A ray of hope for JSW Steel

Though the stock has rebounded from its 52-week low, further rise is unlikely till iron ore mining resumes in Karnataka, or the company finds supply at reasonable prices.

After hitting a 52-week low of Rs 532.05 on October 4, JSW Steel’s stock has gained 32.5 per cent from there on anticipation of higher production. This, however, cannot be sustained till the company’s profitability is at risk, say analysts. The key trigger for further gain could either be lifting of the iron ore mining ban in Karnataka or JSW finding alternative supplies at cost-effective prices.

ORE SUPPLIES UP...
The stock of India’s largest steel producer had plummeted on iron ore unavailability following the Supreme Court’s order banning mining in Karnataka, thereby raising the risk of capacity utilisation touching a minimal 30 per cent. The situation has, however, started changing of late. The apex court provided some relief by allowing e-auction of 25 million tonnes of inventory in a phased manner. NMDC was also allowed to mine 12 mt per annum of ore and sell it through e-auctions, though it has been able to operate at only half that rate and is expected to reach 12 mt only by year-end, reckon analysts.
 

MARGINS UNDER PRESSURE
In Rs crore	FY11	FY12E	FY13E
Net sales	23,900	30,885	35,449
Y-o-Y chg (%)	26.10	29.23	14.78
Ebitda	4453	4956	6849
Ebitda (%)	18.63	16.04	19.32
Net profit	1754	1626	2640
Y-o-Y chg (%)	9.80	-7.32	62.38
EPS (Rs)	84.56	77.16	111.31
PE (x)	8.33	9.14	6.33
E: Estimates Source: Capitaline, Bloomberg, analyst reports

JSW has been able to garner a respectable share of the raw material from e-auctions of inventories in the state. This has raised hope of it being able to run its 10-mtpa plant at 50 per cent utilisation, helping the stock gain some lost ground.

...BUT, AT HIGHER COST
On the flip side, ore through e-auction is coming at a higher cost and is likely to hurt profitability. Nomura analysts, in an October 21 report, observed that JSW secured 2 mt from e-auctions, enough to meet 40 days’ output. The average landed cost, they estimated, was Rs 3,300 a tonne. In the e-auctions held in the first week of November, of 2.2 mt put for e-auction, JSW took 90,000 tonnes. The base price of Rs 2,300 a tonne, though 15 per cent lower than the previous e-auction, would translate into landed cost of ore at Rs 3,500 a tonne, estimates Bikash Bhalotia at PINC Research, who feels the prices are reasonable. However, other analysts believe the e-auction prices are on the higher side and would impact JSW’s profitability. Industry sources say e-auction prices are 50-100 per cent higher than international prices. Ravindra Deshpande at Elara Capital says using ore from e-auctions at current prices can impact JSW’s profitability by 20 per cent.

VOLUMES
Volumes are another crucial monitorable. After production got disrupted, the management tweaked its annual output target for 2011-12 by 14 per cent, to 7.5 mt, and sales target by 13 per cent to 7.8 mt from the earlier nine mt. Analysts say the company may fall short of these. While HSBC’s analysts have retained their 2011-12 sales volume estimates of 6.9 mt as uncertainty on resolution of the ore issue prevails, analysts at Nirmal Bang estimate an FY12 sales volume of 7.7 mt, slightly lower than the official outlook.

OPTIMISM, OUTLOOK
For now, while capacity utilisation will get a boost from improving ore availability, utilisation is still estimated to remain at around 50 per cent. However, optimism on this front is growing. Bhalotia says 24 mines have already got a clean chit in Karnataka and this raises hopes for the Court allowing these mines to commence operations. If this happens, it will be the biggest relief for JSW, that commissioned its plant in Karnataka primarily due to availability of ore in the region.

The JSW management also expects 1.5-3.5 mt a month of incremental ore supply in Karnataka if the apex court gives the mines clearance to operate. The Central Empowered Committee’s environmental impact assessment report is due in the first fortnight of this month and the developments there will need careful watching.

This apart, analysts at Nomura see JSW’s profitability getting boosted with improving traction in the automobile-grade steel business. They say JSW has received approval to produce auto-grade steel from Tata Motors and Volvo-Eicher Motors and for bull gears from Mahindra. Earlier, JSW had negligible presence in this most profitable segment.

Considering the prevailing pressure on profitability due to higher iron ore costs and the issue of volumes, analysts are cautious on the stock. Bloomberg estimates their 12-month target price is Rs 672.34, reasonably lower than the current price of Rs 703. However, developments on clearance of ore mining in Karnataka need to be watched, as any positive outcome can boost the stock.