IIFL Sector Report: Metals – The Sheen Remains

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Premia Research

N

April 11, 2018

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Premia Research

Metals – The Sheen Remains

Tata Steel – BUY

CMP Target Upside

602 744 24%

JSW Steel – BUY

CMP Target Upside

311 369 18%

Hindalco Industries – BUY

CMP Target Upside

230 296 28%

Jindal Steel & Power – BUY

CMP Target Upside

245 304 24%

Prices as on 10/04/ 2018

Financials Tata Steel FY19E FY20E

Rev. 1,35,121 1,38,416

OPM 17.4 17.8

PAT 8,937 9,724

EV/EBITDA (x) 4.9 4.3 Source: IIFL Research

JSW Steel FY19E FY20E

Rev. 74,681 79,229

OPM 22.7 23.7

PAT 6,261 7,066


Hindalco Ind. FY19E FY20E

Rev. 120,190 120,327

OPM 12.0 12.2

PAT 4,806 5,240


JSPL FY19E FY20E

Rev. 34,632 38,725

OPM 28.5 28.2

PAT 2,356 3,518


Global metal market has been in doldrums after retaliatory import tariffs between the US and China. However, this is a temporary setback as the metal sector is likely to see continued earnings growth, as global manufacturing has been in continued expansion (supportive of global steel prices) since May 2016 (refer exhibit 11). In addition, Indian steel producers would benefit from higher domestic consumption. In base metals, aluminium producers would benefit from inventories being at multi-year lows.

Infrastructure spending to boost domestic steel demand

In Union Budget 2018-19, the government set aside `14.34 lakh cr for rural infrastructure spending (an increase of 30.4% yoy). As infrastructure accounts for ~62% of domestic steel demand (refer exhibit 8), we see steel demand growing at 5.7% yoy in CY18 (refer exhibit 2).

Rise in manufacturing, China cuts to support metal prices

Steel prices are expected to remain firm, as improved industrial activity would support higher steel production (refer exhibit 12). Also, high levels of pollution have led the Chinese government to continue capacity reduction in the steel and aluminium industries. The Chinese government is aiming for further capacity cut of 30mn tonnes (1.3% of global capacity) in the steel industry in CY18 and 1.5mn tonnes in aluminium in CY18 (4% of global capacity; Source: CRU). These capacity cuts would support international metal prices going forward.

NCLT to resolve stressed steel assets, consolidate capacity

The NCLT auctions present steelmakers with a golden opportunity to consolidate the steel industry. This consolidation is crucial for the domestic steel industry to become globally competitive. Winning bidders would benefit owing to (a) inorganic expansion by acquiring operating facilities, (b) lower costs through scale of benefits and (c) improving product mix. We like Tata Steel, JSPL and JSW Steel, as they stand to benefit from the improved spending on domestic infrastructure. Tata Steel and JSW Steel would also gain from inorganic acquisitions under the IBC process (refer exhibit 13). JSPL stands to benefit from reduction in debt and higher utilization in its power generation business. Among base metal producers, we like Hindalco for its exposure to global aluminium markets particularly the US auto sector.

Analyst–Noel Vaz [email protected]

mailto:[email protected]

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Steel Outlook

China production flat, India and ASEAN countries to benefit

Chinese steel production is expected to remain stagnant in CY18E given that the pollution levels still remain a concern. With the pickup in global manufacturing (refer exhibit 10), we believe that global steel demand will grow at 1.6% yoy in CY18E. Emerging economies would contribute in large part to this rise in steel demand (refer exhibit 2) i.e. ASEAN countries (up 6.8% yoy CY18E) and India (up 5.7% yoy CY18E). Exhibit 1: Global finished steel demand CY16-18E (mn tonnes)

CY16 CY17 CY18E Growth CY18E (%)

World 1,516 1,622 1,648 1.6

EU 158.2 162.1 164.3 1.4

Other Europe 40.5 40.1 42.2 5.2

CIS 49.4 51.1 53 3.8

NAFTA 132.2 138.7 140.4 1.2

Americas 39.4 40.4 42.3 4.7

Africa 37.6 37 38.2 3.3

Middle East 53.1 53.9 56.5 4.8

China 681 765.7 765.7 0

Developing Asia 174.2 182.1 193.5 6.3

Developed Asia 143.4 144.5 145.7 0.8

Source: World Steel Association

Exhibit 2: Asia finished steel demand CY16-18E Exhibit 3: Share of global steel production

CY16 CY17 CY18E Growth

CY18E (%)

China 681 765.7 765.7 0

India 83.5 87.1 92.1 5.7

ASEAN (5) 74.1 77.7 83 6.8

Developed Asia 143.4 144.5 145.7 0.8

Japan 62.2 64 64.5 0.8

South Korea 57.1 56.2 56.4 0.4

Source: World Steel Association

China50%

India6%

Japan6%

South Korea4%

USA5%

Brazil2%

EU10%

Turkey2%

Russia4% Others

11%

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Steel Outlook

Steel and Metallics Prices

HRC Mumbai (`/tonne)

Rebar Mumbai (`/tonne)

Shredded Scrap Rotterdam (USD/tonne)

62% Import Fine Ore - Qingdao (USD/tonne)

Australian export Hard Coking Coal FOB (USD/tonne)

