sponge iron industry b k oct 06

8/9/2019 Sponge Iron Industry b k Oct 06

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4th October 2006

B&K SecuritiesBatlivala & Karani

SECTOR UPDATE

Indian economy is one of the fastest growing economies of the world

with 7.5-8% expected Real GDP growth. Steel demand is expected to

double by 2012 on rising demand from infrastructure and construction

sector. About 48% of steel is made through secondary route (Electric

route) which uses mix of sponge iron and scrap in steel making.

We see the demand of sponge iron to remain buoyant driven by growth

in steel production.

Production of steel scrap in India is low at 15-20% of its consumption

due to longer product life cycle, as the country is in developing phase andthe consumption pattern is tilted in favour of infrastructure and

construction rather than consumer durables. Therefore, secondary steel

makers have to depend on imported steel scrap. Coal based sponge iron

is fast replacing imported steel scrap due to low cost of production as

non-coking coal and iron ore (two critical raw materials) are domestically

available and its production is rising.

The growth of gas based sponge iron has been limited due to poor

availability and higher cost of gas. Essar Steel, Ispat Industries and Vikram

Ispat are the only producers in India who came up in 1990s on westerncoast of India.

The future of sponge iron will belong to the players who have their

captive sources of raw materials which will insulate them from market

fluctuations. Presently, only Jindal Steel & Power and Monnet Ispat have

captive resources of both iron ore and coal. Tata Sponge has recently

acquired 115 mn tonnes mineable coal deposit in Orissa which will get

functional by FY09.

Key industry data (Sponge Iron production)

(Mn tonnes) FY06 FY12E CAGR (%)

Gas based 4.5 7.1 8

Coal based 7.3 16.3 14

Total 11.8 23.4 12

% of Coal based 61.6 69.6 –

Sponge Iron Industry – Growing with Steel

Sanjay Jain Ashish Kejriwal

[email protected] [email protected]

Tel.: 91-22-4007 6217 Tel.: 91-22-4007 6216


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B&K RESEARCH OCTOBER 2006

SPONGE IRON INDUSTRY 2

Investment arguments

The production of sponge iron (Direct Reduced Iron/Hot Briquetted Iron) started in late

1970’s with one small sponge iron plant in the public sector in Andhra Pradesh viz. Sponge

Iron India Limited. During last decade, due to growth in domestic steel demand, a vigorous

growth in domestic steel production led by the secondary steel making sector, relatively low

cost of investment and ease of setting up of a sponge iron plant, availability of mineralresources, frequent problems of scrap (affordability and availability), the sponge iron industry

has grown manifold and India became the world leader in sponge iron production in 2003.

Growth in steel production

The demand for steel continues to rise due to boom in infrastructure and construction

industry. The production of crude steel has grown at a CAGR of 9% during FY01-06 and

reached at 41.3 MT in FY06.

0

5

10

15

20

25

30

35

4045

F Y 0 1

F Y 0 2

F Y 0 3

F Y 0 4

F Y 0 5

F Y 0 6

( m n t o n s )

Crude steel production

Increasing crude steel production

Source: SAIL

The production of steel through the secondary route (EAF, IF), using hot metal (pig iron),

sponge iron/scrap as their basic raw materials, accounts for approx. 48% of the total steel

output and has grown at a CAGR of 18% during FY01-05. The trend is expected to continue

due to rising availability of coal based sponge iron produced from domestically available raw

material. The flue gases generated in sponge iron making are utilised for production of power

for captive consumption.

