jindal steel - nb

8/10/2019 Jindal Steel - NB

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Jindal Steel & Power.jpg


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Regulatory Overhang + Single-Digit RoIC = De-rating; Sell

We assign a Sell rating to Jindal Steel & Power (JSPL) because of regulatoryoverhang, which will lead to a sharp deterioration in incremental return ratios.Inthe past five years, JSPL has grown multi-fold on the back of captive resources,

but future expansion depends on merchant raw material supply. Besides this,JSPL is apparently one of the few companies which have benefited from captivecoal mine allocation, which along with the companys large size, makes it morevulnerable to regulatory actions like ceiling on merchant power price or demandfor free power (as witnessed in Orissa). We expect RoE and RoCE to declinefrom 21.9% and 12.2% in FY12 to 15.3% and 9.1% in FY14E, respectively, whileRoIC over FY10-14E is likely to be just 3.9%. We have set a TP of Rs300 on JSPL.

Is it still Sell despite 35% underperformance in past six months? We believe Yes:

JSPL has declined 30% in the past six months versus a 5% rise in Nifty, but, westillfeel the pain is not over. The negative news flow is unlikely to stop, which coupled withdistressed earnings due to delay in key projects will continue to lead to de-rating of thestock. Considering the above weakness, we feel a major portion of the price damagehas already taken place, but theres likely to be a sizeable time correction goingahead.

Our estimates substantially below consensus projections: Our FY14EEBITDA/PAT estimates are 9%/19% below consensus projections, respectively,

as we have assumed a subdued pricing scenario for steel prices and power tariff.Our revenue estimate for FY14E is 8% above street estimate. It appears the street istaking very low output from new facilities as these would be non-integrated in nature.

Utkal B1 coal block hits regulatory hurdle: The Orissa government has stoppedapproving mining leases due to a Supreme Court directive that all natural resourcesshould be auctioned. This, coupled with the recent CAG (Comptroller and AuditorGeneral of India) recommendation that coal mines have to be allocated via the auctionroute would prolong the pain, acting as a headwind on the stock.

Jindal Powers (JPL) 2x600MW plant doesnt figure in coal linkage list: The list ofpower plants for coal linkage under fuel supply agreement (FSA) doesnt include JPLsfirst two units of 4x600MW as per the minutes of Standing Linkage Committees (SLC)meeting. Though it is not the end, it has definitely led to uncertainly in respect of coalsourcing. For the remaining 2x600MW units, JPL has to rely on imported and e-auctioned coal, which erodes the returns profile sharply.

Iron ore sourcing at Angul plant remains a concern: JSPL has indicated sourcingofiron ore either from a third-party mine or in-house pellets. We would like to hi


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Share holding (%)

Q3FY12

Q4FY12

Q1FY13

Promoter

58.6

58.9

59.0

FII

22.3

23.1

21.9

DII

7.8

6.9

7.3

Corporate

3.3

3.1

3.9

General Public

8.1

7.9

3.9

One Year Indexed Stock Performance

Price Performance (%)


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2.0

18.2

38.9

11.9

21.1

EBITDA

58,513

63,162

67,932

70,649

80,061

EBITDA (%)

52.8

48.2

37.3

34.7

32.4

Adj PAT

35,730

37,539

39,649

32,770

38,033

EPS (Rs)

38.4

40.2

42.4

35.1

40.7

YoY (%)


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17.3

4.7

5.5

(17.4)

16.1

RoE (%)

34.3

26.6

21.9

15.4

15.3

RoCE (%)

20.6

14.3

12.2

9.9

9.1

P/E (x)

10.6

10.1

9.6

11.6

10.0

EV/EBITDA (x)

7.9

8.1

8.1

8.6

8.2


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Source: Company, Nirmal Bang Institutional Equities Research

Jindal Steel & Power

405060708090100110120130Sep-11Nov-11Jan-12Mar-12May-12Jul-12Sep-12JINDAL STEEL &

PNSE S&P CNX NIFTY INDEX


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Exhibit 1: Operations summary

FY08

FY09

FY10

FY11

FY12

FY13E

FY14E

ProductionStandalone (tn)

Sponge iron

1,185,739

1,248,511

1,309,408

1,319,840

1,319,940

1,350,808

1,492,600

Pig iron

1,250,636

1,262,261

1,508,502

1,665,581


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1,667,851

1,674,367

1,636,600

Steel products

1,425,060

1,844,651

2,251,738

2,272,692

2,756,921

3,145,000

3,915,000

Pellet

-

-

226,818

2,787,284

3,736,915

4,009,830

4,016,250

Power (mu)

2,665

2,831

2,941

3,420

4,630

6,917

8,696


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Volume Standalone (tn)

Sponge iron

405,446

385,583

343,369

113,894

78,457

1,925

-

Pig iron

347,261

280,419

245,193

201,688

85,428

-

-

Steel products


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1,328,390

1,508,121

1,804,863

1,900,383

2,385,224

2,620,860

3,412,850

Pellet

-

-

11,893

564,510

2,028,330

2,032,622

1,926,610

Power (mu)

893

1,124

945

926

1,446

3,055

4,565


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21,106

13,989

17,794

EPS (Rs)

13.3

16.5

15.9

22.1

22.6

15.0

19.0

Jindal Power (Rsmn)

Power volume (mu)

468

5,804


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7,431

7,841

7,833

7,898

8,844

Net sales

1,264

32,585

39,219

33,377

29,797

28,433

32,861

EBITDA

955

27,074

33,846

27,211

23,126

21,167

23,080

PAT

194

15,819

23,188

20,016

17,650

17,442

16,661


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Valuation

JSPL trades at P/E multiples of 11.6x and 10.0x based on FY13E and FY14E earnings, while EV/EBITDAmultiples stand at 8.6x and 8.2x for the same period. The P/E and EV/EBITDA multiples are higher than the

past 10 yearsmedian of 7.0x and 6.7x, respectively. We believe the stock may witness a de-rating due todeterioration in returns ratio and regulatory overhang. As per our calculations,we expect RoICE (returnon incremental capital employed adjusted with CWIP) of 3.7% over FY12-FY14E, while RoICE overFY10-FY14E is also likely to be 3.9%. We have valued JSPL based on SOTP methodology, where powerand steel business have been valued separately. We have valued the steel business at 5.5x FY14EV/EBITDA and CWIP according to each projectsreturns profile and gestation period. Power business has

been valued at 6.0x FY14E EV/EBITDA, while international subsidiaries have beenvalued at 5.5x FY14EEV/EBITDA. Our target price of Rs300 is 26% below the CMP. Our target price is 21% lower than theexisting lowest target price as per Bloomberg database.