Source: Bloomberg, 1 USD = ~65 INR

22000

32000

42000

Apr-15 Sep-15 Feb-16 Jul-16 Dec-16 May-17 Oct-17 Mar-18

20,000

24,000

28,000

32,000

36,000

40,000

May-15 Oct-15 Mar-16 Aug-16 Dec-16 May-17 Oct-17 Mar-18

180

240

300

360

420

Apr-15 Sep-15 Feb-16 Jul-16 Dec-16 May-17 Oct-17 Mar-18

30

50

70

90

Apr-15 Aug-15 Dec-15 Apr-16 Aug-16 Dec-16 Apr-17 Aug-17 Dec-17 Apr-18

40

120

200

280

360

May-15 Oct-15 Mar-16 Aug-16 Jan-17 Jun-17 Nov-17 Apr-18

International scrap steel prices

higher 25% yoy on improved

global steel scenario

Iron ore prices down 19% yoy

over concerns of impact on

Trump tariff on Chinese steel

production

Rebar prices are up 17% yoy

over March 17-18, due to

higher infra spends

HRC prices are up 2% yoy over

March 17-18

International coking coal prices

down 37% yoy as demand supply

situation normalises benefiting

steelmakers

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Aluminium Outlook

Low inventory levels to support aluminium prices

Aluminium prices rose by 32% yoy in CY17, as global inventories fell from 2,300k tonnes to 1,900k tonnes (lower 18.4% yoy). This rally was further supported by reduction in aluminium capacity in China due to pollution control measures. It is estimated that over 2012-17, China cut 3.8mn tonnes of aluminium smelting capacity. Given that Chinese industry is still looking at cutting capacity by 1.5mn tonnes in CY18E (~4% of current global capacity), we can expect inventory levels to remain low going forward (Source: CRU). Low inventory levels combined with higher manufacturing activity would act as a driver for aluminium prices going forward. Exhibit 4: Aluminium prices to remain bullish on low inventory levels

Exhibit 5: Primary aluminium production yet to pick up

Source: LME, Bloomberg, IIFL Research

-

1,000

2,000

3,000

4,000

5,000

6,000

7,000

-

500

1,000

1,500

2,000

2,500

3,000

Aug-10 Sep-11 Oct-12 Nov-13 Dec-14 Jan-16 Feb-17 Mar-18

Aluminum Exchange Inventory LME Aluminum Price

3,501

4,148 4,507 4,418 4,508 4,592

5,100 4,938

-

1,000

2,000

3,000

4,000

5,000

6,000

CY10 CY11 CY12 CY13 CY14 CY15 CY16 CY17

Global Aluminum Primary Production (000s tonnes)

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Aluminium Outlook

Aluminium prices soar after US sanctions on Rusal Rusal’s (second largest aluminium producer) stock collapsed by 50% in yesterday’s trade after US sanctions were expanded to include them. Rusal, a Russian based aluminium maker, has been included in a list of companies sanctioned by the US. The sanctions were imposed to punish Russian companies for the Russian government’s involvement actions in Crimea, Ukraine and Syria, and for its alleged attempts to subvert western democracies. America accounted for 18% of Rusal’s sales volumes in Q4CY17. Thus, this development will significantly impact Rusal, possibly leading to Rusal defaulting on its existing obligations. Also, sanctions by EU countries (45% of sales in Q4CY17) in the near future, is a possibility as well. LME Aluminium prices moved 3% higher on the day of the announcement and are likely to remain higher in the near term. Beneficiaries of this outcome are global aluminium producers such as Rio Tinto. Domestic companies like Hindalco, Nalco and Vedanta stand to benefit from this development as well. Exhibit 6: Rusal’s sales volume breakup for Q4CY17

Source: Rusal

45%

18%

19%

18%

Europe Russia & CIS Asia America

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Metals -Domestic Scenario

Infra sector spending to boost steel consumption

Domestic steel production is linked to GDP growth, infrastructure and construction spending (refer exhibit 7). Given that India’s GDP growth rate is expected grow at an average of ~7% over FY19-20E, we expect steel demand of ~6% over the same period.

Exhibit 8: Crude steel production in India Exhibit 9: Consumption of steel by industry

Source: Bloomberg, Ministry of Steel, Joint Planning Committee, World Steel Association, IIFL Research

-

20

40

60

80

100

120

FY13 FY14 FY15 FY16 FY17 FY18E

Domestic Crude Steel Production (in mn tonnes)

62%10%

3%

22%

3%

Infra & Construction Automotive

Railways / other transport Engineering & Fabrication

Packaging & Others

Exhibit 7: GDP growth rate vs. domestic steel production growth rate

Source: Bloomberg, World Steel Association, Ministry of Steel, IIFL Research

-

2

4

6

8

10

12

14

Jun-13 Dec-13 Jun-14 Dec-14 Jun-15 Dec-15 Jun-16 Dec-16 Jun-17 Dec-17 Jun-18 Dec-18

GDP growth Rate Steel Production Growth Rate

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Metals – Global Scenario

US tariffs to have small impact on Indian steelmakers

On March 9, 2018, President Donald Trump imposed import duties of 25% and 10% on steel and aluminium imports respectively. However, Canada, Mexico, Brazil, EU, South Korea and Australia have been exempted from the new import duties. These exemptions dilute the impact of the import duties on steel, as these countries consist of over 50% of steel imports. This move is likely to impact steel exporting nations like Japan, Russia and Turkey. India would not be impacted much directly, as India’s exports to US stand at only 0.54mn tonnes.

Exhibit 10: Sources of US steel imports CY2017

Source: International Trade Administration, IIFL Research

Canada16%

Brazil13%

South Korea10%

Mexico9%

Russia9%Turkey

7%

Japan5%

Taiwan4%

Germany3%

India2%

China4%

Others18%

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Metals – Global Scenario

Steady growth in global manufacturing

Global manufacturing expanded steadily in March 2018 with the Global Manufacturing PMI reporting a reading of 53.4 against 52.9 in March 2017. The data from the March 2018 PMI indicated that production and new orders rose, though at a slower pace than last month. The data also indicated that optimism about future output remained intact. The improved business scenario led to job creation, albeit at a slower pace than the past six months.

