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Best play on higher steel prices

Strong FCF to drive deleveraging and higher dividend yield

We see Steel Authority of India (SAIL) as the best play on higher steel prices as it: 1) is backward integrated with captive iron ore, 2) has a higher operating leverage due to high conversion cost, and 3) has a higher financial leverage. With limited capex, higher pricing should drive significant deleveraging and boost equity value. We estimate net debt to decline by INR232b (INR56/sh, 76% of CMP) over FY20-23E to INR305b. We also expect higher dividend payouts going forward (implying ~5% yield), supported by strong FCF of INR19/sh (25% yield). We are raising our FY22E/FY23E EBITDA estimate by 34%/37% and TP by 28% on expectation of higher realization and volumes. The stock trades at 4.2x FY22E EV/EBITDA, a 25-30% discount to peers TATA and JSTL.

Higher realization and volume growth to drive earnings

* Given a strong steel cycle, we expect realization to remain high in the medium term, which, coupled with an inefficient cost structure (higher conversion cost), should provide disproportionate margin gains to SAIL. Every INR1,000/t of higher steel price improves SAIL’s FY22E EBITDA by 11%.

* Supported by under-utilized capacities, volume growth is expected to be strong at 9% CAGR over FY21-23E. There is also a likelihood of product mix improvement (higher finished steel sales).

* We estimate 36% EBITDA CAGR over FY20-23E.

Strong FCF to drive deleveraging and higher dividend yield

* With robust EBITDA and limited capex, we estimate FCF to be strong at INR78b/INR86b in FY22E/FY23E, implying a FCF yield of 25-28%.

* Higher FCF should drive significant deleveraging, which should boost its equity value. We estimate net debt to decline by INR232b (INR56/share, 76% of CMP) over FY20-23E to INR305b (2.1x of FY23E EBITDA). Net debt has already declined by INR94b (INR23/share) to INR443b in 9MFY21.

* As SAIL swings to profit and has limited capex needs, we expect a higher dividend payout going forward. As against an inconsistent dividend of INR1- 2/sh (nil in FY16-18), we expect a consistent higher payout of INR4-5/sh, implying a yield of 5-7%.

Valuation is attractive, lower steel price the key risk

* At the CMP, the stock is trading at 4.2x FY22E EV/EBITDA, which is at a 25- 30% discount to peers TATA and JSTL. Even on FY22E P/BV, it is trading at an attractive 0.6x, despite an expected strong RoE of 16%.

* We value the stock at 5x FY22E EV/EBITDA at INR104/share, implying a target P/B of 0.8x (historical average of 0.7x).

* Key risks are lower steel price and higher capex.

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