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Headwinds pile up

Steel Authority of India (SAIL) reported lower than expected EBITDA at Rs61.5bn. Even after adjusting for wage revision provision (long due) from April 1, 2020, EBITDA falls short of estimates. This also leads to increase in employee costs estimates for FY22/23E. Full year FY21 dividend also falls short of expectations at Rs 2.8/share. The investment thesis continues to face the dual headwinds of i) higher employee costs and ii) possibility of higher capex.

Coupled with peak spreads and most of the deleveraging expectations in the price, the investment thesis looks clouded. The pace of deleveraging, given capex programs will take time to ramp-up, limits downside risks to an extent, unlike past cycles. We downgrade to SELL with an unchanged target of Rs 99/share.

* Dual headwinds of higher employee costs and higher capex, at peak spreads. Employee wage revisions are due, and ~Rs11.5bn has been provided on an estimated basis in Q4FY21 (provided for past four quarters). While, more clarity will be obtained in the post result call (scheduled at 11am IST today), higher profits will bring in the headwind of higher employee costs. Also, there have been media reports of higher steel capex from SAIL to take steel capacity upto 50mtpa in keeping with the company’s ‘Vision 2030’ program. Dual headwinds along with peak spreads, don’t allow for any constructive thesis on the name.

* Significant reduction in Net debt. Net Debt (ex of capital advances) has reduced by ~ Rs 161bn to Rs 353bn in FY21. If a controlled capex trajectory is followed, SAIL has the option to reduce Net Debt to EBITDA to 0.7x and 0.37x by FY22/23E. The significant deleveraging prospects can only materialise and benefits maintained if capital discipline is witnessed.

* Downgrade to SELL with a target of Rs99/share (unchanged): Notwithstanding the present earnings scenario, we continue to ascribe ~ 0.55x P/B to FY23E. We believe perhaps the FY22E volume assumptions are also at risk given a weak Q1FY22. Also, given the peak spreads, and the cycle now 5 quarters long, caution is warranted.

* Upside and downside risks. Its still not clear, whether royalty incidence on sale of captive iron ore can allow the same level of profitability as was previously anticipated. Steel sales volume is expected to touch 17-18mnte in FY22E. However, a weak Q1FY22 will perhaps lead to the target being extended out. Also, higher long product mix in Bhilai, Durgapur and IISCO may lead to underperformance of margins (due to diverging prices of flats and longs) in the medium term.

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