Global Manufacturing has been

growing at an accelerating pace since

May 2016

Exhibit 11: Global PMI in expansion phase since May 2016

Exhibit 12: PMI expansion and higher steel prices

Source: Bloomberg, IIFL Research

50

52

54

Jun-17 Jul-17 Aug-17 Sep-17 Oct-17 Nov-17 Dec-17 Jan-18 Feb-18 Mar-18

Global Manufacturing PMI

51.5

52

52.5

53

53.5

54

54.5

55

350

400

450

500

550

600

650

700

Jun-17 Jul-17 Aug-17 Sep-17 Oct-17 Nov-17 Dec-17 Jan-18 Feb-18 Mar-18

Global Manufacturing PMI HRC Shanghai

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IBC resolutions under NCLT

NCLT to resolve stressed assets in steel sector

In June 2017, the Reserve Bank of India (RBI) compiled a list of 12 NPA accounts, which were referred to the Insolvency and Bankruptcy Code (IBC). These 12 accounts, accounted for ~25% of the current gross non-performing assets (GNPAs) of the banking system totalling ̀ 3.1 lakh cr. Out of these 12 accounts, the steel sector accounted for `1.8 lakh cr (57.4% of total NPA exposure). Out of the 12 accounts in the first list, the 3 mentioned below are close to being resolved. Exhibit 13: Steel sector IBC cases successfully resolved so far

Capacity

(mn tonnes) Debt O/S

(`cr) Leading Bidder*

Leading bid (`cr)*

Bhushan Steel 5.6 48,153 Tata Steel 35,200

Monnet Ispat & Energy

1.8 12,262 Aion - JSW

Steel 3,700

Electrosteel Steels 2.5 10,288 Vedanta 4,500

Source: Company, IIFL Research, Ace Equity, *Bid details are from media reports, company filings

This resolution process is a great opportunity for large integrated domestic steel makers (JSW Steel and Tata steel) to inorganically expand their capacities, as the demand for steel is growing in the country.

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Tata Steel Ltd

CMP: `602; 1-year Target: `744

Sector Metals

Recommendation BUY

Upside 24%

Stock Data

Sensex 33,880

52 Week h/l (`) 748 / 404

Market cap (`Cr)

67,781

BSE code 500470

NSE code TATASTEEL

FV (`) 10

Div yield (%) 1.3

Shareholding Pattern

Jun-17 Sep-17 Dec-17

Promoters 31.4 31.4 31.4

DII+FII 43.9 45.3 45.5

Individuals 24.7 23.4 23.2

Source: www.bseindia.com

Share Price Trend

Prices as on 10/04/ 2018

Tata Steel Ltd (TSL) is the second largest private producer of steel in the country. We see volume growth at 5.4% CAGR and 2% CAGR for the domestic and Europe business respectively over FY17-20E. This would result in EBITDA growing at 23.3% CAGR over FY17-20E. The stock is currently trading at 4.2x FY20E EV/EBITDA vs. its peers SAIL (7.4x FY20E EV/EBITDA) and JSW Steel (5.6x FY20E EV/EBITDA). We value TSL using SOTP (refer exhibit 3) and recommend BUY with a target price of `744.

JV with ThyssenKrupp Europe to turnaround European business: In September 2017, ThyssenKrupp agreed to form a 50:50 JV with TSL Europe. This new company would become the second largest European steel maker with indicative crude steel deliveries of 21.3mn tonnes, as on June 17 TTM (refer exhibit 4). The scale of benefits of the JV is expected to lead to cost reduction of 400-600mn euros (`3,200-4,800cr) p.a.

Inorganic acquisitions to trigger next phase of expansion: TSL has emerged as the highest bidder for Bhushan Steel Ltd (BSL). The EBITDA/tonne of TSL India stood at `12,031 per tonne for 9MFY18. Given that Bhushan Steel operated at ~`8,800 EBITDA/tonne for FY17, TSL has significant scope to raise profitability through operational synergy.

Attractive valuations: We estimate EBITDA to register 22.9% CAGR over FY17-20E, led by turnaround of Europe business. We value the domestic steel business of TSL at 7x FY20E EV/EBITDA due to its high utilization levels and competitive cost of production. We value TSL Europe at 6x FY20E EV/EBITDA, due to its lower utilization levels (~70%) and lower demand growth. Financial Summary

Consolidated `cr FY17 FY18E FY19E FY20E

Revenue 1,15,423 1,29,466 1,35,121 1,38,416

Growth (%) yoy 0.6 12.2 4.4 2.4

EBITDA (%) 11.4 16.1 17.4 17.8

PAT -4,248 6,198 8,937 9,724

EPS -35.3 51.5 74.2 80.7

P/E (x) -16.5 11.7 8.1 7.5

EV/EBITDA (x) 10.3 6.0 4.9 4.3

ROE (%) -10.4 13.8 15.7 14.7

ROCE (%) 0.3 7.1 8.9 9.0 Source: Company, IIFL Research

80

100

120

140

160

Apr-17 Jul-17 Oct-17 Jan-18 Apr-18

Tata Steel Sensex

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Premia Research Tata Steel Ltd

