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EBITDA contraction cycle keeps playing out

JSW Steel (JSWS) reported lower-than-expected Q3FY22 driven by a QoQ drop in reported realisations and headwinds because of coking coal costs (up US$100/te QoQ). Resultant EBITDA/te at Rs16,993/te was ~Rs3,000/te below estimates. JSW Coated EBITDA/te nearly halved QoQ and the impairment in Piombino led to a disappointment in global EBITDA as well. Bhushan Power continues to surprise, with management categorical that there are no one-offs in Bhushan. JSWS has highlighted that ~Rs10bn is the impact because of higher iron ore premium paid due to IBM’s revision of iron ore prices in Odisha on Jan’12, excluding certain auctions which JSWS conducted from its captive mines. JSWS has challenged the same, according to management. We have seen two quarters of EBITDA correction after an upcycle that lasted ~5 quarters; we expect the EBITDA downcycle to play out over 4-5 quarters. Maintain REDUCE, with a reduced target price of Rs570/share [Rs625 earlier].

* Standalone EBITDA/te at Rs16,993 was down ~ Rs5,952/te QoQ. Q3FY22 was second successive quarter of EBITDA correction. Management was non-committal towards direction of EBITDA/te movement in Q4FY22 given increased volatility of coking coal prices; was broadly confident that higher raw material prices can potentially sustain/propel steel prices over Feb, Mar 22. JSWS has revised down its production/sales guidance for FY22E at 94-95% of previous levels, given delayed rampup of Dolvi. While such a guidance would still imply strong Dolvi volume rampup and overall sales performance for Q4FY22, it also leads to us downgrading our FY23/24E sales volume estimates. With the revised guidance for FY22E, JSWS has seen ~4% increase in cumulative sales volume (standalone) over FY19-22E; the key question that keeps concerning us is whether the domestic market is healthy enough to absorb such an influx of capacity (~40mnte) as has been announced by all majors.

* Higher premium to be paid on iron ore because of revision in IBM prices impacted EBITDA by ~ Rs10bn. In a writ filed before the High Court of Orissa, JSWS has challenged the IBM's 12 Jan’22 decision of revising the sales price, which forms the basis of royalty, premium and other mining-related taxes, issued for the months of September, October, November and December, 2021 by excluding iron ore sales from the steelmakers' mines in Odisha. IBM’s suggestions that these were lower than average sales prices and related party transactions have been challenged by JSWS in the High Court of Delhi. The steel maker has since moved to the High court of Odhisa claiming that IBM’s decision to exclude sales from average selling price (ASP) computation was a violation of MCDR.

* We maintain REDUCE, revise down our target price to Rs 570/share. The completion of the upstream and downstream capex can help improve the throughcycle EBITDA and RoE profile. This should manifest in the next downturn. This explains our high 1.8x P/B (FY23E) multiple.

* India capacity moving towards 33mtpa. 5mtpa Dolvi expansion has commenced operations (produced 0.18mnte in Q3FY22). Project to increase steel-making capacity by 5mtpa at Vijayanagar from the existing 12mtpa is also underway. Total estimated capex is Rs150bn. Expansion is expected to be completed by FY24. Management expects to leverage existing facilities at Vijayanagar i.e surplus pellets, sinter, coke making facilities at existing operations to meet the key raw material requirements. There are also plans for expansion at Vijayanagar of existing facilities to enhance capacity by further 2.5mtpa (1+1.5) in phases. Organic brownfield capacity expansion capex is well below global benchmarks of replacement cost of ~US$1,000/te for BF-based capacity. Further management has announced ~ Rs30bn capex for expanding BPSL capacity from 2.6mtpa to 5mtpa in the last quarter. With 15mtpa capacity coming on-stream in next three years, management appears confident of suitable placement of the same.

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