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In-line quarter, all eyes on export tax; maintain Neutral

* JSW Steel (JSW)’s consolidated net sales declined 32% YoY and 19% QoQ to INR381b in 1QFY23, in line with our estimate of INR391b.

* Consolidated EBITDA at INR43b (down 58% YoY and 52% QoQ) for the quarter was also in line with our estimate of INR42b. Consolidated EBITDA/t during the quarter was INR9,597/t (down 68% YoY and 46% QoQ), which came in line with our estimate of INR 9,554/t.

* Adjusted PAT stood at INR8.5b (down 85% YoY and 79% QoQ), 22% below our estimate due to a sharp reduction in other income, which, at INR1.9b was down 19% QoQ.

* Standalone Revenue/EBITDA/APAT stood at INR311b/INR34b/INR10b in 1QFY23, down 14%/65%/82% YoY, respectively, led by higher coal costs and lower ASP.

* The management remained optimistic on the removal of export tax, though the timelines and modalities are unknown.

* Among the subsidiaries, JSW Steel Coated Products reported an EBITDA loss of INR1.5b of provisioning for inventory; while BPSL posted an EBITDA of INR7b, down 55% QoQ. Acero Junction’s EBITDA plunged to USD1.4m, down 87% QoQ; however, Plate and Pipe Mill reported better numbers on strong plate demand, with EBITDA at USD33m, up 14% QoQ. Europe reported operating profit by securing rail orders.

* In view of the rising inventory and weak demand coupled with fewer opportunities to export profitably in the near term, the company has moderated its production. We have marginally reduced our volume expectation for FY23 (already below management guidance), though management remained confident of recouping the lost volumes in subsequent quarters.

Provisions mask business EBITDA; correction in coal price to support margins

* During the quarter, JSW made several provisions part of which we believe, though operational, may not recur with such magnitude going forward. Some of these provisions are: a) provisioning for inventory on net realizable value (NRV) to the tune of INR 8.13b and b) FX translational loss of INR7.47b due to steep depreciation in INR v/s USD in the quarter and c) INR0.8b provision due to cancellation of grant by the US for the US subs of JSW.

* We do not consider the export duty of INR2.42b as one-off as it will continue to recur as long as the duty is in force and the company exports.

* Prime coking coal price has corrected 39% through 1QFY23 and by further 21% since the beginning of 2QFY23. Overall, prime coking coal has corrected by USD283/t (52%) since 1st Apr’22. In addition, JSW has started sourcing PCI coal, anthracite and semi-soft coking coal from Russia at steep discount, which should reduce the costs substantially from Sep’22 onwards. Hence, we expect margin recovery from 3QFY23 onwards.

Valuation and view

* The volume growth story of JSW has been rocked by the imposition of export duty. The timing of the export duty coincided with weakening global steel demand and consequently, global steel prices and at the time when the steel industry was absorbing the peak input cost. The culmination of these factors led to sharp erosion in both profitability and valuation of JSW.

* However, we believe the worst of steel price correction is behind us, though the resurgence in prices will depend on economic recovery in China to a large extent. Sharp corrections in coking coal and other inputs such as iron ore and ferro alloys have brought down the cost structure sharply and the spot spreads are now at a comfortable level.

* However, there is excess finished steel inventory in the industry that will prohibit any price hike to be effective. We believe, to evacuate the inventory, the companies will have to either moderate production or export some quantities and book losses, or, do both partly. We expect this inventory depletion to be over by end-2QFY23 and price hikes to start from mid-Sep’22 onwards.

* We expect another round of correction in steel prices in the near term as steel industry may look at flushing out the excess inventory from the system before making a case for any hike. The seasonally weak quarter due to the monsoons also supports our expectation of further price correction.

* We raise our FY23 EBITDA estimate marginally by 4% to reflect the sharp correction in input costs that would offset steel price correction. We retain our Neutral rating with a revised TP of INR565 (v/s INR525), based on 6x FY23E EV/EBITDA. Stimulus in China will be a key upside trigger for the stock.

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