Financial Summary – Balance Sheet


Assets

Current Assets 45,249 57,193 64,270 70,916

Fixed assets 92,007 95,434 96,474 97,289

Other long‐term assets 35,192 30,099 28,069 26,370

Total Assets 1,72,447 1,82,726 1,88,812 1,94,576

Liabilities

Current Liabilities 32,013 35,675 37,013 37,747

Borrowings 82,350 77,350 72,650 70,650

Other long‐term liabilities

18,663 15,736 14,186 13,314

Shareholder’s equity 39,421 53,964 64,962 72,865

Total liabilities 1,72,447 1,82,726 1,88,812 1,94,576

Ratios

Net Debt to Equity 2.0 1.2 0.8 0.6

Interest Coverage 6.3 6.5 6.5 6.5

Net Debt to EBITDA 5.9 3.1 2.3 1.9

Source: Company, IIFL Research

Company Background

Tata Steel Ltd (TSL) is an international steel company with presence in Europe and Asia. The domestic steel production capacity of the company stands at 13mtpa, with a total steel capacity of 27.5mtpa (FY17). The domestic operations of TSL are protected against increase in raw material prices due to backward integration. The company has recently completed a ̀ 12,800cr rights issue, which would help TSL with their bids for stressed assets.

Exhibit 1: Realizations and volume forecast for FY17-20E

Consolidated ` cr. FY17 FY18E FY19E FY20E

Tata Steel India

Realisations (` / ton) 44,000 45,800 46,500 46,900

Volumes (mn ton) 10.9 12.3 12.5 12.8

EBITDA / ton 10,900 12,500 12,900 13,300

Tata Steel Europe


Volumes (mn ton) 10.0 10.2 10.4 10.6

EBITDA / ton 1,300 5,400 7,000 7,200


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Tata Steel Ltd

Exhibit 2: Peer Comparison

Mcap (`cr)

Net Debt (`cr)

Enterprise Value (`cr)

FY20E EBITDA (`cr)

FY20E EV /EBITDA (x)

JSW Steel 75,248 42,068 1,17,316 18,741 5.9

SAIL 31,678 25,281 56,959 7,820 7.2

Tata Steel 67,781 66,801 1,34,582 24,641 4.3

JSPL 23,686 38,372 62,058 10,929 4.4


Exhibit 3: Valuation Matrix

SOTP valuation `cr EBITDA FY20E Multiple EV FY20E Tata Steel India 16,997 6.5 1,10,482

Tata Steel Europe 7,644 6.0 45,862

Total 1,56,344

Less: Net Debt 66,801

Equity Value 89,543

Number of shares cr* 120.4

Target price (`) 744

CMP (`) 602

Upside (%) 24 Source: Company, IIFL Research, *rights issue is assumed to be fully subscribed

JV with ThyssenKrupp to lower costs, improve product offerings

ThyssenKrupp and TSL Europe signed an agreement on September 20, 2017 to form a 50:50 Joint Venture. The JV would be the second largest European steelmaker Arcelor Mittal Europe. The JV is expected to create cost synergies of 400-600mn euros (`3,200-4,800cr) per annum. Areas of synergy are – (1) integration of commercial and staff functions, (2) logistics, (3) integration of R&D activities and (4) higher utilisation of downstream operations. The deal is expected to be finalized by December 2018, with the JV formation by March 2019.

Exhibit 4: Details of TSL Europe and ThyssenKrupp Europe JV June 2017 TTM

Deliveries mn tonnes

Turnover `cr

EBITDA `cr

Debt `cr

Tata Steel Europe 9.8 53,497 5,066

ThyssenKrupp Steel Europe 11.5 62,224 6,277

ThyssenKrupp Tata Steel 21.3 115,722 11,343 18,120


Tata Steel is inexpensive at 4.9x FY20E

EV/EBITDA compared to its peers, SAIL

and JSW Steel

Synergies from the JV are expected to

create value in TSL’s Europe business

Tata Steel Europe is valued at a

discount as European steel demand is

expected grow at only 1.4% yoy in

CY18E

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Tata Steel Ltd

Kalinganagar expansion to increase capacity by 5 mtpa

TSL is planning to upgrade the capacity of the Kalinganagar plant from 3 to 8 mtpa by FY22 at a total cost of `23,500cr. This would take the domestic steel capacity of TSL to ~18mtpa by FY22. This expansion is required given that TSL India is operating at ~93% utilization for FY18E.

Exhibit 5: Kalinganagar expansion plans

Cost `cr Capex (`cr/tn )

Project capex upto HRC 16,000 3,200

RM facilities 2,000

2.2 mtpa Cold Rolling Mill 5,500

Total 23,500 4,700


Bhushan Steel – a potential source of value

TSL has been formally acknowledged as the highest bidder for (Bhushan Steel) BSL with a bid of ~`35,000cr. Given that TSL India operates at `10,000-12,000 Ebitda per tonne and BSL operated at `7,000-8,000 Ebitda per tonne, BSL has significant room to improve profitability. There is also room to grow production volumes at BSL, as the utilization level stood at ~56% in 9MFY18 against an industry average of ~72% over the same period.

Exhibit 6: Bhushan Steel production ramp up

FY17 FY18E FY19E FY20E

Volume* (mn ton) 3.3 3.5 3.7 3.9

Utilization (%) 59 63 66 70

Revenue (`cr) 13,706 15,170 15,893 16,856

EBITDA/ton 8,852 7000 8500 9500

EBITDA (`cr) 2,921 2,470 3,142 3,724

Source: Company, IIFL Research, *production volumes are estimations based on secondary sources

Key risk factors – (1) Ramp up and turnaround of Bhushan Steel unit does not occur in a timely manner, (2) European steel market experiences excess supply due to imposition of tariff by Trump which would halt exports, (3) JV with ThyssenKrupp fails to materialise.