Exhibit 2: Valuation summary

(Rsmn)

EBITDA

EV/EBITDA multiple (x)

Amount

Steel segment

48,413

5.5

266,273

Power segment

23,080

6.0

138,479

International & other segments

8,569

5.5

47,127

Total


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80,061

5.6

451,879

Cash

5,359

Debt

285,408

CWIP (discounted as per project specific)

112,686

Minority interest

4,222

Market capitalisation

280,295

No of shares (mn)

935

Target price (Rs)


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300

Downside (%)

26%

Source: Nirmal Bang Institutional Equities Research

Our estimates versus consensus projections

Our FY13E EBITDA and PAT estimates are 7% and 19% below consensus projections, respectively,largely due to lower price assumption in the steel segment. We believe that consensus is yet to factor in therecent decline in steel prices and this should result in more downgrades in coming months. We would alsolike to highlight that consensus is yet to factor in the exceptional loss on account of Bolivian investment. After1QFY13, consensus EBITDA estimate for FY13E has been downgraded by 5%, or Rs4,019mn, while PATestimate has been downgraded by 8%, or by Rs3,352mn. We would like to note that1QFY13 EBITDA andadjusted PAT were 17% and 12% below consensus estimates, which coupled with a ex

ceptional loss ofRs5,741mn would have resulted in bigger reduction in PAT estimate. Our FY14E EBITDA/PAT estimatesare 9%/19% below consensus projections, largely driven by lower steel price assumption and highercosts assumption due to delay in raw material integration. We expect steel prices at export parity due tosubstantial capacity addition. Besides this, the steel plate (major incrementalrevenue driver in comingquarters) market is more vulnerable compared to overall steel market due to hugecapacity addition in thatsegment. Surprisingly, our FY13E/FY14E revenue estimates are 2% and 8% higher than consensusprojections as it appears the street is not factoring in any material revenue from the non-integrated segment.

Exhibit 3: Our estimates versus consensus projections

(Rsmn)

NBIE estimates

Bloomberg consensus estimates

Deviation (%)

FY13E


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FY14E

FY13E

FY14E

FY13E

FY14E

Net sales

203,771

246,841

199,563

228,171

2.1

8.2

EBITDA

70,649

80,061

75,614

87,643

(6.6)

(8.7)

PAT

32,770

38,033

40,661

46,741

(19.4)

(18.6)

Source: Bloomberg, Nirmal Bang Institutional Equities Research


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0160320480640800

Apr-02May-04Jun-06Jul-08Aug-10Sep-12JSPL share price6.0x10.0x14.0x18.0x(Rs)06121824Apr-02May-04Jun-06Jul-08Aug-10Sep-12P/EMedian P/EMed +1SDMed +2SDMed -1SD(x)0160320480640800Apr-02May-04Jun-06Jul-08Aug-10Sep-12JSPL share price3.0x6.0x9.0x12.0x(Rs)04

81216Apr-02May-04Jun-06Jul-08Aug-10Sep-12EV/EBITDAMedian EV/EBITDAMed +1SDMed +2SDMed-1SDMed -2SD(x)0160320480640800Apr-02May-04Jun-06Jul-08Aug-10Sep-12JSPL share price1.0x1.5x2.0x2.5x(Rs)-

2.04.06.08.0Apr-02May-04Jun-06Jul-08Aug-10Sep-12P/BVMedian P/BVMed +1SDMed +2SDMed -1SD(x)152229364350-510152025Apr-02May-04Jun-06Jul-08Aug-10Sep-12P/EAverage RoE (RHS)(x)(%)152229364350-3691215Apr-02May-04Jun-06Jul-08Aug-10Sep-12EV/EBITDA Average RoE (RHS)(x)(%)152229364350-1.53.04.5

6.07.59.0


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Apr-02May-04Jun-06Jul-08Aug-10Sep-12P/BVAverage RoE (RHS)(x)(%)Exhibit 4: 1-year forward P/E

Exhibit 5: 1-year forward average P/E



Exhibit 6: 1-year forward EV/EBITDA

Exhibit 7: 1-year forward average EV/EBITDA



Exhibit 8: 1-year forward P/BV

Exhibit 9: 1-year forward average P/BV



Exhibit 10: Average P/E, RoE

Exhibit 11: Average EV/EBITDA, RoE

Exhibit 12: 1 Average P/BV, RoE


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Exhibit 13: Revenue-Consensus estimate vs. our projection

Exhibit 14: EBITDA-Consensus estimate vs. our projection



Exhibit 15: PAT-Consensus estimate versus our projection



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0918273645FY06FY07FY08FY09FY10FY11FY12FY13EFY14ERoCE RoE(%)01020304050101520253035FY07FY08FY09FY10FY11FY12FY13EFY14ERoCE adjusted with CWIPRoIC (RHS)(%)(%)-

0.91.82.73.64.5FY08 FY09 FY10 FY11 FY12 FY13E FY14ESteel productsPellet(mt)(0.0)0.71.42.12.8

3.5FY08 FY09 FY10 FY11 FY12 FY13E FY14ESteel productsPellet(mt)Return ratios to deteriorate substantially

JSPL is going to witness a very sharp fall in return ratios in the coming yearsas new expansion is likely to bevalue dilutive. We expect RoE and RoCE to drop from 21.9% and 12.2% in FY12 to 15.3% and 9.1% inFY14E, respectively. Return on capital employed, excluding CWIP, is also expected to witness a sharpdrop from 19.4% in FY12 to 12.8% in FY14E. The key indicator, return on incremental capital employed

(RoIC) is likely to remain in low single-digits over FY12-FY14E. The huge deterioration in return ratios wouldlead to de-rating of the stock as earnings disappointment sets in.

