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Start of an EBITDA decline cycle

Jindal Steel & Power (JSPL) becomes the first entity with zero domestic net debt in our Indian steel coverage. Current net debt of Rs112bn can be attributed to foreign operations. With divestment of Jindal Power (JPL), management looks to become net debt free by FY23E – a very likely scenario in our view. We introduce a simple mental model. Previous down cycle equity value was ~ Rs60bn, Net debt was ~ Rs450bn. EV was ~ Rs510bn. With Debt 0, Equity value should be ~Rs510bn in this down cycle. We reduce the equity value we used to attribute for power (then) i.e ~ Rs110bn and the equity value we attributed for Oman i.e ~ Rs20bn. Some more attribution on account of capital advances and acceptances (which management doesn’t account in its net debt print), like to like downcycle equity value this time should be Rs350bn against current market cap of Rs425bn. This assumes no incremental profit expansion on account of higher steel spreads. We downgrade to HOLD from BUY with a revised target price of Rs433/share.

* Margins disappoint, impending margin pressures ahead. JSPL reported lower than expected EBITDA/te. Realisations (derived) declined ~Rs2241/te QoQ while EBITDA declined ~ Rs7000/te QoQ. This has been driven by increase in RM costs by ~ Rs7000/te QoQ. The increase in RM costs has been driven by ~ Rs5500/te QoQ increase in iron ore costs as Sarada iron ore inventory draws down, Rs800/te has been the impact on account of increased coking coal prices. Management doesn’t expect more than US$50/te of coking coal price increased in Q3FY22 (QoQ) given the current inventory (including in transit) and the increasing coking coal supplies of 2.5mtpa expected from Australia and Mozambique.

* Integration benefits to flow in gradually. JSPL has recently won the Kasia iron ore mine with an EC of 7.5mnte which will be ramped up gradually, Along with Tensa mines (2.5mtpa capacity) FY23E should see 7-7.5mtpa of captive production meeting ~ 50% of JSPL’s requirements. Also the management expects to derive 2.5mtpa of coking coal from Australia and Mozambique combined.

* 6mtpa Angul expansion will hardly stretch the balance sheet; management maintains to achieve Net debt free status by FY23E. Current net debt Rs112bn will go down further by Rs30bn as payment for divestment of JPL flows in. Management continues to maintain guidance for being a net debt free entity by FY23E. Capex intensity for Angul appears low due to i) not commensurate downstream expansion ii) brownfield addition with inhouse civil structural, fabrication works. Increase in pellet capacity to 21mtpa (from 9mtpa at present) along with a slurry pipeline will help in further cost support and can significantly increase RoE.

* Downgrade to HOLD. A simplistic downcycle EV calculation would peg downcycle valuation at ~ Rs350bn. If the EBITDA/te contracts for 4-5 quarters, won’t there be a better value discovery? Offcourse yes – one may look to enter at better levels. We downgrade to HOLD from BUY with a target of Rs433/share (P/B of 1.1x).

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