SAIL’s margins get squeezed in Sep quarter

SAIL’s margins get squeezed in Sep quarter

Steel Authority of India Ltd (SAIL) has experienced a considerable dent in profitability in the September quarter. Earnings before interest, tax, depreciation and amortization (Ebitda) fell by 26.2% year-on-year and 17.6% quarter-on-quarter (q-o-q) to 1,765 crore.

It was after adjusting for an additional provision made for employee costs in the previous two quarters and a reversal of prior-period items in the year-ago quarter.

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Volumes rose by as much as 30% sequentially to 3 million tonnes and operating revenue rose by 17.5% to 10,961 crore. Average price realizations fell by around 10% q-o-q.

The decline in realizations was expected, considering that average selling prices in the June quarter were relatively high after price hikes announced in May by steel manufacturers. But this was followed by sharp price cuts in July following a build-up in inventory, though prices were raised in August, it didn’t compensate for the cuts in July.

Meanwhile, the sharp hike in contract prices of coking coal and iron ore this year was expected be fully reflected in the September quarter results, leading to a steep rise in raw material costs.

With realizations being lower, it was evident that these costs wouldn’t be absorbed and that raw material costs as a percentage of sales would rise substantially. But raw material costs as a percentage of sales rose by as much as 15 percentage points q-o-q, leading to a sharper-than-expected drop in margins.

Ebitda on a per tonne basis fell by as much as 30% q-o-q. SAIL’s results tend to suffer when there is a drop in realizations because of the company’s high fixed-cost structure.

It’s interesting to note that margins were squeezed despite a steep rise in volumes. One positive is that employee costs fell from 19% of revenue in the June quarter to 15.4% last quarter.

SAIL shares have fallen by around 10% from the highs in early October, even while the movement in the broad market has been sideways. One of the reasons could be that there are no near-term triggers for the stock.

While SAIL is aggressively expanding capacity, the benefit from this is likely to be visible only in 2013-14. The outlook for volume growth in the near term is subdued.

Meanwhile, the high capex will lead to negative free cash flow and will push the company into a high net debt position from a virtually debt-free position. Besides, with a large amount of captive mines, SAIL could get affected if the proposal on sharing 26% of mining profit is implemented.

And even while the shares have corrected, valuations are still rich at around 13-14 times FY11 earnings.

Graphics by Yogesh Kumar/Mint

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