Exhibit 16 : RoCE and RoE

Exhibit 17: RoCE adjusted with CWIP and RoIC



Volume growth to be healthy in FY12-FY14E, but not profitable due to non-integrated nature

We expect the company to report a 20% CAGR volume growth in steel during FY12-FY14E. However,most of the growth would be driven by the non-integrated segment. The company has commissioned various

downstream facilities like plate mill, wire rod mill and bar mill without commensurate increase in semi- finishedsteel capacity. The company is also marginally short on metallics capacity. It w


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ill have to source thesematerials from a third party on merchant basis, which leaves very little scope for incremental profitability. Weexpect almost 66% of the incremental volume to be based on usage of merchant semi-finished steelas a raw material during FY12-FY14E. After registering a multi-fold jump in pellet sales, we expect pellet

volume to marginally decline in FY14 due to commissioning of DRI plant at Angul.The company is alsoexpected to register strong volume growth in the power segment to the tune of 76% CAGR duringFY12-14E, but most of this growth would be driven by 6x135MW Angul power plant,which is notprofitable due to ceiling on power tariff and higher proportion of e-auctioned coal.

Exhibit 18 : Steel and pellet production

Exhibit 19: Steel and pellet volume




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0123450246810FY08 FY09 FY10 FY11 FY12 FY13E FY14EJSPL power generationJSPL power volume (RHS)(bu)(bu)0246810FY08 FY09 FY10 FY11 FY12 FY13E FY14ETamnar 1 volumeTamnar 2 volume(bu)

Exhibit 20: JSPL power generation and volume

Exhibit 21 : JPL power volume



Angul steel plant value dilutive in medium term

JSPL is investing Rs128,000mn in Angul steel plant, which includes 2.0mt of gas-based DRI, 1.6mt steelmelting shop (SMS), 1.5mt plate mill and 810MW (6x135MW) power plant. The company expects the DRIplant to get operational by the end of 1QFY14, while SMS would also be commissioned at the same time. Weare factoring in a three-month delay in commissioning of this plant and expect commercial production to start

from 3QFY14. We are also conservative on the ramp-up schedule and expect 15% capacity utilisationin 2HFY14. JSPL has started commercial production at its plate mill last month,but the company would getthe feedstock from its Raipur plant and other local suppliers in Orissa till itstarts SMS. We have estimated40% capacity utilisation in FY14E, but it would not have a material impact on profitability, as over 75%of plate mill raw material would be sourced from a third party. The company is using coal gasificationplant instead of normal conventional natural gas at the DRI plant. JSPL believesthere would not be anymaterial savings in the cost structure of sponge iron, but the grade of finishedsteel would be much better thannormal conventional sponge iron routed-steel. The company has been allocated Utkal B1 coal block for itssponge iron operations at Angul. The company has not been allocated any iron oremine and it expects to signthird-party contracts for the same.

Exhibit 22: Angul project details

Project costs

Capacity

Capex (Rsmn)


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DRI (mt)

2.00

31,410

Plate mill (mt)

1.50

26,000

SMS (mt)

1.60

35,770

Power (MW)

810

34,820

Total project costs

128,000

Source: Company


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6x135MW power plant - losing proposition in the absence of linkage/captive coal

JSPL has commissioned two units of 135MW each and both are operating at 70-75% of their capacity. Out ofthe remaining four, the company expects the first unit to start operations by the end of 2QFY13, while the

other three units would get commissioned in every two-three months subsequently.However, the company islikely to commission all units before FY13 in order to get Section 80IA tax benefit. We would like to highlightthat in 3QFY12, JSPL had given guidance to commission all the units prior to FY12 as the Section 80IAtax benefit was scheduled to expire in March 2012. Currently the company has coal linkage for four unitsfrom Mahanadi Coalfield (MCL), but it is receiving only around 35-40% of linkagecoal with the rest beingsourced through e-auction. JSPL is incurring losses on these units as power tariff for captive power plant is

fixed in Orissa and the company is currently selling power at Rs3.2/unit, whilethe costs remain high - inthe range of Rs3.0-3.5/unit - due to large component of e-auctioned coal. Therefore, we believe, it is notcommercially viable to start these units as profitability would remain under severe pressure. We dont expectthe company to operate these units at optimum capacity until there is some clarity on coal sourcing.

Utkal B1 coal block is a major value driver, but uncertainty lurks

JSPL has been allocated Utkal B1 coal block for its sponge iron operations at Angul, Orissa, which has

reserves of 228mt. Despite securing all the clearances (environmental and forestI and II) over sixmonths ago, the company has not been able to sign its mining lease agreement. Earlier, the dispute wasregarding free power supply to Orissa government, where the government finally agreed to 13% freeelectricity off-take of surplus power. However, after the CAG audit of coal mineallocation and the SupremeCourts directive that all natural resources should be auctioned, the Orissa government stopped approvingmining leases for all mining assets. We do not expect resolution of this issue in the near term as coal mineallocation has become a fierce political issue. A revamp of the coal mine allocation policy would takemore than a couple of quarters and we fear the sector may get trapped in policyparalysis, just like thetelecommunications sector.

This coal mine remains significant as it is the most critical asset which will determine the profitabilityof Angul steel and power plant. JSPL would have peak production capacity of 6mtrun of mine (ROM) fromthis mine. The grade of coal is between E and F and hence the company has set upa coal washery. JSPLwould get around 2.1mt of washed coal, which would be used in coal gasification

projects for DRI. Themiddlings production of around 3.6mt would be used in 810MW power plant. We believe that until JSPL starts


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coal mines, its power plants are not likely to turn profitable. We expect aroundRs3,000/tn of saving in steelcosts and Rs1.5/unit of saving in power costs.

