SAIL: Ironing out the dents

While a favourable demand environment augurs well, a possible increase in wages and higher production costs will be dampeners

After weathering a rather difficult demand environment until the mid of 2017, State-owned steel major SAIL started to turnaround, shrinking its losses substantially in FY18. Over the last three quarters of FY19, the company returned to profitable terrain, as operating margins improved remarkably (to 16 per cent in the nine months ended December 2018 from 6 per cent a year ago) as the macro environment improved for metals, and SAIL was able to benefit from the increased demand.

Prior to August 2018, the stock rallied in line with the company’s good showing, but the correction in the broader markets over the past year and the uncertainties in the metal sector caused by the US-China trade negotiations have led to a substantial decline in its share price since then.

Fundamentally, while a favourable demand environment augurs well for the company, possibility of an increase in wage cost, higher production costs and delays in the ramp-up of capacities, could be dampeners.

At the current market price of ₹57, the stock is trading at a multi-year low of nine times its trailing 12-month earnings. However, this is at a premium to those of its peers Tata Steel and JSW Steel. Hence, existing investors can hold on to their shares. Any further correction in the stock could be a good buying opportunity for the long term.

Scope for higher sales

SAIL has eight steel plants across Chhattisgarh, West Bengal, Odisha, Jharkhand, West Bengal, Tamil Nadu, Karnataka and Maharashtra. It has an existing steel-making capacity of about 21.5 million tonnes per annum (mtpa). The company produces both long and flat steel, catering to the needs of several industries such as construction, infrastructure and railways. The steel plants currently run at an average capacity utilisation rate of 75 per cent, providing leeway to ramp up production if demand continues to improve. Also, the on-going modernisation and expansion projects (capex pegged at ₹4,000 crore for FY18-19) could also help increase productio. SAIL’s production has increased at a compounded annual growth rate (CAGR) of almost 3 per cent in the last five years.

Thus, the company is well placed to capitalise on the increasing demand for steel in the country. A new report by the World Steel Association forecasts that the demand for the metal would grow above 7 per cent in the current as well as next year on account of a wide range of continuing infrastructure projects.

Also, aside from strong demand, government regulations are expected to support steel prices in the country. Higher sales and improved realisations are expected to help the company boost its top-line.

Profitability under check

One notable cost to the company is its employee expense. SAIL has the highest proportion of wage cost to sales in the industry.

Being a government firm, SAIL is required to follow government guidelines on pension benefits and revise the pay scales of its employees. But the company has not provided entirely for the same, following a office memorandum issued by the Department of Public Enterprises which allows lower increments and contributions towards the pension fund.

The company’s auditors have stated that pending negotiations with the employees, SAIL should have made additional provisions. This could have impacted profits — for the nine months ended December 2018, the company reported a profit of ₹1,727 crore; this would have been a loss of ₹152 crore had the provisions been made.

Further, the cost of production (CoP) of SAIL is also high owing to the nature and structure of its steel plants. Though the company’s CoP is lower than JSW Steel’s on account of the former’s captive iron-ore mines, it is still way higher than that of Tata Steel’s.

The financial performance of the company has improved materially since FY18.

The net losses of the company declined from ₹4,021 crore in FY16 to ₹482 crore in FY18.

In the nine months of FY19, too, the operating performance of the company has been quite impressive.

While the revenue rose 20 per cent to ₹47,944 crore, there was a whopping threefold increase in the operating profit to ₹7,806 crore compared with the same period a year ago.

This was on account of improved realisations and reduced production costs.

The firm’s realisations in the December quarter stood at ₹48,000 per tonne, a 17 per cent rise from the corresponding period a year ago.

The debt-equity ratio has been stable over the last couple of years, at 1.25 times (as of December 31, 2018).

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