Focused on navigating choppy waters
Higher exports and cash conservation to help tide over weak demand
* JSW Steel (JSTL)’s FY20 Annual Report highlights the company’s strategy to combat the fallout of COVID-19. JSTL plans to ramp-up exports to 30% of sales (v/s 21% in FY20 and 16% in FY19) to compensate for weak demand in the domestic market.
* Even in FY20, domestic volumes fell 10.7% YoY, which was partly compensated through higher exports, with overall sales volumes declining 4% YoY.
* JSTL is planning targeted cost savings, supported by technology and digitalization, to reduce the cost base across areas of operation. Employee costs have already been cut, with FY21 likely to see flat manpower costs despite the new capacity at Dolvi.
* Capex has also been curtailed, with FY21 planned at INR90b v/s INR102b in FY20. Planned capex of INR487b over FY18–22 is, however, only halfway through and likely to spill over to FY23 and beyond. This is attributed to the company’s current focus being on conserving cash.
* Leverage has risen further in FY20 to 5.7x net debt/ EBITDA with an INR64b YoY increase witnessed in net debt to INR629b (USD8.4b), a key concern. We estimate net debt to rise further to INR676b in FY22 on weak profitability and capex plans.
* However, the debt maturity profile is comfortable, with 63% of long-term debt due for repayment after FY22. While INR139b of long-term debt (23% of the total) is due for repayment in FY21, we believe it should be comfortably managed with refinancing as well as cash and cash equivalents in hand of INR120b as of Mar’20. Consolidated RoE and ROCE fell sharply in FY20 to 6.1% (-18.3pp) and 4.5% (-6.5pp), respectively, weighed by weak domestic demand and significant losses in overseas subsidiaries. These would be subdued even in FY21 due to the COVID-19 impact.
* We expect consolidated Revenue/ EBITDA/ PAT at INR672b/ 112b/ 20b, -7%/+1%/- 9% YoY respectively. However, with an expectation of better demand in FY22 and commissioning of the 5mtpa Dolvi expansion, we expect Revenue/ EBITDA/ PAT to improve substantially by 30%/ 59%/ 165% YoY to INR875b/ 178b/ 52b respectively.
Higher exports to combat weak domestic demand, but dilute margins
* In FY20, JSTL ramped-up exports by 33% YoY to 3.2mt amid 10.7% YoY decline in domestic volumes (due to weak demand from auto and other flat steel consumers). Share of exports rose to 21% of sales (v/s ~16% in FY19).
* JSTL expects share of exports to rise further to ~30% in FY21 as domestic demand is likely to be weak due to the disruption caused by COVID-19.
* Higher exports would, however, result in a weaker blended per ton realization and EBITDA margin in FY21. We estimate EBITDA to decline 3% YoY in FY21
Capex curtailed as focus on cash conservation
* JSTL’s announced capex plans of INR487b over FY18–22 are just halfway through in FY20, with capex of INR239b spent thus far.
* Amid uncertainties arising from COVID-19, JSTL is focusing on cash conservation and has thus recalibrated its capex plans to prioritize returnaccretive projects. FY21 capex has thus been curtailed to INR90b v/s the earlier planned spend of INR163b.
* The total capex plan of INR487b is thus likely to spill over to FY23 and beyond.
Net debt increases by INR64b in FY20; net debt / EBITDA rises to 5.7x
* Net debt (including acceptances) increased by INR64b YoY to INR639b in FY20 on weak domestic margins, significant losses in subsidiaries, and a higher capex spend. However, gross debt surged by INR121b to INR759b as JSTL increased liquidity in hand due to uncertainty in cash flows stemming from COVID-19.
* Net debt / EBITDA rose to 5.7x in FY20 (from 3.0x in FY19) and would remain elevated at 5.9x in FY21, weighed by the expectation of weak profitability.
* JSTL is exposed to currency risk on its debt, with 48% of debt being USDdenominated, 47% INR, and the balance 5% other currencies.
* Average cost of debt stood at 6.7% in FY20, but MTM loss on forex debt (at INR24b) implies additional cost of 3.3%, taking the total cost to 10%.
* In FY21, debt of INR139b (USD1.8b) is lined up for repayment. However, we expect it to be managed comfortably through refinancing and JSTL’s strong cash and cash equivalents position of INR120b.