Iron ore sourcing a major concern

JSPL has not been allocated any iron ore mine for its Angul steel plant. The com

pany is contemplating variousoptions, which include increasing the output at its existing mine, i.e. Tensa mine from 3mt to 5-6mt, signingthird-party contracts with local vendors in Orissa and using pellets from Barbilunit. However, we believe thatincreasing iron ore output from its current mine requires all necessary approvals and logistics infrastructure,as the company has not applied for the same and it would be a long-drawn affair.We rule out this possibility inthe medium term of two-three years. After the recent controversy regarding the existing third-party contract,with Sarada mines, we feel there is least possibility of the company getting thi

rd-party vendors at lucrativerates. Usage of pellets from Barbil unit is a fair possibility, but we would like to highlight that thecompany is not adding any new pellet unit in Barbil in the next two years; therefore the existingmerchant pellet volume would only be diverted for captive purpose. This would only shift the profitabilityfrom one unit to another, rather than adding any incremental profits.


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-5001,0001,5002,0002,500

FY08FY09FY10FY11FY12(Rs/tn)Exhibit 23: Iron ore costs rose by almost three times in past four years

Source: Company

Returns profile of Angul steel plant

As per our calculations, JSPL needs EBITDA/tn of around Rs11,800 in order to achieve 14% RoE.Although JSPL has achieved this kind of EBITDA in the past at Raigarh steel plan

t, it was achieved with thehelp of captive resources i.e. iron ore and thermal coal. As stated earlier, thecompany is facing tough time ingetting iron ore projects on stream for Angul steel plant, which will result inlower profitability of the unit. Asper our calculations, the company is likely to generate EBITDA/tn of around Rs8,600. This will lead toRoE and RoCE of a mere 2.5% and 5.8%, respectively. Just to give a proper perspective, the companyposted standalone RoCE (CWIP adjusted) of 16.4% for FY12, while average RoCE (CWIP adjusted) for pastfive years stood at 18.5%. In order to generate RoCE similar to FY12, the company needs to achieve

EBITDA/tn of Rs18,150/tn, which seems to be a herculean task in the current situation. As per ourcalculations, EBITDA/tn would improve to around Rs18,000/tn in case of captive raw material sourcing.

Exhibit 24: Return ratios at different EBITDA/tn levels

(Rsmn)

Desired

Actual likely

Various scenario

EBITDA (Rs/tn)

11,836

8,600

9,000

10,000

11,000

12,000


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14,000

16,000

18,000

EBITDA

17,755

12,900

13,500

15,000

16,500

18,000

21,000

24,000

27,000

Depreciation

4,659

4,659

4,659

4,659

4,659

4,659

4,659

4,659

4,659

Interest costs

7,175

7,175

7,175

7,175

7,175

7,175


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7,175

7,175

7,175

PBT

5,921

1,066

1,666

3,166

4,666

6,166

9,166

12,166

15,166

PAT

3,914

705

1,101

2,093

3,084

4,076

6,059

8,042

10,025

RoE (%)

14.0

2.5

3.9

7.5

11.0

14.6


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21.7

28.8

35.9

RoCE (%)

9.3

5.8

6.3

7.3

8.4

9.5

11.6

13.7

15.8

Source: Nirmal Bang Institutional Equities Research

Pellet expansion Not so remunerative

JSPL has 4.5mt pellet plant at Barbil, Orissa, and it is currently operating atcapacity utilisation of around90%. It is currently sourcing fines from own inventory as well as own generation. The company expectsinventories to last for another two-three years. Pellet product was in strong profit cycle in the past 24-36months due to iron ore shortage, but this situation is likely to change going forward. The company isexpanding its pellet production capacity from 4.5mt to 9.0mt, because of the rising requirement of Angul steelplant, which is likely to be commissioned in the next 18-24 months. However, bythe time the companycommissions its next pellet unit, the pellet market would witness pressure on profitability from twosides. Firstly, overcapacity in pellet market with several players setting up pellet units and secondly,the availability of iron ore fines is a cause for concern. As a large number ofpellet units are gettingcommissioned, the current inventory is likely to get exhausted in next 24 monthsat various mines, whilecurrent fines production would not be able to match demand. This will result inhigher prices for iron ore finesand lower prices for pellets.

4x135MW power plant stable operations

JSPL has built captive power units in anticipation of steel capacity rising at i


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ts Raigarh unit. The company isusing middlings as a feed to these units and therefore the variable costs are around Rs1/unit. These units arecurrently making strong profits on the back of lower costs and stable merchant price realisation. However, thecompany is operating three units at optimum capacity (operating at 65-70% due tousage of middlings as

feed) and the fourth unit is likely to stabilise in the next two months.


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2.02.83.64.45.26.00246810FY08 FY09 FY10 FY11 FY12 FY13E FY14ETamnar 1 generation Realisation(bu)(Rs/unit)-142842

5670FY09FY10FY11FY12FY13EFY14ERoERoCE(%)JPLs 1,000MW plant operating at full capacity - the golden phase is over

The company posted strong profits from JPLs 1,000MW power plant with average RoEbeing 49% overFY09-11 on the back of strong merchant power tariff and lower costs due to captive coal mines. Althoughcaptive coal mining would continue to keep costs low for JPL, merchant power tariff has dropped considerablyin the past 12 months. The company is operating at a PLF (plant load factor) of

98% for the past three yearsand there are no levers available to improve the profits except merchant tariff.We believe merchant powertariff will remain in the range of Rs3.5-4.0/unit in the coming quarters. We also believe that stateelections in coming quarters will not have a material impact on merchant power tariff as subdued economicenvironment has hurt demand. Besides this, in case merchant power tariff moves up, there is significantrisk of regulatory action as JSPL has been looked at as a profiteering company due to highermerchant power tariff and lower generation costs on account of captive coal mines.

