JSW Steel is currently selling HRC at Rs38,000 in the spot market and upward of Rs40,000 for contractual sales.
Our revised forecast is based on HRC price assumption of Rs33,000. In our revised forecast, EBITDA per tonne is $138 as compared to previous forecast of $194/tonne and $240/tonne in FY08.
The company is currently expanding its production capacity by 2.8 million tonnes (Phase 1) to 7.6million tonnes. The expanded capacity was expected to be commissioned by September 2008 but has been delayed by a couple of months.
As a result, we have reduced our volume forecast for FY09 to 4.5m tonnes from 5 million tonnes. Additionally, for FY10 we have reduced volume forecast (6.4m tonnes versus 6.9 million tonnes previous estimate) for company’s long products.
The management has confirmed that it has secured funding for its 3.2 million tonne (Phase 2) expansion expected to commission in 2010. Its capex in FY09 and FY10 are estimated to be Rs43 billion and Rs63 billion, respectively, for both phases of expansion.
It will borrow Rs65 billion for the capex plus an additional Rs10 billion for working capital. Given its significant funding needs and increasing cost of borrowing and credit crunch, there is a possibility of a delay in the Phase 2 of the expansion plan.
We are downgrading JSW from Buy to REDUCE due to a 48.7% reduction in EPS estimate for FY10.
Our revised target price of Rs280 is based on 4x FY10 EPS as compared to previous target price of Rs1,100 which was based on 8x FY10 EPS.
The higher P/E multiple of 8x was based on company’s EPS growth of over 50% and improving profitability. However, in an environment of declining steel prices, increasing interest costs, and general weakness in credit growth, we believe a fair multiple is 4x.