mining activities in Karnataka. Following the report, the Supreme Court banned mining and transportation of iron ore from the Bellary district in the state with immediate effect. The next hearing is scheduled for August 5.

JSW Steel currently sources about three-fourths of its iron ore requirement from Bellary. As a result of the ban, operations are likely to be significantly impacted as volumes are expected to fall and procurement and transportation costs will rise, thereby impacting profitability of the low-cost steel producer.

During the April to June quarter, the company's consolidated net sales increased 53% to . 7,438.69 crore while its net profit rose 64% to . 485.16 crore yearon-year, registering the highest growth rate in the past six quarters. The growth was on account of higher volumes and better realisations and from contribution from Ispat Industries. The steelmaker's operating profit increased 33% to . 1,434.83 crore. However, the company took the brunt of higher fuel and raw material charges, which decreased margins by 300 basis points to 19%. But compared with other domestic steel producers that have announced results so far, JSW has faced the least margin compression. However, due to the ban, JSW's margins are likely to get squeezed even more.

The company's raw material expenses amounted to . 4,496.14 crore, or 60%, of its net sales. Its net debt, which was . 14426.36 crore as of March 2011, is 2.8 times its trailing 12-month operating profit. On Thursday, following the company's press conference where the management denied all allegations and stated they were open to all further investigation, the stock closed at a price of . 688, which is 7.3 times its earnings per share (EPS).

The fate of the company lies in the court hearing today, the outcome of which is anybody's guess. Even though 25% of the country's iron and steel production comes from Karnataka, it would be premature to assume the ban will be lifted anytime soon.