EBITDA seen to be improving, but leverage to remain high
Net debt/EBITDA remains discomforting at 5x
* SAIL’s 1QFY21 result was weak, as expected, with EBITDA loss of ~INR4.0b posted due to weak domestic demand and prices. The outlook, however, has improved, with both demand and pricing recovering in the quarter.
* We expect better volumes and pricing to drive a 30% CAGR in EBITDA over FY20–22E. Net debt, however, is expected to remain elevated at INR467b in FY22, implying 5x net debt/EBITDA. The stock also trades at 6.3x EV/EBITDA, implying limited upside. Thus, we maintain Neutral, with TP of INR42.
Negative operating leverage leads to EBITDA loss
* Standalone revenue declined 44% QoQ to INR90.7b (our estimate: INR93.7b) in 1QFY21 on 40% QoQ (32% YoY) decline in volumes to 2.2mt (in-line). This was weighed by weak domestic demand due to country-wide lockdown in 1QFY21. Share of exports stood at ~24% of total volumes.
* Derived realization declined 6% QoQ to INR40,534/t (our estimate: INR42,194/t) on lower steel prices and an adverse product mix.
* SAIL’s high fixed cost structure impacted margins adversely as negative operating leverage inflated fixed cost (such as employee cost) by ~INR2,100/t and other expenses by ~INR2,000/t.
* Lower realization, coupled with negative operating leverage, led to per ton EBITDA loss of ~INR1,801 (est.: -524/t) v/s gains of INR5,218/t in 4QFY20.
* As a result, SAIL reported EBITDA loss of INR4.0b v/s EBITDA of INR19.5b in 4QFY20 (our estimate: INR1.2b loss).
* The company reported PBT loss of INR19.9b (our estimate: INR18.2b) and PAT loss of INR12.7b (v/s adj. PAT of INR2.9b in 4QFY20).
Volumes improving on market share gains; NSR higher by 3000+/t QoQ
* SAIL registered sales of 1.58mt in Jul’20 (+50% YoY) and 1.43mt in Aug’20 (up 35% YoY). This resulted in decline of ~25% in finished steel inventory levels to 1.23mt at Aug-end v/s 1.65mt in Jun’20.
* Avg NSR stood at INR35,400/t in 1QFY21, lower by INR3,000/t QoQ. Average NSR for 2QFY21 is expected to be higher by ~INR3,000/t QoQ.
* SAIL guided for improvement in longs steel prices, led by demand improvement post the monsoons.
* In 2QFY21, raw material cost is likely to benefit from decline in coking coal prices. Coking coal prices, which stood at INR12,500/t in Jun’20, declined to INR10,800/t in Aug’20. Higher operating leverage should reduce the impact of fixed cost on a per ton basis.
* SAIL expects to sell 16.0mt of steel in FY21, targeting exports of 2.4mt. Over Apr–Aug, it had already exported 1.0mt.
* SAIL’s gross debt stood at INR544b at 1QFY21-end; however, it declined to INR498b at Aug-end owing to improved sales and liquidation of inventory.
* SAIL has sold 500kt of iron ore from its mines thus far in 2QFY21 (100kt in 1QFY21).
Valuation and view
* We expect sales volumes to improve marginally by 1% in FY21, after factoring 10% volume growth for the remaining 9MFY21. We expect SAIL to post ~8% volume growth to 15.6mt in FY22, implying a 4.5% CAGR over FY20–22.
* With improved pricing, lower coking coal costs, and better operating leverage, we expect SAIL to record EBITDA/t in excess of INR6,000/t in 2QFY21. We expect volume recovery and pricing in 2HFY21 to be supported by demand recovery in Infra and Construction post the monsoons.
* Despite an expected reduction in net debt by INR69b to INR465b over FY20– 22E, net debt/EBITDA would stay elevated at ~6x in FY21 and 5x in FY22. This remains a key concern as it makes the company vulnerable in the event of a downcycle in steel prices.
* We value the stock at 6.5x FY22E EV/EBITDA at INR42/sh. Maintain Neutral
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