Headwinds pile up
Steel Authority of India (SAIL) reported inline EBITDA at Rs65.8bn; on the back of lower than expected volumes. The investment thesis continues to face the dual headwinds of i) higher employee costs and ii) possibility of higher capex. Management has announced Rs650bn of capex to increase capacity by 13mnte across three plants. Coupled with peak spreads and most of the deleveraging expectations in the price, the investment thesis looks clouded. The pace of deleveraging, given capex programs will take time to ramp-up, limits downside risks to an extent, unlike past cycles. We maintain SELL with an unchanged target of Rs 99/share.
* Dual headwinds of higher employee costs and higher capex, at peak spreads. Employee wage revisions are due, and ~Rs14bn has been provided on an estimated basis till Q1FY22 (provided for past five quarters). Higher profits will bring in the headwind of higher employee costs. Management announced ~13mnte of new expansion across Burnpur, Bokaro and Rourkela for a total capex of Rs650bn. Expansion capex will witness a pickup from FY24; management suggested a possibility of preponing the expansion capex as well. Target capex (as directed by GoI) is Rs80bn for FY22E, management guided to achieve Rs60bn capex in FY22E.
* Significant reduction in Net debt; difficult to sustain the trajectory. Net Debt (ex of capital advances) has reduced by ~ Rs 50bn to ~Rs300bn in Q1FY22. If a controlled capex trajectory is followed, SAIL has the option to reduce Net Debt to EBITDA to 0.7x and 0.37x by FY22/23E. The significant deleveraging prospects can only materialise and benefits maintained if capital discipline is witnessed.
* Maintain SELL with a target of Rs99/share (unchanged): Notwithstanding the present earnings scenario, we continue to ascribe ~ 0.6x P/B to FY23E. We have started witnessing earnings downgrade across the sector; our FY22/23E EBITDA reduces by 20/25% on the back of i)weaker volumes in FY22E and ii) start of a steel price correction cycle (also iron ore has corrected ~US$40/te in a couple of weeks, coking coal has doubled in the past month).
* Upside and downside risks. Its still not clear, whether royalty incidence on sale of captive iron ore can allow the same level of profitability as was previously anticipated. Steel sales volume is expected to touch 16mnte in FY22E (ticked down from previous expectations). Also, higher long product mix in Bhilai, Durgapur and IISCO may lead to underperformance of margins (due to diverging prices of flats and longs) in the medium term.
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