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JSW Steel Ltd


Sector Metals

Recommendation BUY

Upside 18%

Stock Data

Sensex 33,880

52 Week h/l (`) 320 / 175

Market cap (`Cr)

75,248

BSE code 500228

NSE code JSWSTEEL

FV (`) 1.00

Div yield (%) 0.8



Promoters 41.6 41.6 41.7

DII+FII 37.7 37.6 37.1



Share Price Trend

Prices as on 10/04/2018

JSW Steel is the largest domestic private steel maker, with a focus on value added steel products. The company’s crude steel production rose 5% yoy in 9MFY18 owing to a 10% growth in long steel products. Given the increase in infrastructure spending in the country, we expect the company to grow production volumes by 5.3% CAGR over FY17-20E. This is likely to lead to EBITDA expansion of 176bps over the same period. We recommend BUY with target price of `369 (7x FY20E EV/EBITDA). Infrastructure and construction spending to boost revenues: Long products have grown 10% yoy in 9MFY18 (refer exhibit 2) due to a pick-up in infrastructure activity in the country. In Union Budget 2018-19, the government has set aside `14.34 lakh cr for rural infrastructure spending. This infrastructure spending is likely to help support growth in long steel volumes for JSW Steel.

Backward integration to aid margins: JSW Steel has won the bids for 5 iron ore mines in Karnataka. The company expects that by September 2018, 4.7mtpa of iron ore mining capacity would be available for captive consumption. This would help reduce raw material costs significantly (53.5% of net sales in FY17) going forward.

Steel sector poised for revival, integrated players to benefit: The Indian steel sector has several favourable tailwinds to support ~6% volume growth over FY17-20E. This secular growth would strongly benefit integrated steel players like JSW Steel. We believe that JSW Steel’s efforts at backward integration, organic/inorganic expansion, and secular growth in steel consumption puts the company in a sweet spot.

Financial Summary


Revenue 55,605 69,135 74,681 79,229

Growth (%) yoy 33.8 24.3 8.0 6.1

EBITDA Margin (%) 21.9 21.2 22.7 23.7

PAT 3,510 5,168 6,261 7,066

EPS 14.5 21.4 25.9 29.2

P/E (x) 21.4 14.6 12.0 10.6

EV/EBITDA (x) 9.0 7.4 6.5 5.9

ROE (%) 16.9 21.3 22.4 21.9

ROCE (%) 10.1 11.9 12.6 12.8


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100

120

140

160


JSW Steel Sensex

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JSW Steel Ltd



Assets

Current Assets 20,961 30,617 32,921 36,389

Fixed assets 58,730 61,261 67,392 71,073


Total Assets 87,956 1,01,154 1,10,499 1,18,381

Liabilities


Borrowings 37,296 40,296 42,796 43,796


3,627 3,221 3,878 4,404


Total liabilities 87,956 1,01,154 1,10,499 1,18,381

Ratios



Net Debt to EBITDA 2.9 2.4 2.2 1.9


Company Background

JSW Steel is the largest private sector steel manufacturer in the country with a capacity of 18mn tonnes per annum (mtpa) as of FY17. The company is planning to expand its facilities at Dolvi, which would double the capacity from 5mtpa to 10mtpa. This is in-line with the company’s aim to expand domestic capacity to 23mtpa by 2020. The company also owns a plate mill in USA and iron ore mines in Chile. The company offers flat steel products ranging from hot rolled and cold rolled coil to colored/ galvanized sheets. The company also markets long steel products such as TMT bars. Valuation & peers – JSW Steel trades at premium to steel industry

JSW Steel (5.9x FY20E EV/EBITDA) trades at a significant premium to Tata Steel (4.3x FY20E EV/EBITDA). This premium is justified give JSW Steel’s superior Net Debt to EBITDA, which stood at 1.6x for FY17. JSW also has better growth prospects primarily a domestic steel player and does not have much exposure to the slower growing European economy. Due to this reason, JSW Steel’s revenue CAGR is expected at 12.5% for FY17-20E against a revenue CAGR of 4.7% for Tata Steel.

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JSW Steel Ltd

Exhibit 1: Peer Comparison

Mcap (`Cr)

Net Debt (`Cr)

Enterprise Value (`Cr)

FY20E EBITDA (`Cr)

FY20E EV /EBITDA(x)

JSW Steel 75,248 42,068 1,17,316 18,741 5.9

SAIL 31,678 25,281 56,959 7,820 7.2

Tata Steel 67,781 66,801 1,34,582 24,641 4.3

JSPL 23,686 38,372 62,058 10,929 4.4


Long Products to benefit from increased infrastructure spending

In Union Budget 2018-19, the government has set aside ~`23 lakh cr for various infrastructure and construction projects. The management has stated that long steel products grew by 36% yoy in February 2018 due to increase in infrastructure activity in the country. Given the massive increase in infrastructure spending, it is likely that crude steel production for JSW Steel would grow at 3% CAGR over FY18-20E.

Exhibit 2: JSW’s long product volume up 10% yoy in 9MFY18

9MFY17 9MFY18

Source: Company

8.07

2.28

0.47

Flat Long Semis

8.2

2.51

0.69

Flat Long Semis

The long products segment is likely to continue to grow as long products are extensively in construction and infrastructure projects.

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JSW Steel Ltd

Exhibit 3: JSW Steel Business Segments

3Q FY17 3QFY18

Source: Company

Captive sourcing of iron ore to reduce costs

The Supreme Court had raised the iron ore mining cap in Karnataka from 30mtpa to 35mtpa for category A and B mines. JSW Steel has recently begun mining operations at an iron ore mine in Tunga (0.3mtpa capacity) and it plans to commission another 0.4mtpa mine in the next two months. The balance three mines are in various stages of approval and should be commissioned by September 2018. With the addition of the mines, JSW Steel would increase its captive iron ore mining capacity by 4.71mtpa.