Increasing production through the secondary route

(Mn tonnes) FY01 FY02 FY03 FY04 FY05 CAGR (%)

Crude steel production 26.9 28 30.4 34.2 38.5 9

Main producers 17.3 17.8 19.0 20 20.0 4

Secondary producers 9.6 10.2 11.5 14.2 18.5 18

EAF 5.3 5.9 6.7 8.2 10.2 –

IF units 4.3 4.3 4.8 6 8.2 –

% share of secondary producers 36 36 38 42 48 –

Source: JPC

Domestically available raw

materials would continue to

drive growth


3/30



Continued substitution demand for scrap

Proportion of sponge iron in secondary production is expected to go up. Production of steel

scrap in India is low at 15-20% of its consumption due to longer product life cycle, as the

country is in developing phase and the consumption pattern is tilted in favour of infrastructure

and construction. Domestic availability of scrap is low, as the ship-breaking industry (main

source of indigenous scrap generation) isn’t getting enough ships for breaking. Therefore,

secondary steel makers have to depend on imported steel scrap. Coal based sponge iron is

fast replacing imported steel scrap due to low cost of production, as non-coking coal and iron

ore (two critical raw materials) are domestically available and its production is rising.

Increasing share of sponge iron by secondary producers

(%) 00-01 01-02 02-03 03-04 04-05 05-06

Sponge iron 30 30 38 43 50 60

Scrap/Pig iron 70 70 62 57 50 40

Source: AML Steel

As Indian steel producers have to depend on import of scrap, the domestic prices of sponge

iron align with the landed price of scrap.

0

50

100

150

200

250

300

1 9 9 6

1 9 9 8

2 0 0 0

2 0 0 2

F e b - 0 3

A p r - 0 3

J u n - 0 3

A u g - 0 3

O c t - 0

3

D e c - 0

3

F e b - 0 4

A p r - 0 4

J u n - 0 4

A u g - 0 4

O c t - 0

4

D e c - 0

4

F e b - 0 5

A p r - 0 5

J u n - 0 5

A u g - 0 5

O c t - 0

5

D e c - 0

5

F e b - 0 6

A p r - 0 6

J u n - 0 6

-

2,0004,000

6,000

8,000

10,000

12,000

14,000

16,000

Scrap Shredded fob Rotterdam $/ton (LHS)DRI prices, Kolkata (Rs/ton incl. excise & taxes, RHS)

Scrap vs. DRI prices

Source: Metal Bulletin, JPC

Sponge iron replacing

imported steel scrap due to

low cost of production

Sponge iron price move in line

with landed cost of steel

scrap


4/30



Overview

The Indian sponge iron industry has seen a rapid and powerful growth in the coal based

sponge iron segment in the country, while the gas based segment is restricted mainly to 3

producers namely Essar Steel, Vikram Ispat and Ispat Industries due to expensive and limited

supply of natural gas. Moreover, the cost of setting a gas based sponge iron unit is very high

which is not feasible for small players. The demand of sponge iron in India has grown at aCAGR of 10% over the last 10 years.

Production – Processes & Technologies

In India, mainly coal based rotary kilns and gas based shaft furnace reactors are used for

producing sponge iron.

Coal based process

Coal based plants are of smaller size, requires low capital investment. Sponge iron is produced

by reducing iron ore using non-coking coal. Iron ore lumps and non-coking coal are charged

into a rotary kiln in requisite proportion along with fluxes. Coal plays a dual role in the process

by acting as a redundant as well as fuel for providing heat to maintain the requisite temperature

inside the kiln at 950°-1050°C. The reduction process occurs in solid state. Waste heat from

spent gases is utilised to produce power.

Gas based process

Gas based plants are of relatively larger sizes, require higher capital investment and uses

Midrex and HYL-III technologies for reducing iron ore pellets with natural gas as the redundant

in the reactor. The difference between the two technologies is the process of reforming and

use of the spent gas. The Midrex uses CO2(+ steam) based reforming of the natural gas while

HYL-lll uses mainly the H2

O reforming process. The specific consumption of various raw

materials for production of 1 tonne sponge iron (by Midrex process) include iron oxide 1.49

tonnes, natural gas of 2.5 GCal and 100 KWh of electricity. The hematite ore pellets/lumps

should possess 67% Fe minimum.

