JSW Steel: It’s a steal

The stock price of JSW Steel is down 9 per cent since our last ‘Buy’ call in January 2018. This can be attributed to the turmoil witnessed in the metals industry in the last one year, caused by the US imposing a 25 per cent tariff on import of steel products into the country.

Given the company’s strong fundamentals, the fall in the stock price presents a good buying opportunity.

JSW Steel’s ability to cater to the rising demand, its cost-control measures and stable financials make the stock attractive.

At ₹262, the stock trades at about nine times its trailing 12-month earnings; lower than its three-year average of 17 times. Though costlier than its rival, Tata Steel, which trades at 6 times its trailing 12- month earnings, JSW Steel’s growth prospects make it attractive.

It needs to be noted that earnings growth will revive only from FY21, as commissioning of new capacities and impact of the company’s various costs-saving initiatives will come into effect after FY20.

Hence, long-term investors with moderate-risk appetite can consider buying the stock at current levels.

Expansion to meet demand

The prospects of the global steel industry look healthy in spite of signs of slowdown in the economy. China’s steel production increased in 2018, despite the ongoing US-China trade stand-off, to meet increasing global consumption demand.

Domestically, too, the growth in steel industry is expected to be robust, with increase in demand from segments such as pre-engineered buildings, engineering, railways, and other government-aided infrastructure projects. In the last two years — FY18 and FY19 — steel consumption in India grew by 7-7.5 per cent annually and is expected to grow at an average rate of above 6 per cent over the next few years.

Major steel companies in India are already running at higher utilisation rates and the output is mainly consumed domestically with only a portion (about 10 per cent) exported. Around 10 per cent of the domestic demand is met through imports currently.

Given this supply constraint, only capacity additions can cater to the increasing demand for the metal.

The domestic market contributes 85 per cent of JSW Steel’s sales volume. JSW Steel has about 14 per cent market share in the domestic steel industry and is well-placed to capitalise on the growing demand, with its ongoing capacity expansion projects.

The crude steel production capacity at Dolvi plant is being expanded from 5 million tonnes (mt) to 10 mt, which is expected to commissioned by the end of FY20. Also, the revamping of blast furnace-3 at Vijayanagar plant; modernisation-cum-capacity enhancement at downstream facilities of its subsidiary — JSW Steel Coated Products — is expected to give a leg up to the production.

Thus, though the guidance for the volume growth for FY20 is subdued at 1.5 per cent Y-o-Y, it is expected to pick up to more than 8-10 per cent from FY21, as majority of the expansions would be completed by the end of FY20.

Cost-control to lift margins

JSW is focussed on overcoming its cost-disadvantage in its key raw material, iron ore, when compared to Tata Steel. Currently, JSW Steel procures its iron ore mainly from external sources, while Tata Steel sources it from captive iron ore mines; this brings down the cost.

JSW Steel has now operationalised three iron ore mines and started using captive iron ore to an extent, thereby reducing dependency on imports or domestic purchases.

Out of a total requirement of 32 mt of ore, 5 mt is expected to be derived from captive sources by the end of FY20. (In FY19, the company used 1.35 mt of iron ore from captive sources). The company is set to bag more captive iron ore mines by participating in the auctions that would be held before March 2020.

This is expected to reduce the additional outgo on iron ore procurement in periods of low availability (cost could go up to ₹600 per tonne in such periods).

Various cost-saving measures taken earlier will yield results from FY20. For instance, its 20 km pipeline conveyor for transportation of iron ore to the integrated Vijayanagar plant from the mines — that was commissioned recently — will benefit the company to the tune of ₹300-500 per tonne.

The company expects to transport 11 mt of iron ore in FY20 through this conveyor.

Stable financials

The company’s financial performance has been stable in FY19 despite slowdown in automotive sector, tight liquidity and fall in steel prices during the year.

The consolidated revenue and the net profit for the year grew by 16 per cent and 23 per cent to ₹84,757 crore and ₹7,524 crore respectively. The operating margins, too, improved to 22 per cent from 20 per cent from one to two years ago.

Production at both the international subsidiaries — JSW Steel (Italy) S.r.i. (Aferpi) and JSW Steel USA Ohio Inc (Acero) — are steadily ramping up and are expected to turn positive at the operating profit level by the end of the FY20.

All the Indian subsidiaries contribute to the group’s operating profits except the recently-acquired Monnet Ispat, which is expected to turn positive in six months to one year time.

Net debt is a point of concern as it jumped sharply from ₹38,000 crore in FY18 to nearly ₹46,000 crore in FY19 due to capex and acquisition of Monnet Ispat, US and Italian units. Acquisition of Bhushan Power would further increase the debt levels for the company.

However, despite debt increase in absolute terms, the key metrics such as net debt-to-equity improved from the previous year and stands at 1.34 time Key risks include steep fall in steel prices, possible increase in debt and hence finance costs that could put pressure on the margins.

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