Monnet Ispat - a conservative bid with great upside

A consortium of Aion Capital and JSW Steel are the sole bidders for Monnet Ispat and Energy Ltd with a bid of ~`3,700cr. The details of the bid are – (1) an equity infusion of ~`1,075cr, (2) a working capital advance of `125cr and (3) `2,500cr of debt. This puts the bid at ~`20,500cr per tonne, a 67% discount to Tata Steel’s bid for Bhushan Steel. JSW Steel would hold 30% equity stake in the consortium with Aion Capital holding the rest. Under the terms of agreement, JSW Steel would take over the operations of Monnet Ispat to help turnaround the distressed asset. The management of JSW Steel has also hinted that they would consider merging Monnet Ispat into JSW Steel after it has become profitable. The bid is currently awaiting NCLT approval.

57%32%

12%

OEM Retail Auto

54%30%

15%

OEM Retail Auto

JSW Steel’s low bid for Monnet Ispat offers significant upside potential to shareholders

JSW Steel to benefit from addition of iron ore mines as well as raising of mining cap in Karnataka.

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JSW Steel Ltd

Monnet Ispat has a capacity of 1.8mn tonnes with 230MW of captive

power generation. Lenders led by the State Bank of India hold 51% of Monnet Ispat, with the promoters holdings at 25.2%. The company original debt stood at ~`10,300cr, implying a haircut of ~76% for lenders. Key risk factors – (1) Delay in commissioning and production ramp up of newly acquired/expected iron ore mines in Karnataka, (2) Steel exports slowdown due increasing global protectionism, (3) Steel prices contract in aftermath of Trump tariff hike.

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Hindalco Industries Ltd

CMP: `230; 1 year Target: `296

Sector Metals

Recommendation BUY

Upside 28%

Stock Data

Sensex 33,880

52 Week h/l (`) 284 / 179

Market cap (` Cr)

51,713

BSE code 500440

NSE code HINDALCO

FV (`) 1.00

Div yield (%) 0.5



Promoters 34.7 34.7 34.7

DII+FII 45.8 46.2 46.3



Share Price Trend


Hindalco Industries Ltd (Hindalco) is one of the largest producers of base metals in the world. Rising domestic industrial activity would help revenues for the domestic copper and aluminium segments to grow at 7.5% and 3.5% CAGR over FY17-20E. Hindalco’s Novelis subsidiary would grow at 2.7% CAGR due to rise in shipments to US vehicle makers (refer exhibit 1). Pricing and volume improvements across businesses would lead to EBITDA margin expanding by 26bps over FY17-20E. We recommend BUY with target price of `296 (7x FY20E EV/EBITDA).

Supply cuts in China to act as support for aluminium prices: China has begun reducing capacity in the aluminium industry by phasing out old plants. Over 2012-17, China cut 3.8mn tonnes of aluminium smelting capacity and is planning to cut 1.5mn tonnes in CY18E (~4% of current global capacity). Given the Chinese capacity cuts, it is likely that aluminium prices would rise in the medium term.

US vehicle sales to boost Novelis shipments: Novelis’ revenue for 9MFY18 grew by 23% yoy due to a 5% yoy rise in shipments and improved product mix. This growth was supported by a 12% yoy increase in aluminium auto sheet in Q3FY18. Given the strong growth in US auto sales (~54mn average annual sales over CY14-17), we expect the shipments from Novelis to grow at 2.7% CAGR over FY17-20E. The Trump imposed import tariff on aluminium would not impact Novelis much as it sources raw materials from Canada and US.

Low aluminium inventory, US auto volumes to boost revenues: We like Hindalco for its exposure to domestic base metals and the US auto sector. Volume growth backed by steady realizations would lead to higher EBITDA margins for copper and aluminium products. Hence, we value the company at 7x FY20E EV/EBITDA (refer exhibit 3).

Financial Summary


Revenue 1,00,184 1,19,443 1,20,190 1,20,327

Growth (%) YoY 1.4 19.2 0.6 0.1

EBITDA Margin (%) 12.3 11.9 12.0 12.2

PAT 1,900 4,398 4,806 5,240

EPS (`) 8.5 19.6 21.4 23.3

P/E (x) 27.2 11.8 10.8 9.9

EV/EBITDA (x) 7.1 5.8 5.3 4.8

ROE (%) 4.4 9.2 9.4 9.5

ROCE (%) 4.2 6.6 6.8 7.0


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Assets

Current Assets 42,246 49,882 50,237 50,755

Fixed assets 84,663 83,075 81,982 80,971


Total Assets 1,45,661 1,52,086 1,51,410 1,50,971

Liabilities


Borrowings 58,451 54,651 49,651 44,651


10,045 10,515 11,045 11,621


Total liabilities 1,45,661 1,52,086 1,51,410 1,50,971

Ratios



Net Debt to EBITDA 4.1 3.2 2.8 2.4 Source: Company, IIFL Research

Company Background

Hindalco is one of the largest producers of aluminium and copper globally. The company’s domestic aluminium business is fully integrated with aluminium smelting and alumina capacities of 0.5mtpa and 1.5mtpa respectively. Hindalco also operates a 0.5mtpa copper smelter in Dahej. Hindalco’s overseas subsidiary, Novelis, is the global leader in aluminium products with a focus on providing value added aluminium products for the automobile industry.