Composition of Coal and Gas based Sponge Iron

(%) Fe (Metallic) Metallisation Carbon Sulphur Phosphorus Size

Coal based 81-84 90 (+/-2) 0.2-0.3 .025-.03 max .05-.06 max 3-30 mm

Gas based 86.5 93+ 1.5-3 .015 max .04 max 6-200 mm

India has been the world’s largest producer of sponge iron since 2003 producing 11.8 mntonnes in FY06, registering a growth of 15% over the last year. This has been due to rapid and

powerful growth in the coal based sponge iron segment in the country.

Sponge iron produced by

reducing iron ore using

non-coking coal

Requires high capital

investment, sponge iron

produced by reducing iron ore

pellets using natural gas


5/30



The share of coal based DRI production has increased from about 37% in FY01 to about

62% in FY06 and the gap is expected to widen further in the coming years.

Sponge iron (DRI/HBI) production

(Mn tonnes) FY04 FY05 FY06 FY07E FY08E FY09E FY10E FY11E FY12E

Gas based 4 5 5 6 7 7 7 7 7

Coal based 4 6 7 10 12 13 15 16 16

Total 8 10 12 16 19 20 22 23 23

Growth (%) 17 27 15 32 20 7 8 7 1

% of Coal based 51 55 62 62 63 65 67 69 70

0

2

4

6

8

10

12

14

16

18

F Y 0 4

F Y 0 5

F Y 0 6

F Y 0 7 E

F Y 0 8 E

F Y 0 9 E

F Y 1 0 E

F Y 1 1 E

F Y 1 2 E

p r o d u

c t i o n ( m t p a )

Gas Based Coal Based

Sponge Iron production

Source: JPC & B&K Estimates

Gap expected to widen further

in coming years

Source: B&K Estimates


6/30



Raw materials scenario

Non-coking coal

Non-coking coal is the basic raw material for coal based sponge iron plant. Although, India

has a vast reserves of non-coking coal (about 221 bn tonnes out of which proven reserves

are about 79 bn tonnes) but of inferior quality with higher percentage of ash content. The

high ash content is a major problem for sponge iron producers, as higher coal consumption is

needed in order to affect the same degree of reduction. Over 75% of non-coking coal

production is the lower D, E, and F grade. Generally, with 1% increase in the ash content,

production capacity decreases by about 2.5%. According to industry estimates, calibrated

non-coking coal (grade B/C) requirement is about 1-1.2 tonnes per tonne of sponge iron

produced but if low grade (grade D/E/F) coal is being used, then the coal required will go up

to as much as 2.5 tonnes or more.

The non-coking coal with a higher % of ash content needs to be washed and should be

brought it to a level of 25% or less for use in sponge iron kilns which adds to the cost. Freight

charges by railways constitutes about 30-40% of the total cost of non-coking coal. So, it’sbeneficial for the DRI (Direct Reduced Iron)/sponge iron producers to set up plants near

coal mines so as to save on transportation costs. Therefore, most of the players are located in

Chhattisgarh, Orissa and West Bengal region.

Many big players have already acquired captive coal blocks or are in the process of acquiring

it. But small players which are numerous in India have to depend on the market. Coal India

Limited has introduced the system of E-auction and supply of coal through Multi Commodity

exchange for the core sector other than the power utilities. So, now the prices are market

driven which will inevitably interrupt consistent supplies for producers who depend on market.

Higher ash content and increasing coal prices due to demand-supply mismatch put pressureon the margins of the players. Some players like Tata Sponge Iron Limited started importing

low ash content non-coking coal and blend it with high ash content domestic non-coking coal.

Although, imported non-coking coal is very expensive vis-à-vis domestic one but in order to

improve the efficiency of the kilns, large players have started doing so.

Iron ore

Coal based sponge iron plants normally use 100% lump ores with Fe content greater than

62% while the gas based plants normally use a feed mix of iron ore pellets and lumps of

around 67% Fe content. According to industry norm, about 1.6 tonnes of calibrated lump

iron ore (5-18mm, Fe: Minimum 62%) is required to produce 1 tonne of sponge iron.