* The debt maturity profile (excl. working capital borrowings) is forecast as follows: FY21 – 23% (INR139b), FY22 – 14% (INR88b), FY23 – 21% (INR127b), and post-FY23 – 43% (INR263b).
EBITDA to OCF conversion improves, but FCF remains negative
* JSTL’s FY20 operating cash flow (OCF) declined by INR18.5b YoY to INR128b, dragged down by weaker EBITDA of INR112b (down 41% YoY). This was partly offset by the release of working capital of INR16b (v/s an increase of INR16b in FY19) and lower income tax payments.
* The cash conversion ratio (OCF post working capital / EBITDA) improved to 1.2x (v/s 0.9x in FY19), driven by working capital release in FY20.
* While OCF was weaker, cash capex came in higher at INR128b in FY20 (up INR26b YoY), resulting in negative free cash flow (FCF) of INR41.1b (post interest payments and acquisition spends) v/s negative INR6.6b in FY19.
Overseas subsidiaries continue to incur losses, require parent support
* JSTL’s overseas subsidiaries widened their losses in FY20. Key overseas subsidiaries – JSW (USA) Inc, JSW (USA) Ohio Inc, and JSW Italy Plombino S.p.A – reported combined EBITDA loss of INR12.4b v/s loss of INR2.8b in FY19.
* JSTL extended loans of ~INR12.0b to Periama Holdings, LLC – holding company of JSW (USA) Inc and West Virginia coal operations – in FY20, taking the total receivables from the same to INR61.3b.
* JSTL is implementing measures to turnaround its overseas operations. In the US, the integration of Ohio and Baytown (Plate Mill) operations is planned to derive synergies. The Plate Mill at Baytown is also being modernized, which is likely to provide cost savings in FY21.
Other key points from Annual Report
* Bhushan Power acquisition further delayed due to legal issues: The erstwhile promoters of Bhushan Power and Steel (BPSL) and certain operational creditors have filed an Appeal before the Supreme Court against the NCLAT order declaring JSTL the winner of the bid process to acquire BPSL. If JSTL is upheld as the winner, this would result in a further increase in debt by at least INR30b. This calculation is based on the INR197b deal value, 70% debt funding, and JSTL taking 51% stake in the asset, with the balance being sold to strategic investors.
* 24km pipe conveyor operationalized at Vijayanagar: JSTL operationalized a 24km pipe conveyor with a capacity of 10mtpa in FY20 (likely to be enhanced to 20mtpa). Furthermore, it transported ~3.4mt of iron ore during the year, generating savings of INR560m (INR165/t of iron ore); the full potential of these developments is likely to be achieved in FY21.
* Captive iron ore production adding to fixed cost: JSTL mined 4.1mt of iron ore from its captive mines in Karnataka. It paid statutory dues (premium and royalty) of INR6.5b on the same in FY20, implying cost of INR1,588/t. Production in Karnataka is guided to rise to 7mt in FY21.
* Shift to new tax regime unlikely in near future: In its standalone operations, JSTL has minimum alternate tax (MAT) credit entitlement of INR42b, which it expects to utilize over the next six years. The company thus does not plan to shift to the new tax regime of 25% over this period as it would have to forego the MAT credit.
* In FY20, employee cost rose by 6% YoY to INR15.0b on a 4% increase in employee count to 13,159 and 4% in per employee cost, partly offset by 34% decline in managerial remuneration to INR570m.
Valuation and view
* We like JSTL given its strong pipeline of projects and cost reduction initiatives. On the domestic front, while on the one hand, it should deliver above-industry volume growth in FY22, driven by expansion, margins should also improve, aided by a better product mix. Any turnaround in its loss-making overseas operations could provide a further upside.
* In the near term, we expect JSTL to tide over the disruption caused by COVID19, supported by higher exports, cost reductions, and capex curtailment. Although net debt is expected to rise to INR676b in FY22E (from INR639b in FY20), we expect it to decline subsequently as the capex phase ends and invested projects start to generate cash flows. We value JSTL at 7.0x FY22E EV/EBITDA to arrive at TP of INR242/share. Maintain Buy.
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