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Weak results; margins to bottom out in 4QFY22

Lower volumes, high input costs impact EBITDA; coal continues to rise

* JSW Steel (JSW)’s consolidated EBITDA at INR91b (up 54% YoY, down 12% QoQ) came in 10% below our estimates. Rising coking coal prices impacted margins negatively. Standalone sales volumes at 4mt were 11% lower than our expectation due to delayed ramp-up at Dolvi (5mt expansion).

* We expect the weakness in margins to continue in 4QFY22 as coal prices continue to rise due to seasonal cyclones in Australia. However, we expect coal prices to peak out in 4Q and anticipate an improvement in both steel demand and prices from 1QFY23. Maintain Buy.

Weak consol results; overseas subs continue to disappoint

* JSW’s consolidated topline was up 10% QoQ to INR380b, but EBITDA/PAT at INR91b/INR45b was down 12%/32% QoQ and 10%/16% lower v/s our estimates. The miss was driven by continued cost pressure. The management claimed a one-off pertaining to higher royalty on iron ore of INR11b, for which it has filed a writ petition in the Orissa High Court.

* EBITDA/t at the consolidated level stood at INR19,724/t (up 48% YoY, down 18% QoQ), 12% below our estimate of INR22,370/t. If the iron ore one-off (as claimed by the company) is excluded, the resultant EBITDA/t is in line with our estimates.

* The 9MFY22 topline/EBITDA/PAT stood at INR995b/INR298b/INR174b, significantly higher YoY by 89%/158%/383% – 9MFY21 reflected the low point as the economy reeled from the impact of the pandemic and lockdowns.

* BPSL’s consolidation during the quarter resulted in debt increasing by INR75b to INR663b, as guided by the management previously.

* The standalone topline/EBITDA/PAT for the quarter stood at INR289b/INR69b/INR32b (+3%/-22%/-36% QoQ).

* Subsidiaries’ performance was impacted as value-added steel prices corrected sharper than the base grades. As a result, EBITDA for Coated dropped 45% QoQ, while EBITDA for the subsidiaries cumulatively fell 55% QoQ (ex-BPSL, as it was consolidated for the first time). Coated/BPSL EBITDA for the quarter stood at INR15.5b/INR5.7b (down 45%/24% QoQ). However, BPSL has maintained EBITDA/t of INR26k for the past two quarters.

* We note that a) the current tussle between JSW and the Indian Bureau of Mines (IBM) regarding average iron ore prices for the calculation of royalty and b) JSW’s stand to provision the premium basis the IBM prices despite contesting the same follow a prudent accounting principle. We have not adjusted the EBITDA for the disputed costs and await further clarity on the same.

* Valuation: The stock currently factors in EBITDA of less than INR14,000/t, which we believe is fairly pessimistic. If China implements the stimulus package to boost the economy post the Winter Olympics, we believe steel demand prices would improve in India as well. We value the stock at 7x FY23E EV/EBITDA with TP of INR790/sh.

Highlights from management commentary

* BPSL – which was operating as a jointly controlled entity with promoter group companies – has now become a subsidiary of the company after the conversion of the optionally fully convertible debentures. JSW held 49% stake in BPSL prior to the conversion and now holds 83.28% stake post the conversion.

* The management has guided for an increase of USD25–50/t in coking coal costs in 4QFY22. We note that the increase could be sharper in case of any further disruptions in coking coal supplies from Australia. Queensland accounts for around 57% of the seaborne coking coal trade, and Indian steel players largely import from Australia. As a result, their margins remain susceptible to coal price volatility.

* JSW operates three mines in Odisha, from where it serves its own plants as well as sells on the merchant market. It also sells iron ore to group companies. IBM has issued a show-cause notice to the company for allegedly selling iron ore at significantly lower than the average prices published by IBM. As per the management, the entire ore is e-auctioned in a transparent manner, with several parties (both related and un-related) bidding for the same. The ore is sold to the highest bidder in the relevant auction, following which the material is graded and sampled for the ore grade and other specifications. As a result of the dispute, IBM has revised up its prices for Sep’21 and Oct’21, excluding certain ore sales conducted by JSW. The prices have been revised up to INR4,095/t (from INR2,305/t), implying a hike of INR1,790/t. This directly impacts the premium payable by JSW on ore mined from its own mine. As per the management, it has impacted EBITDA by INR10.5b, of which INR2.64b is for 2Q and the balance for 3Q.

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