India has vast reserves of medium grade iron ore (hematite ores, Fe: 62-65%) which are

mainly located in the states of Orissa, Jharkhand, Chhattisgarh, Karnataka and Goa region.

Vast reserves of non-coking

coal but of inferior qualitywith higher percentage of ash

content

Players located near coal

mines

Increasing coal prices put

pressure on the margins of

the players


7/30



Increasing prices

About 54% of the total domestic production is exported in FY05 due to better realisation at

the global level owing to the higher demand of steel worldwide, in particular China. The price

at the domestic level is also moving northward.

Recoverable reserves of hematite as on 1.4.2000

(Mn tonnes) High Grade Medium Grade Low Grade Others Total

(Fe+65%) (Fe 62-65%) (Fe


8/30



Raw material facility

More than 80% of the sponge iron producers are small producers (installed capacity of less

than 60,000 TPA) and have to depend on the market for basic raw materials. Producers are

unable to utilise their capacity to the fullest and are on the verge of closure amidst fluctuating

and increasing prices of raw materials, shortage of power facilities and lack of infrastructure.

Integrated players having captive raw materials are at advantageous position.

Captive power position

(Unit: KWh) Module-wise power position

Module (TPA) Power generation Own consumption Surplus power

150,000 10-12 3.5 6.5

100,000 7-8 3 5

30,000 2-2.5 1.5 1

Source: JPC

Regional overview

State/Region Total No. Captive power Coal Iron ore

of units generation linkage source

Chhattisgarh 38 8 24 7

Orissa 33 4 24 2

West Bengal 30 0 23 2

Jharkhand 11 2 5 2

Karnataka 13 1 1 3

Andhra Pradesh 12 1 6 1

Tamil Nadu 2 0 2 1

Goa 3 0 1 1

Maharashtra 5 0 2 1

Others 56 0 0 0

Total 203 16 88 20

Source: JPC

Raw material availability and regional production

Chhattisgarh alone accounts for about 38% of total coal based sponge iron production.

Besides, production is largely concentrated in Eastern region (Orissa, West Bengal and

Jharkhand) contributing about 39% in total coal based production in FY05 due to their

proximity to basic raw materials – iron ore and non-coking coal. The industry is virtually non-

existent in North India due to scarcity of raw materials. Gas based producers are located in

Western India only due to their proximity to natural gas. The whole production is consumed

domestically. This scenario is unlikely to change in the coming years due to increasing domestic

demand by the secondary producers.

Additional income to Coal

based sponge iron plant


9/30



Sponge iron production – Geographical distribution

Chhattisgarh, Orissa, West

Bengal and Jharkhand

contributing approx. 77% of

total Coal based DRI

production in FY05


10/30



0

0.5

11.5

2

2.5

3

3.5

4

F Y 0 1

F Y 0 2

F Y 0 3

F Y 0 4

F Y 0 5

F Y 0 6

m t p a

Capacity Production Sales Captive cons.

Sponge iron

Source: Essar Steel, annual reports

The Gas based Sponge Iron producers

Gas-based sponge iron is produced by Midrex process and HYL-III process using naphtha

or natural gas. This process is employed by Essar Steel, Ispat Industries and Vikram Ispat

(only Vikram Ispat uses HYL-III process). The entire sponge iron production of Vikram

Ispat is sold in the open market. Other gas based producers mainly consume it internally for

the production of steel.

Essar Steel

Essar Steel operates the world’s largest gas based Direct Reduced Iron (DRI) plant with a

production capacity of 3.4 million tonnes per annum (MTPA) at Hazira, Gujarat (5 gas based

modules with Midrex technology). The plant uses state-of-the-art technology, which ensures

high quality raw material for the steel plant. DRI is produced in two forms, namely, Hot

Briquetted Iron (HBI) and Hot Direct Reduced Iron (HDRI).The HDRI system is an Essar

innovation that saves approx. 100 KWh/tonne of HDRI consumed by Electric Arc Furnace,

thus, utilising the 650° Celsius heat contained in the HDRI. The plant is supported by a

captive power plant of 32 MW, which operates at 100% capacity.