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US auto sales to support further rise in Novelis’ shipments

Despite initial expectations that Novelis would be impacted by the Trump tariff, it is now expected that the impact would be largely muted. With the exclusion of Canada (~45% of US imports) from the aluminium import duties, we expect that Novelis is unlikely to face a major supply disruption. Novelis’ shipments grew by 5% yoy in 9MFY18, due to a 12% yoy growth in shipments to automakers. US auto sales have maintained at an average of ~54mn units per annum. This run rate is expected to be maintained which is a boost to Novelis’ auto business. We expect shipments to grow at 2.7% CAGR over FY17-20E due to demand from the US auto segment.

Exhibit 1: US Auto sales remain close to multi-year highs

Source: Bloomberg, IIFL Research

46 48

53 55 54 54

-

10

20

30

40

50

60

CY12 CY13 CY14 CY15 CY16 CY17

US auto vehicle sales (in millions)

US Auto sales have remained at an average of 54mn units a year over CY14-17

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EBITDA margin for domestic business to expand over FY18-20E

Hindalco is likely to see EBITDA margins for its domestic business to expand over FY18-20E due to a multitude of reasons. Firstly, aluminium margins were impacted in FY18 as prices of raw materials (like coal tar pitch and calcined pet coke) rose sharply during the period. However, with the management focusing on cost efficiencies in the domestic business, we see EBITDA margins rising by 40bps and 46bps for the Aluminium and copper businesses respectively.

Exhibit 2: Assumption forecast for FY17-20E

Consolidated ` cr. FY17 FY18E FY19E FY20E

Aluminium – India

Volumes (000s tons) 1,250 1,270 1,300 1,320

EBITDA/ ton 3,200 3,400 3,400 3,500

Copper – India

Volumes (000s tons) 390 400 410 420

EBITDA/ ton 3,700 4,300 4,400 4,600

Novelis

Shipments (000s tons) 3,200 3,300 3,400 3,400

EBITDA/ ton 2,300 2,400 2,400 2,400



SOTP valuation

`cr EBITDA FY20E Multiple EV FY20E

Aluminium 4,592 7.0 32,146

Copper 1,924 7.0 13,471

Novelis 8,210 7.0 57,471

Total 1,03,087


Equity Value 66,434


CMP (`) 230

Upside % 28


Key risk factors – (1) Trump tariff on aluminium imports causes significant rise in raw material costs for Novelis, (2) Prices of coal tar pitch and calcined pet coke remain at elevated levels in FY19-20, (3) US auto sales decline as rising interest rates impact vehicle financing.

Cost efficiencies to improve margins in domestic aluminium and copper businesses.

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Jindal Steel & Power Ltd


Sector Metals

Recommendation BUY

Upside 24%

Stock Data

Sensex 33,880

52 Week h/l (`) 294 / 103

Market cap (` Cr)

23,686

BSE code 532286

NSE code JSPL

FV (`) 1.00

Div yield (%) -



Promoters 61.9 61.9 61.9

DII+FII 18.9 21.2 23.6



Share Price Trend


Jindal Steel & Power Ltd (JSPL) is a steel and power generation company. The company recently completed a successful QIP of ~`1,200cr at `233 per share. We expect consolidated revenue CAGR of 22.1% over FY17-20E supported by (1) production ramp up at Angul, (2) improved power demand and (3) 80%+ utilization for the Oman unit. Given the scale of benefits from the rise in volumes across all businesses, we see EBITDA margins rising to 28.2%, up 610bps over FY17-20E. We value JSPL using SOTP (refer exhibit 3) and recommend BUY with a target price of `304.

Volume ramp-up at Angul & Oman unit, to boost revenue growth: The ramp-up at the Angul facility began on schedule and would help increase JSPL’s standalone steel production volume increase by ~63% over FY18-20E. The Oman unit has ramped up volumes faster than expected and would deliver 80%+ utilization levels over FY18-20E. JSPL would see revenue CAGR of 22.1% over FY17-20E.

Power business to improve utilizations sharply over FY18-20E: Utilization levels for Jindal Power are expected to improve to ~55% in FY20E from ~38% 9MFY18 due to higher participation of Discoms in short term markets. With ~30% of the power capacity of JSPL tied up in PPAs, there is enough capacity to address the short term market.

Capacity expansion over, utilization ramp up key to profitability: We like JSPL for its potential to improve utilizations in its business segments. Standalone steel production is expected to reach 6mn tonnes in FY20E from 3.5mn tonnes in FY17 (19.8% CAGR). Similarly, power volumes are likely to grow at 21.2% CAGR over FY17-20E. We expect EBITDA margins to improve by 610bps over FY17-20E due to higher utilizations. Thus, JSPL would probably be profitable by FY19E.

Financial Summary


Revenue 21,051 24,585 34,632 38,725

Growth (%) YoY 14.6 16.8 40.9 11.8

EBITDA Margin (%) 22.1 23.1 28.5 28.2

PAT -2,281 -1,202 2,356 3,518

EPS (`) -23.6 -12.4 24.4 36.4

P/E (x) -10.4 -19.7 10.0 6.7

EV/EBITDA (x) 13.5 10.5 5.4 4.4

ROE (%) -7.3 -4.0 7.5 10.3

ROCE (%) 0.8 1.8 6.9 8.1


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Sensex

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Assets

Current Assets 16,480 22,003 29,941 32,926

Fixed assets 65,900 63,784 61,190 58,687


Total Assets 94,144 96,024 1,02,011 1,02,587

Liabilities


Borrowings 40,049 39,958 35,958 29,958


6,339 5,515 5,330 5,099


Total liabilities 94,144 96,024 1,02,011 1,02,587

Ratios



Net Debt to EBITDA 8.5 6.4 3.1 2.2 Source: Company, IIFL Research

Company Background

Jindal Steel & Power Ltd. (JSPL) is a power and steel conglomerate promoted by Naveen Jindal. The company’s domestic steel capacity currently stands at 8.6mtpa (December 2017). The company operates a 2mtpa steel mill in Oman under its subsidiary Jindal Shadeed (100% stake). The company's international coal mining operations are based out of Australia, South Africa and Mozambique. JSPL has a captive power capacity of 1,634MW to cater to its domestic steel production. The company’s commercial thermal power generation is operated through its subsidiary Jindal Power Ltd (96.4% stake) and has a capacity of 3,400MW.

