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Earnings hit but deleveraging continues

Steel Authority of India (SAIL) reported lower-than-expected EBITDA of Rs34.1bn (CentrumE: Rs36.0bn), down 51% QoQ. The deviation was mainly due to one off employee cost of Rs4.26bn due to change in actuarial valuation. Overall, EBITDA was hit due to higher coking coal cost, lower volume and higher employee cost. EBITDA/t at Rs8,881, down by ~Rs 7,513/t QoQ. Despite poor operating performance, SAIL’s deleveraging journey continues and debt fell by Rs35.6bn QoQ to Rs211.5bn. The major capex on next phase of expansion will begin from FY24 onwards and SAIL will continue to reduce debt till then. We expect SAIL’s margins to have nearly bottomed out in Q3FY22 with employee cost peaking and improving steel prices could potentially offset higher coking coal cost. We cut our FY22/FY23 EBITDA by 13%/14% primarily to factor in higher employee and coking coal cost. Despite the sharp cut, we retain our BUY rating with TP of Rs200 (earlier Rs241), valuing SAIL at 5.5x average of FY23E/FY24E EV/EBITDA.

Higher coking coal, employee cost and lower volume offset higher steel prices

Higher employee cost, coking coal and lower volume offset pricing gain and as a result, SAIL recorded EBITDA of Rs34.1bn, down 51% QoQ and EBITDA/t of Rs8,881, down Rs7,531/t QoQ. CoP ex-employee cost/t stood at Rs47,196, up Rs8,701/t QoQ while overall CoP, at Rs56,863/t, was up Rs10,578/t QoQ. Employee cost at Rs37.1bn was up 11% QoQ (Q2: Rs33.3bn).This includes one off amount of Rs4.26bn related to revised actuarial valuation of employees related liabilities. Even after removing the one off, employee cost stood high at ~Rs32.9bn as the final wage settlement occurred at higher rate. Management guides FY23 employee cost of Rs115-120bn. Besides this, higher coking coal (up ~Rs9850/t QoQ to ~Rs25,000/t), lower steel volume (down 10% QoQ to 3.84mt) and lower iron ore sales offset higher steel prices (up Rs3,500/t QoQ to Rs59,040/t).

Debt reduced to Rs211.5bn; further expansion to be in phases

During the quarter, SAIL recorded operating cashflows of ~Rs65bn which helped it to reduce debt further by ~Rs35.6bn QoQ to Rs211.5bn (Rs165.3bn debt reduction in 9MFY22). Interest cost reduced further by 28% QoQ to Rs3.16bn. With the estimated capex of Rs60bn in FY22E and Rs80bn in FY23E and no cash outflow on taxes for the next three years, we expect net debt to reduce to ~Rs194bn by FY22E-end and further to ~R107bn by FY23E-end. Management is hiring consultant to help in deciding product mix for future expansion. We believe that any meaningful capex on expansion (13-15mtpa in phases) will accrue from FY24 onwards only. We believe this capex will not lead to any leveraging of balance sheet, as the maximum capex/year could be ~Rs100bn and SAIL has the ability to generate such cash flows (assuming EBITDA/t of Rs8,500-9,000 and volume of 18mt).

Reiterate BUY with TP of Rs200

We believe that SAIL’s margins have nearly bottomed out in Q3F22 and expect EBITDA increase in Q4FY22 amid firm steel prices and higher volumes. With all wage settlement done, employee cost too have peaked out. SAIL’s deleveraging journey will continue (reduced debt by ~Rs323bn (Rs78/share) from FY20-end), though it will be near to net debt free only by FY24. We believe that most of negatives have been priced in the current stock price. Risk reward is favourable. We retain our BUY rating with TP of Rs200, valuing SAIL at 5.5x average of FY23E/FY24E EV/EBITDA. At our TP, it trades at 1.3x FY23E P/B.

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