Exhibit 25 : JPLs Tamnar-1 power generation, realisation

Exhibit 26 : JPLs RoE, RoCE



4x600MW Tanmar - 2 power plant value dilutive

JPL is setting up a 2,400MW (4x600MW) power plant at the same location as Tamnar1 with a capitalexpenditure of Rs134,100mn. The company started work on the plant around 2009, but it had to stop the workas it was lacking environmental clearance. It got all clearances by the end of FY11 and started work on theproject, which is likely to be commissioned by June 2013. Although JPL indicatedthat it is trying hard to

commission its first unit before March 2013 in order to avail the tax benefit under Section 80IA of Income TaxAct, we remain circumspect about commissioning of this unit before March 2013. T


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he remaining three unitswould be commissioned every three months subsequently and the company expects full commissioning bythe end of FY14. We expect the first unit to start commercial power generation by the end of 3QFY14 orthe beginning of 4QFY14. A large portion of volume growth from these projects would be visible in

FY15E and FY16E.

Coal allocation first 2x600MW not figuring in CIL coal linkage list creates uncertainty

JSPL has indicated that it has been allocated coal linkage for first two units of 1,200MW by MahanadiCoalfields (MCL). These mines are part of the Talcher coal block. The company isnot clear about thedefinition of long-term power purchase agreement (PPA), a mandatory requirementfor getting coal linkagefrom Coal India, and the counterparty to PPA. The company has made its presentat

ion to the government thatlong-term PPAs have been out of the market since quite some time. However, we are surprised to see thatthe list of power plants meant for coal linkage under FSA doesnt include first two units of 1,200MWas per the minutes of Standing Linkage Committees (SLC) meeting. Although it doesnt mean that theseunits would never feature in the list again, it has surely added uncertainly tocoal sourcing. For the remainingunits (2x600MW), JPL may have to rely on imported and e-auctioned coal, which would diminish the returnsprofile substantially. The company is also contemplating coal import from overseas subsidiaries. JPL plans to

increase the production at its current coal mines, i.e. Gare Palma IV/2 and IV/3, which supply coal to Tanmar1,000MW unit. This mine has total reserves of 246mt and its peak production capacity is 6.25mt. We seelower possibility of getting coal linkage or increased production at the existing mines, while coal frominternational arms would only shift profitability from one unit to another.


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As per our calculations, the first two units of the project is likely to generate net present value (NPV)of Rs28,574mn based on 65% linkage coal and 35% e-auctioned coal. The company needs to provide 5%power to state grid at a variable cost in case of getting coal linkage. Therefore, we have assumed 3.25% of

power sales at variable cost. Besides this, Chhattisgarh government has first right of refusal for 30% of grosscapacity at a rate to be approved by the appropriate electricity regulatory commission for a period of 20 years.We have assumed long-term merchant rate of Rs3.8/unit for our calculations. However, the remaining twounits are likely to generate negative NPV of Rs11,551mn based on 50% coal sourcing through e-auction and the rest via imports. The entire project is likely to generate NPV of Rs17,022mn,significantly lower than the equity investment of Rs33,525mn.

Largest coal allocation to JSPL makes it vulnerable to regulatory action

JSPL and JPL have been allocated nine coal blocks for captive usage and three coal blocks are operationalfrom these. JSPL has been allocated five coal blocks since 2006 and these blocksare listed in the CAG reporton coal scam. We expect a long wait before the coal scam issue is put to rest and it would impact thecompanys performance. Though Utkal B1 coal block was allocated in September 2003,the recent directivefrom the apex court that all natural resources should be auctioned made the Orissa government to stopsigning mining lease agreements for all mines. The companys sheer size with the f

act that JSPL hasbeen allocated maximum coal reserves, to the tune of 2,587mt, makes it vulnerable to potentialregulatory action. Although, we believe that CAG reporting gains made by privateminers are overstated.Just to cite an example, the CAG has calculated a loss of Rs163,953mn from Ramchandi promotional block. Itmay be noted that foreign currency savings on account of indigenous crude oil, time value of money, indirectand direct tax income, employment generation and overall economic growth enabledwith the help of theseprojects have not been considered by CAG. Nonetheless, JSPL topping the list ofcoal mine allocation has ledto potential fear of regulatory action.

Exhibit 27: Coal blocks allocated to JSPL group

Company

Date of Allotment

Block allocated

Coal fields

State

End-use


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Reserves (mt)

JSPL

20.06.1996

Gare-Palma-IV/1

Hasdoe-Arand

Chhattisgarh

Sponge Iron

124.00

JPL

01.07.1998

Gare-Palma-IV/2

Mand Raigarh

Chhattisgarh

Power

123.00

JPL

01.07.1998

Gare-Palma-IV/3

Mand Raigarh

Chhattisgarh

Power

123.00

JSPL

29.09.2003

Utkal B 1

Talcher

Orissa

Sponge Iron

228.40

JSPL


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13.01.2006

Gare Palma IV/6@

Mand Raigarh

Chhattisgarh

Sponge Iron

156.00

JSPL

20.02.2007

Jitpur

Chupperbita

Jharkhand

Power

81.09

JSPL

17.01.2008

Amarkonda Murgadangal#

Birbhum

Jharkhand

Power

205.00

JSPL

27.02.2009

Ramchandi Promotion Block

Talcher

Orissa

CTL

1,500.00

JSPL

12.10.2009

Urtan North*


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Sohagpur

Madhya Pradesh

Sponge Iron

46.55

Note: @ This block is through a JV with Nalwa Sponge Iron, # This block is via aJV with Gagan Sponge Iron, * This block is via a JVwith Monnet Ispat,

Source: Coal ministry


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Power project costs of JPL highest among peers

The Tamnar-2 power projects total capital cost stands at Rs134,100mn i.e. Rs55.9mn/MW. The costs ofGodda and Dumka power projects are also in a similar range - Rs54.7mn/MW and Rs55.6mn/MW. The costs

remained high compared to peers, which ranges between Rs33.0-52.2mn/MW. This canpartially be attributedto the BTG contract given to BHEL as compared to Chinese players by peers.