Significant space for volume expansion across all segments

JSPL commenced operating its Basic Oxygen Furnace at the Angul plant in late December 2017. Since then the plant has been ramping up its production as per schedule and is likely to support ~70% increase in production volumes for the domestic steel operations over FY18-20E. This is also a crucial step, as it marks the last major capital expenditure for the company.

Most business segments of JPSL are operating at below 50% utilization

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Exhibit 1: Realizations and volume forecast for FY17-20E

Consolidated ` Cr. FY17 FY18E FY19E FY20E

JSPL Standalone


Volumes (mn ton) 3.5 3.7 5.2 6.0


EBITDA / ton (`) 8,500 9,600 9,900 9,600

JPL

Volumes (bn units) 9.2 13.1 14.9 16.4


EBITDA `cr 1,104 2,054 2,567 2,698

Jindal Oman

Volumes (mn ton) 1.3 1.7 1.8 1.9


EBITDA / ton (`) 5,100 8,100 8,600 8,900

Mines

Volumes (mn ton) 1.2 2.7 3 3.3



Rebar sales to sustain Jindal Shadeed’s growth trajectory

Jindal Shadeed successfully ramped up production during FY18 to become one of the larger steel players in the GCC region. Steel volumes for Jindal Shadeed are expected to grow at 6.1% CAGR over FY18-20E. We expect utilization levels to ramp up from 80% in FY18E to 90% in FY20E. As a result we see EBITDA/ton improving from `8,100 in FY18E to `8,900 in FY20E. `1,200cr QIP completed at `233 per share

JPSL has successfully completed a `1,200cr QIP at `233 per share. The proceeds of the QIP would be used for (1) payment of creditors, (2) repayment of long term loans, and (3) any other purpose in accordance with the conditions specified by the lenders.

Construction activity in GCC regions to keep volumes growing at Jindal Shadeed

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Valuation & peers – JSPL trades at discount to steel industry

JSPL trades at a significant discount to peers due to a various reasons. We value the power business at 6x FY20E EV/EBITDA vs. 8.6x FY20E EV/EBITDA industry average, due to its low utilization levels (55% in FY20E vs. ~60% current industry average). Similarly, the mining business also operated at a low utilization level of ~29% in FY17. Given these reasons, coupled with the high debt level (net Debt-to-EBITDA of 6.8x FY18E), JSPL is trading at a discount to peers. Exhibit 2: Peer Comparison

Mcap (`Cr)

Net Debt (`Cr)

Enterprise Value (`Cr)

FY20E EBITDA (`Cr)

FY20E EV /EBITDA(x)

JSW Steel 75,248 42,068 1,17,316 18,741 5.9

SAIL 31,678 25,281 56,959 7,820 7.2

Tata Steel 67,781 66,801 1,34,582 24,641 4.3

JSPL 23,686 38,372 62,058 10,929 4.4



SOTP valuation

`cr EBITDA FY20E Multiple EV FY20E

Standalone – Steel 5807 6.5 37,745

Power 2698 6.0 16,187

Oman 1691 6.0 10,148

Mines 733 5.0 3,666

Total 67,746


Equity Value 29,374


CMP (`) 245

Upside % 24


Key risk factors – (1) Power volume growth impacted, as power Discoms reduce offtake due to weak financials, (2) Falling coal prices impact overseas mining operations, (3) Steel realisations fall, as sales volumes rise faster than domestic demand.

The power and mines segments are valued at a significant discount to peers due to low utilization levels

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Disclaimer

Recommendation Parameters for Fundamental/Technical Reports: Buy – Absolute return of over +10% Accumulate – Absolute return between 0% to +10% Reduce – Absolute return between 0% to -10% Sell – Absolute return below -10% Please refer to http://www.indiainfoline.com/research/disclaimer for recommendation parameter, analyst disclaimer and other disclosures. India Infoline Limited (Formerly “India Infoline Distribution Company Limited”), CIN No.: U99999MH1996PLC132983, Corporate Office – IIFL Centre, Kamala City, Senapati Bapat Marg, Lower Parel, Mumbai – 400013 Tel: (91-22) 4249 9000 .Fax: (91-22) 40609049, Regd. Office – IIFL House, Sun Infotech Park, Road No. 16V, Plot No. B-23, MIDC, Thane Industrial Area, Wagle Estate, Thane – 400604 Tel: (91-22) 25806650. Fax: (91-22) 25806654 E-mail: [email protected] Website: www.indiainfoline.com, Refer www.indiainfoline.com for detail of Associates. Stock Broker SEBI Regn.: INZ000164132, PMS SEBI Regn. No. INP000002213, IA SEBI Regn. No. INA000000623, SEBI RA Regn.:- INH000000248 For Research related queries, write at [email protected] For Sales and Account related information, write to customer care: [email protected] or call on 91-22 4007 1000

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IIFL Sector Report: Metals – The Sheen Remains

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Transcript of IIFL Sector Report: Metals – The Sheen Remains