SAIL is India’s largest steel company with more than 20% domestic market share and owned 85.8% by the Indian government.
It has an annual saleable steel capacity of about 13MT, of which 57% comprises flats, 15.5% is longs and 8% is rails (virtual monopoly in this segment).
SAIL is embarking on an aggressive expansion plan which would increase its saleable steel capacity by 10MT to 23.13MT in the next three years at a capex of Rs543 billion.
With Rs164 billion cash reserve, it would be in position to meet its capex requirement through internal cash flows and by raising debt of close to Rs.300bn, within comfortable debt-equity ratio of 1-1.2 : 1
Steel demand has fallen very sharply during the last few months, and prices have been weakening for most products in many regions.
Long steel products demand has been hit by softness in real estate and slowdown in infrastructure spending while flat steel product demand has been hit due to almost collapse of commercial vehicles demand, depressed capital investments and fall in consumer spending on automobiles and white goods.
US witnessed maximum production cuts with utilization levels reaching below 50% in December. In Europe the production cuts are in the range of 30-35% and in the range of 40-45% in CIS.
In China, the production cuts were in the range of 25-30% but the cuts happened much earlier than other regions and lot of steel mills have restarted production in December.
For India, the three critical regions for steel imports are China, South Korea and CIS (Ukraine + Russia).
Steel prices in China have bucked the global trend and seen sharp revival of prices in last few weeks from the very low levels it reached earlier. Whether this bounce back is sustainable would be known in the next few weeks. Elsewhere the steel prices are still drifting lower.
SAIL has cash levels of Rs164 billion which would be good enough for meeting capex requirement of FY09E and FY10E.
Long-term debt is expected to rise sharply by Rs50 billion in FY11E and Rs150 billion in FY12E to meet the ongoing capex requirement. Debt cost is assumed to be 260bps higher than the FY08 levels.
SAIL traded in the range of 2x to 4x 1yr forward EV/EBITDA for the period mid 2003-2006.
We believe the stock is likely to trade in the above range for the next few months as macro environment stress continues and margin contraction is likely given lower steel prices without any significant fall in the raw material costs particularly coking coal.
We value the company based on 3.5x EV/EBITDA for FY10E and assign a REDUCE recommendation with a 6-month target price of Rs69.