Exhibit 28: Power project capital expenditure of various players

Power projects

Capacity (MW)

Total costs (Rsmn)

Costs/MW (Rsmn)

Adani Power Mundra I and II

1,320

43,500

33.0

Sterlite Energy Jharsuguda

2,400

82,000

34.2

Reliance Power Shahapur

1,200

48,000

40.0

Reliance Power Sasan

3,960

160,950

40.6

Reliance Power Rosa II

600

24,600

41.0


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Adani Power Mundra III

1,320

57,960

43.9

Reliance Power Rosa I

600

27,020

45.0

Adani Power Mundra IV

1,980

89,600

45.3

Indiabulls Power Nashik

1,335

60,480

45.3

Adani Power Tiroda I and II

1,980

92,630

46.8

Reliance Power Butibori

300

14,050

46.8

Sterlite Energy Talwandi Sabo

1,980

93,200

47.1

Reliance Power Urthing Sobla

400


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20,800

52.0

Indiabulls Power Amravati

1,320

68,880

52.2

Jindal Power Dumka

1,320

72,240

54.7

Jindal Power Godda

660

36,660

55.5

Jindal Power Tamnar 2

2,400

134,100

55.9

Source: RHP of respective companies


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Too early to start factoring in future projects

The company has announced various projects to increase iron and power capacity multi-fold in the nextcouple of years. However, these projects are just at the early stage of implementation and would take a

couple of years before these projects commence commercial production.

Godda (1x660MW), Jharkhand

JPL is setting up a 660MW power plant in Jharkhand, which was earlier envisagedby JSPL as a captivepower plant (CPP) for supply of power to JSPLs steel plant expansion project in Jharkhand. JSPL has beenallocated Jitpur coal block for this project, which has reserves of 81mt. JSPL has entered into long-term coalsupply agreement with JPL to supply coal for 25 years at a price which would bea sum of mining costs,

transportation charges, loading charges, statutory charges, levies and other charges. In return, JSPL would beentitled to buy 350MW of power for a period of 25 years at a fixed of Rs2.8/unituntil FY19 and Rs2.5thereafter. We are valuing investment in these assets at a discount of 50% considering high gestationperiod and uncertainty regarding coal allocation.

Dumka (2x660MW), Jharkhand

JPL is setting up a 1,320MW power plant (2x660MW) in Jharkhand, which was earlier envisaged by JSPL asa CPP for supply of power to JSPLs steel plant expansion project in Jharkhand. JS

PL, in a joint venture withGagan Infraenergy i.e. Shrestha Mining and Metals Pvt Ltd (SMMPL) has been allocated Amarakonda Murgadangal coal block for this project, which has reserves of 205mt. SMMPL hasentered into a long-termcoal supply agreement with JSPL to supply coal for 25 years at a price which would be a sum of mining costs,transportation charges, loading charges, statutory charges, levies and other charges. In return, JSPL would beentitled to buy 675MW of power for a period of 25 years at a fixed rate of Rs2.8/unit until FY19 and Rs2.5/unitthereafter. We are valuing investment in these assets at a discount of 50% considering high gestationperiod and uncertainty regarding coal mine allocation.

Patratu steel plant, Jharkhand

The company has started work on 3mt steel plant, which would produce long products with an investment ofRs128,000mn. However, the work is expected to expedite post commissioning of Angul steel plant. Thecompany has recently deferred the commissioning date to March 2016 as compared to earlier guidance ofMarch 2015. We believe there can be further delay as sof Angul plant is likely to take more time than

anticipated by the company. We are factoring in a modest capex during FY13-FY14and we are valuing thiscapex at a discount of 50% considering the high gestation period and uncertainty


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regarding resourceallocation.

Coal to Liquid (CTL) project, Orissa

In order to reduce the dependence on imported crude oil and capitalising vast coal sources in India, the

government is planning to set up a first of its kind coal to liquid (crude) project in India. JSPL is one of the twoparticipants, which has been selected for setting up this unit. This project would produce 80,000 barrels perday of crude oil at peak capacity. The project involves a capex of around Rs400,000mn. However, thecompany has made very little progress on this project, while after the CAG report, matters have more or lessstagnated. We dont expect any significant outlay on this project going forward and hence we are notfactoring in any value from this project.

Hydro-power plant

The company plans to set up three hydro power plants with an aggregate capacityof 6,100MW at anestimated capex of nearly Rs400,000mn. The company has started work on these projects, but as hydro-power projects usually have a very high gestation period, JPL expects the firstunit of 1,600MW to becommissioned in FY18, while the rest of 4,500MW power projects would be commissioned by FY20. Thecompany has invested around Rs3,950mn on these projects until now and we expectfurther investment ofRs5,500mn over FY13-FY14. However, we are valuing capital expenditure at a disco

unt of 50%considering the high gestation period.


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International operations

The company has started various projects overseas, of which a couple of them have started yielding results,while a few others are at advance stage of commissioning.

Shadeed steel plant

The company has 1.5mt of gas-based hot briquetted iron (HBI) plant and currentlyit is operating at 90% of itscapacity. Shadeed steel plant sources pellets from merchant market, while the company has signed a long-term gas supply agreement for a period of 10 years at US$1/mmBtu. The company iscurrently havingEBITDA margin of around 20% at current prices and we expect it to sustain in thecoming quarters too. Weare estimating EBITDA of Rs6,306mn and Rs6,107mn for FY13E and FY14E, respectively. The company

is also looking to add a steel melting shop (SMS) with an investment of US$260mn, but it would take around18-24 months to start the project and hence we have not factored this in our earnings estimates. We havevalued SMS capital work in progress at a 20% discount. Although the company hasstated that it is notplanning to add downstream operations, we believe, it would eventually do so.