Raw materials linkages

• Iron ore – The company has a long-term contract with National Mineral Development

Corporation for calibrated lump iron ore and fines. The company has 8 MTPA capacity

pelletisation plant at Visakhapatnam and 8 MTPA iron ore beneficiation plant at Bailadila.

• Natural gas – The company also has long-term contracts for the supply of gas with GAIL,

IOCL, BPCL, GSPC etc. But, the supply of gas is erratic. Normally, 125 KWh of electricity

is consumed and on an average 325 SM3 of natural gas is used for producing a unit of

HBI.

HBI produced for captive consumption

Essar uses the HBI-Electric Arc Furnace-Continuous caster-Hot strip mill route to strip

making. The company consumes almost entire HBI produced for making steel.

World’s largest gas based DRI

plant having production

capacity of 3.4 MTPA

Long-term linkages for iron

ore and natural gas

Production mainly for captive

consumption


11/30



Ispat Industries Ltd.

Ispat Industries Limited (IIL) (formerly known as Nippon Denro Ispat), promoted by the

Mittals of Ispat group, is one of the leading integrated steel makers in India. The company

commissioned its gas based single mega-module plant for making sponge iron in Dolvi, Raigarh

(Maharashtra) in 1994 using direct-reduction technology “Megamond series 1000 module”

from Midrex Corporation, US, the world leader in this field. The current installed capacity of

the plant is 1.6 MTPA.

Raw materials dependence

• Iron ore – The company sources its iron ore pellets requirements from National Mineral

Development Corporation, as IIL has no captive iron ore mines.

• Natural gas – Natural gas is sourced from GAIL, India but IIL is getting less gas due to

overall shortage of gas supply in India. Therefore, the company is not able to operate the

plant at its enhanced capacity.

Captive consumption

Ispat Industries, being the producer of hot rolled coils in India, currently consumes almost

entire sponge iron produced internally. In FY06, the production of HBI got affected due to

lower availability of natural gas as well as due to shutdown of plant for 35 days during May-

June for capital repairs.

0

0.2

0.4

0.6

0.81

1.2

1.4

1.6

1.8

F Y 0 1

F Y 0 2

F Y 0 3

F Y 0 4

F Y 0 5

F Y 0 6

m t p a

Capacity Production Sales Captive cons .

Sponge iron

Source: Ispat Industries, annual reports

Less availability of natural

gas restricts plant to operate

at its enhanced capacity

Production mainly for captiveconsumption


12/30



Vikram Ispat (Unit of Grasim Ind.)

Vikram Ispat, a unit of Grasim Industries Ltd. is located at Salav village in Raigad, Maharashtra.

The plant was set up in 1989 with a capacity of 0.75 MTPA of sponge iron in the form of

HBI, based on HYL-III technology from HYLSA, Mexico. In 1998, Oxygen Injection System

and DRI Cooling system was commissioned and the plant capacity was increased to 0.9

MTPA. The plant can produce both HBI and DRI from the same reactor.

Raw materials

• Iron ore in the form of pellets is sourced from Gujarat Industrial Investment Corporation

and lump ore from Bailadila .The company doesn’t have captive mines.

• Natural gas consisting of 90-95% methane is sourced from the piping network of GAIL,

India. The plant has been integrated with total energy concept (due to HYL III process)

with 8.7 MW power capacity.

