While the go-ahead for Chiria mines offers raw material security for SAIL, dependence on imported coal is a major risk.
The environmental clearance for one of the largest iron ore mines in Asia (Chiria, Jharkhand) not only secures a long-term iron ore source for Steel Authority of India Limited (SAIL), but also comes at a time when the company is getting ready to launch its follow-on public offer (FPO). These mines, with reserves of 1,166 million tonnes, are critical for SAIL’s upcoming capacities.
Though these are positive developments from the long-term perspective, analysts are worried over higher valuations, delays in execution and dependence on imported coking coal, another key raw material in the near term. These two raw materials account for three-quarters of the company’s raw material costs. “We are bearish on the stock, considering the delays in expansion and higher valuations,” says Ravindra Deshpande, who tracks the metals sector at research firm Elara Capital. The stock is trading at 12 times its 2012-13 earnings and 1.6 times its book value, considered high, looking at the growth in earnings at a mere eight per cent annually, over next two years. In fact, analysts have cut their estimates.
| STABLE MARGINS | |||
| In Rs crore | FY11E | FY12E | FY13E |
| Sales | 43,720 | 48,030 | 53,935 |
| % change y-o-y |
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“SAIL is likely to finish 2010-11 with flat volumes of 12.1 million tonnes and 2011-12 with a five per cent growth. We have cut our financial year 2011-2012 earnings per share estimate to incorporate lower volume growth and operating inefficiencies,” says Sanjay Jain, metal analyst at Motilal Oswal.
BENEFITS OF NEW MINES
Incremental revenue growth for the company can either come through volumes (expansion by adding new capacities) or higher steel prices. Steel (HRC) prices have recently corrected marginally to about Rs 36,200 per tonne, but are expected to go up over the next two years by 6-10 per cent. The rise in steel price may not be enough for growth, especially for partially integrated players like SAIL. The company needs to put additional capacities to drive higher profit growth. Over the last few years, it has not added any new capacities. This is also the reason that despite higher capacity utilisation, volumes have moved up marginally from 11.3 million tonnes in FY2008-09 to 12.1 million tonnes in FY2009-10 and is expected to remain at the same level at the end of 2010-11. Thus, the environment clearance for the new mines acts as a positive trigger, as this could facilitate its ongoing capacity expansion and help the company to grow its volumes as well.
The new mines will be commissioned by the end of 2015, by when the company’s steel manufacturing capacities would also double from the current 13 million tonnes per year to 26 million tonnes. The new mines could last over 150 years (considering the reserves) and will provide full iron ore integration for new capacities. However, its progress needs to be monitored. “Whether the company meets the deadline because of the size and scale of the project needs to be watched,” says Eric Martins, who is a metal sector analyst at Systematix Research.
WORRIES
If the capacities come on stream, as scheduled, the benefits will only be visible from the financial year 2012-13 and thereafter. Investors will have to be patient, as there may not be any major revenue and profit growth over the next two years in the absence of volume growth. Also, the biggest risk remains in terms of coking coal. The company meets about 75 per cent of its coking coal requirements from imports and rest is procured from the domestic market, leading to pressure on margins. For instance, the company made earnings before interest, depreciation, taxes and amortisation of $123 per tonne in the December quarter as against peers Tata Steel at $362 per tonne and JSW Steel at $140 per tonne. “The company has been looking for mines in the international markets but nothing has happened so far," says Martins.
BALANCE SHEET
While there are worries over volumes and raw material (coking coal), funding for its expansion is not an issue. Though the company has chalked out Rs 69,000 crore expansion till 2014, cash on the balance sheet to the tune of Rs 13,500 crore and the fact that it is likely to generate cash profits to the tune of Rs 14,000 crore over the next two years will come handy. Besides, it also plans for an FPO in May. The company is expected to issue five per cent fresh equity and another five per cent could be an offer for sale from the government. Considering this the market price of Rs 170 a share, the issue size could be in the range of Rs 7,000 crore. So, it is possible to garner another Rs 3,500-4,000 crore from the FPO, with marginal dilution and no impact on valuations.
