Angel upgrades JSW Steel to `Buy`

Monday, 31 JAN2011
Angel Broking has recommended `Buy` on JSW Steel with a price target of Rs 1,047 as against the current market price (CMP) of Rs 898 in its report dated Jan. 29, 2011.
The broking house gave the following rationale:
Spot iron ore prices have continued to rise: Higher crude steel production has led to an increase in international spot iron ore prices to over USD 180/tonne. However, growth in production of iron ore in China has remained flat during the past quarter. Due to crackdown on illegal mining by the government, India`s iron ore prices have increased as well.
while coking coal prices have spurted recently: The flooding in Australia during December 2010-January 2011 has severely hit mining operations in Queensland, which accounts for 50% of the world`s coking coal trade, which has resulted in spurt in spot prices of coking coal since then. The rise in spot prices is likely to result in higher contract prices for 1QFY2012.

resulting in rise in steel prices recently: The steep rise in iron ore and coking coal prices has resulted in higher steel prices across the globe. However, steel production continues to rise globally, while there is lack of clarity on demand in western economies. We believe the rise in prices of key inputs will be more than offset by the increase in steel prices during FY2012. Hence, we expect profitability of companies with low levels of integration such as JSW Steel to decline in the coming few quarters.

Valuation: JSW Steel is expanding its capacity by 3.2 mn ton from the current level of 7.8mn tonnes, thus taking its total capacity to 11mn tonnes by FY2011. Furthermore, JSW Steel will become India`s largest steel company with total capacity of 14.3mn tonnes on successful completion of Ispat Industries acquisition.

We expect the company to reap benefits of economies of scale on account of large-scale production, which should slightly destroy per unit cost of production. Also, the commissioning of the beneficiation plant by March 2011 is expected to lower iron ore cost for the company by USD 10-30/tonne.

However, rise in prices of key inputs (particularly coking coal) is likely to result in profitability decline during FY2012. At the current market price (CMP) of Rs 898, the stock is trading at 7.5x FY2011E and 5.9x FY2012E EV/EBITDA.
Given the recent decline in the stock price, we upgrade the stock to Buy from Accumulate with a revised Target Price of Rs 1,047 (earlier Rs 1,310), valuing the stock at 6.5x FY2012E EV/EBITDA. We have increased our estimates for FY2012E to factor in higher realisations. However, we have lowered our EBITDA margin estimates for FY2012E to account for higher iron ore and coking coal costs.(sourced: IRIS Exclusive via myiris.com)