South Africa coal mine

This coal mine is located at Piet Retief, Mpumalanga, South Africa, with total high grade (anthracite and leanbituminous) mineable reserves of 50mt. The company is targeting production of 1m

t in FY13E and we areassuming 1mt of production for FY13E and FY14E each. Due to the high grade coal,the company is ableto garner US$30-35/tn premium over the benchmark thermal coal prices in international markets, while pricesremain similar to benchmark prices in the domestic market due to export parity.The distance between themine and the nearest port is 320km, where in a large part - to the tune of 90% -is covered by rail. The minehas a stripping ratio of 1:2 and the mining costs are around US$50-60/tn while freight charges are aroundUS$40/tn. We are estimating EBITDA of Rs1,485mn and Rs1,250mn for this mine forFY13E and FY14E,respectively.

Mozambique coal mine

The mine has total reserves of 1.2bn of mineable coal (thermal as well as coking), spread across 25,000hectares, with a grade of 6,000 GCV (gross caloric value). Total distance from mine to the port is 700km,which is covered by road and rail network of 120km and 580km, respectively. Thecompany is guiding to startcoal production in October 2012 and we believe it would be able to start the mine by the end of 4QFY13. The

mine has a stripping ratio of 1:2 and the mining costs are around US$35-40/tn, while the freight charges arearound US$40-45/tn. The company has guided around 1mt of coal production for FY1


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500570640710780850Apr-10Sep-10Mar-11Sep-11Mar-12Sep-12China steel priceGlobal steel price(US$/tn)28032036040044080110140170200Apr-10Sep-10Mar-11Sep-11Mar-12Sep-12Iron OreCoke (RHS)(US$/tn)(US$/tn)4075110145180-

3.57.010.514.0FY07FY08FY09FY10FY11FY12FY13EFY14EFY15EFY16ECapacityDemandDemand/Capacity (RHS)(mt)(%)Industry dynamics painful for integrated producers

Steel prices have corrected significantly in the past six months globally. Chinese domestic as well as exportprices have corrected by 19% each during the same period while European prices have declined 8%. Steel

price drop is lower to a certain extent in American market, to the tune of 4%. An important point to note isthat the decline is not going to materially hurt non-integrated producers as spot iron ore and cokingcoal prices have corrected 37% and 28% in the past six months, respectively, while scrap prices havecorrected 29% in the same period. However, it will surely impact players like JSPL, which is 100%integrated in iron ore and 100% integrated in thermal coal used for sponge iron.

Exhibit 29: Steel price

Exhibit 30: Iron ore and coke prices

Source: Bloomberg

Source: Bloomberg

Plate Industry in India Vulnerable due to capacity addition

The Indian plate industry is going to witness a tough time due to significant capacity addition in the comingquarters. The market was in deficit situation during FY06-09, which was met through imports (this includedhigher grade imports from power players for boiler requirement as well). However, capacity addition by Essarand Welspun resulted in higher capacity than demand, although imports also continued during this period ofhigh grade material that was not available in India. Plate consumption in Indiais 4.5mt versus capacity of 7mtduring FY12. Industry is likely to add around 3mt of capacity during FY13 by pla

yers like Steel Authority ofIndia (SAIL) and JSPL, which would take demand to capacity ratio at 51%. Thoughwe accept the ramp-


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up to be slow, the demand to capacity ratio is expected to remain at 55% in FY14as well. This is likelyto put significant pressure on plate prices. Though we remain negative on the flat steel segment, plate industryremains more vulnerable considering significant capacity addition and low demandto capacity ratio.

Exhibit 31: Plate industry demand and capacity

Source: Crisil Research

Pellet Industry in India Another victim of overcapacity

Pellet industry is also facing enormous capacity addition in Indian market, which would outpace demand by asignificant margin. As per CRISIL research estimate, pellet capacity is likely to rise from 42mt in FY12 to

85mt by FY16. The pellet industry is likely to face a double whammy due to significant capacity addition. Onthe one side, pellet prices are likely to drop significantly due to higher supply, while higher capacity additionwould increase iron ore fines requirement massively, resulting in higher fines prices going forward.


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Risks

Steel prices remain high compared to our estimates

We have assumed around 9% correction in steel prices from 1QFY13 to 4QFY14, largely driven by

higher supply and lower demand due to subdued economic environment. We stand byour assumption thatsteel prices would move towards export parity from import/trade parity. However,in case producers are ableto fine-tune their production and take coordinative action, steel prices may notdecline to the same extent.

Reforms in mining and environmental space

In case the company is able to start Utkal B1 coal block soon, it would give significant boost to share price.Besides this, higher coal production by Coal India would also help in lowering c

oal costs for the company.

Merchant prices surge due to low hydro availability and election

We are assuming merchant power tariff of Rs3.8/unit for FY13E and FY14E, but considering the droughtsituation currently, which would result in lower hydro-power generation, coupledwith election in some statescan result in higher power tariff.


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Financials (consolidated)

Exhibit 32: Income statement

Y/E March (Rsmn)

FY10

FY11

FY12

FY13E

FY14E

Revenue

110,915

131,122

182,086

203,771

246,841

YoY growth (%)

2.0

18.2

38.9

11.9

21.1

Raw material costs

29,976

36,193

68,024

90,172

120,817

% of sales

27.0

27.6

37.4


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44.3

48.9

Employee costs

2,750

4,149

5,913

6,961

7,510

% of sales

2.5

3.2

3.2

3.4

3.0

Power & fuel costs

6,577

8,742

11,298

12,407

12,958

% of sales

5.9

6.7

6.2

6.1

5.2

Admin. & other expenses

13,099

18,875

28,920


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23,581

25,494

% of sales

11.8

14.4

15.9

11.6

10.3

EBITDA

58,513

63,162

67,932

70,649

80,061

EBITDA margin (%)

52.8

48.2

37.3

34.7

32.4

Depreciation

10,006

11,510

13,865

14,777

17,917

EBIT

48,508

51,652

54,067


57/80

55,872

62,145

Interest expenses

3,576

2,596

3,600

8,221

13,570

Other income

603

815

1,419

751

900

Exceptional loss (gain)

0

0

0

5,741

0

PBT

45,535

49,871

51,886

42,661

49,475

Provision for tax

9,189

11,830

11,863


58/80

9,790

11,379

Effective tax rate (%)

20.2

23.7

22.9

22.9

23.0

PAT before MI

36,346

38,040

40,023

32,871

38,096

Minority interest

755

659

574

568

583

profit of associates companies

139

158

200

466

520

PAT after MI

35,730

37,539

39,649


59/80


60/80

103,237

140,169

180,176

211,196

247,479

Shareholders' fund

104,168

141,103

181,111

212,131

248,413

Long-term borrowings

53,298

73,776

111,796

160,596

208,196

Short-term borrowing

32,745

65,952

59,112

68,312

77,212

Total loan fund

86,043

139,728

170,908

228,908

285,408

Minority interest


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1,659

2,335

3,071

3,639

4,222

Deferred tax liability

8,455

10,055

11,920

13,388

15,095

Total liabilities

200,325

293,221

367,010

458,065

553,138

Application of funds

Gross fixed assets

131,582

192,433

222,803

281,653

399,342

Less: Accumulated dep.


