Shareholders can stay invested in steel producer Bhushan Steel while keeping a watch on its performance in the quarters ahead.

The company specialises in making value-added products using cold rolled steel, and caters mainly to the automobile and consumer durable sectors. Even as many other steel stocks faltered, Bhushan Steel gained 38 per cent on the bourses over the past six months.

At its current price of Rs 470, the stock discounts its trailing 12-month earnings by 9.8 times. This is higher than the levels it had traded in the past (seven to nine times).

The valuation is almost at par with SAIL and at a premium to Tata Steel. Current valuations seem justified, given Bhushan Steel’s strong execution track record and margin benefits from the integration process.

Integration bodes well

The run-up in the Bhushan Steel stock has been aided by improved financial performance due to the company’s backward integration into hot-rolled coils (key input).

The company’s hot-rolled coil facility in Orissa caters to the input needs of its re-rolling plants in Maharashtra and Uttar Pradesh. The company expects to increase capacity in hot-rolled coils from 1.9 million tonnes per annum (mtpa) to 4.4 mtpa by the end of this calendar.

It is also expanding its value-added steel capacity from 1.2 mtpa to 2.15 mtpa to cater to increased demand.

Besides, Bhushan Steel hopes to complete acquisition of the iron ore and coal mines in Odisha over the next two or three years.

Bhushan Steel also has 70 per cent stake in the Bowen Energy of Australia which has high-potential coking coal mines.

All this should aid the company’s efforts at full-integration and improve its long-term prospects.

Debt and slowdown concerns

Bhushan Steel has resorted heavily to debt to fund its integration and growth plans. The company’s debt is around Rs 20,000 crore and its debt-to-equity ratio, though moderated from earlier levels, still remains high at around 2.6 times. Interest and depreciation costs are shaving off a good portion of its healthy operating profits.

While operating margin, aided by the integration efforts, is above 30 per cent, net margin is sharply lower at around 12 per cent.

The company has planned a rights issue to the tune of around $300-500 million (Rs 1,650-Rs 2,750 crore) to pare down debt levels. But this could be delayed till market conditions improve.

The company grew sales in FY-12 by around 42 per cent to Rs 9,623 crore. Profits also grew by a marginal 2 per cent to Rs 1,024 crore.

Profit growth in the latest March quarter was higher at 15 per cent, thanks to improved volumes (up 46 per cent). But the company’s performance could suffer if there is slip-up in project execution or in demand for its products. The latter is a bigger worry in the present scenario.

Uncertainty about the global economic conditions has led to a softening in demand for and prices of steel products over the past few months. In India, demand for steel products continues to grow, but the rate is sedate.

Also, unlike the global markets, steel prices in India have held up. But this is more due to the steep depreciation in the rupee which has made steel imports costlier. A rebound in the rupee could lead to price of steel in the Indian markets also heading lower. The global slowdown worries have also caused a fall in the price of iron and coking coal — key inputs in the manufacture of steel. This provides a hedge to companies such as Bhushan Steel which depend on imports for a good portion of their coking coal requirement. But, here, the rupee depreciation diminishes the benefit. The company derives the majority of its sales (more than 85 per cent) from the domestic market.

Its key customer segments — automobiles and consumer durables — have seen growth moderate in the recent months.

If this worsens to a slowdown, Bhushan Steel could see its volumes weaken. This along with a dip in realisations due to increasing capacities in the sector, and the company’s high depreciation and interest cost, could be a drag on financials.

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