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32,608

43,998

57,863

72,639

90,556

Net fixed assets

98,974

148,435

164,940

209,013

308,786

Capital work in progress

79,470

93,809

136,520

177,670

159,981

Total fixed assets

178,444

242,245

301,460

386,683

468,766

Goodwill on consolidation

1,007

1,018

918

918

918

Non-current investments


63/80

3,185

2,979

3,776

4,242

4,762

Inventories

14,308

27,734

35,795

37,654

47,335

Sundry debtors

7,533

11,537

13,068

13,157

16,107

Cash and bank balances

1,128

4,784

1,635

3,437

5,359

Loans and advances

45,541

70,593

93,425

111,884

128,274

Total current assets


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68,510

114,648

143,922

166,133

197,074

Trade payables

16,586

9,336

12,514

12,949

16,600

Other current liabilities

13,792

27,270

29,104

36,661

41,700

Provisions

20,522

31,063

41,449

50,300

60,083

Net current assets

17,611

46,980

60,856

66,222

78,692

Misc. exp. not written off


65/80

78

0

0

0

0

Total assets

200,325

293,221

367,010

458,065

553,138


Exhibit 33:Cash flow

Y/E March (Rsmn)

FY10

FY11

FY12

FY13E

FY14E

EBIT

48,508

51,652

54,067

55,872

62,145

(Inc.)/dec. in working capital

4,010


66/80

(13,300)

(23,403)

(370)

(13,383)

Cash flow from operations

52,517

38,351

30,664

55,502

48,762

Other income

603

815

1,419

751

900

Depreciation

10,430

11,510

13,865

14,777

17,917

Interest paid (-)

3,576

2,596

3,600

8,221

13,570

Tax paid (-)

7,630


67/80


68/80

10,481

21,410

12,200

11,900

Inc./(dec.) in long-term debt

(174)

44,883

11,634

49,196

47,986

(Inc.)/dec. in investments

2,057

273

(797)

(6,591)

(550)

Equity issue/(buyback)

441

113

38

0

0

Cash from financial activities

8,910

55,750

32,285

54,806

59,336

Others

1,978


69/80

276

212

(5,741)

0

Opening cash

6,694

1,128

4,784

1,635

3,437

Closing cash

1,128

4,784

1,635

3,437

5,359

Change in cash

(5,566)

3,656

(3,149)

1,802

1,922


Exhibit 35: Key ratios

Y/E March


70/80

FY10

FY11

FY12

FY13E

FY14E

Per share (Rs)

EPS

38.4

40.2

42.4

35.1

40.7

Book value

111.9

151.1

193.7

226.9

265.7

Valuation (x)

P/E


71/80

10.6

10.1

9.6

11.6

10.0

P/BV

3.6

2.7

2.1

1.8

1.5

EV/EBITDA

7.9

8.1

8.1

8.6

8.2

EV/sales

4.2

3.9

3.0

3.0

2.7

M-cap/sales

3.4

2.9

2.1

1.9

1.5

Return ratios (%)


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RoE

34.3

26.6

21.9

15.4

15.3

RoCE

20.6

14.3

12.2

9.9

9.1

RoCE Adj CWIP

33.6

21.3

19.4

16.3

12.8

RoIC

10.3

2.8

3.2

1.0

5.3

Margin ratios (%)


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EBITDA margin

52.8

48.2

37.3

34.7

32.4

PBIT margin

43.7

39.4

29.7

27.4

25.2

PBT margin

40.8

37.8

28.3

20.9

20.0

PAT margin

32.0

28.5

21.6

16.0

15.4

Turnover ratios


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Asset turnover ratio (x)

1.2

1.5

1.2

1.4

1.6

Avg. collection period (days)

24.8

32.1

26.2

23.6

23.8

Avg. payment period (days)

121.9

53.4

42.2

37.5

38.0

Solvency ratios (x)

Net debt-equity ratio


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0.8

1.0

0.9

1.1

1.1

Interest coverage ratio

16.4

24.3

18.9

8.6

5.9



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Disclaimer

Stock Ratings Absolute Returns

BUY > 15%

HOLD 0-15%

SELL < 0%

This report is published by Nirmal Bangs Institutional Equities Research desk. Nirmal Bang has other business units with independent research teams separated byChinese walls, and therefore may, at times, have different or contrary views onstocks and markets. This report is for the personal information of the authorisedrecipient and is not for public distribution. This should not be reproduced or r

edistributed to any other person or in any form. This report is for the generalinformationfor the clients of Nirmal Bang Equities Pvt. Ltd., a division of Nirmal Bang, and should not be construed as an offer or solicitation of an offer to buy/sell any securities.

We have exercised due diligence in checking the correctness and authenticity ofthe information contained herein, so far as it relates to current and historicalinformation, but do not guarantee its accuracy or completeness. The opinions expressed are our current opinions as of the date appearing in the material and may

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Team Details:


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Name

Email Id

Direct Line

Rahul Arora

CEO

[email protected]

+91 22 3926 8098 / 99

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Head of Research

[email protected]

+91 22 3926 8017 / 18

Sales and Dealing:


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Dealing Desk

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jindal steel - nb

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