0

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0.4

0.6

0.8

1

F Y 0 1

F Y 0 2

F Y 0 3

F Y 0 4

F Y 0 5

F Y 0 6

m t p a

Capacity Production Sales

Sponge iron

Source: Grasim Industries, annual reports

Less availability of natural gas rising input cost

In FY06, due to an acute shortage of natural gas (continuous reduction in the generation of

gas from ONGC wells over the last five years), the plant couldn’t be utilised properly and

hence production fell. In order to cater to the market demand, the plant has been using

supplementary energy sources like naphtha and propane which are 5-6 times costlier than

natural gas. The input cost has increased in multiples leaving the business margins bare

minimum.

No captive consumptionVikram Ispat is the only gas based sponge iron player selling its entire production in the

market, as the company has no steel making facility. In FY06, sponge iron constitutes approx.

9% to the total turnover of the company.

Plant having capacity of 0.9

MTPA can produce both HBI

and DRI from the same

reactor

Entire production is sold in

the open market


13/30



Coal based sponge iron producers

Jindal Steel & Power Ltd.

Jindal Steel & Power Limited (JSPL) with an installed capacity of 1.37 MTPA (10 kilns) in

Raigarh, Chhattisgarh is the world’s largest coal based sponge iron plant today. JSPL, being

integrated backwardly has its own captive raw material resources (iron ore & coal) and power

generation, which in turn has enabled the company to insulate itself from the market fluctuations

of raw material prices and to control quality and enhance production. Presently, JSPL is using

in-house Jindal technology for producing sponge iron.

Captive raw materials insulating JSPL from market fluctuations

• Iron ore: JSPL is operating a captive iron ore mine at Tensa in Orissa. The requirement of

iron ore is met from company’s Tensa mines.

• Non-coking coal: The total requirement of non-coking coal of +6-20 mm size is met from

the captive colliery (equipped with coal washery with the capacity of 6 MTPA) developed

by JSPL at Tamnar in Chhattisgarh. JSPL saves on transportation owing to having its

plant near captive coal mines.

• Dolomite: Dolomite is sourced from Baradwar in Chhattisgarh (about 70 km from Raigarh).

• Captive power generation: JSPL also saves on power front due to captive power generation

based on flue gases generated in sponge iron making.

0

0.2

0.4

0.6

0.81

1.2

1.4

1.6

F Y 0 1

F Y 0 2

F Y 0 3

F Y 0 4

F Y 0 5

F Y 0 6

( m t p a )

Capacity ProductionSales Captive cons.

Sponge iron

*Increased capacity in FY05 to 1.37mtpa from 0.65mtpa

Source: JSPL, annual reports

Four new kilns for making sponge iron have been added in 2005 which has raised thecapacity from 0.65 MTPA to 1.37 MTPA. The increased production of sponge iron will be

consumed internally for ramping up production of steel.

World’s largest coal based

sponge iron plant having

capacity of 1.37 MTPA

Increased production of DRI will be used internally for

ramping up of production of

steel


14/30



Monnet Ispat

Monnet Ispat Limited (MIL), promoted jointly by Sandeep Jajodia and Jindal Strips in 1990

manufactures sponge iron, steel billets and various finished steel products near Raipur in

Chhattisgarh. MIL is one of the largest coal-based sponge iron producer in India (installed

capacity: 0.3 MTPA) backed by captive resources of raw material viz. coal, iron ore and

captive power.

Over the years, MIL has steadily ramped up capacities from 0.1 MTPA of sponge iron in

FY00 to 0.3 MTPA in FY04. MIL is setting up six sponge iron kilns (4 kilns of 350 TPD and

2 kilns of 100 TPD each) with total capacity of 0.5 MTPA which is expected to commence

production in the beginning of 3QFY07.

The company also has captive power plant at Raipur (60 MW) operating on flue gases from

sponge iron kilns which reduces company’s dependence on state electricity boards. MIL is

also in the process of installing 90 MW captive power plant at Raigarh operating on char and

coal fines from sponge iron plant and captive coal mine.

Backward integration gives competitive advantageCoal Mine – Raigarh: This underground mine has extractable reserves of 86 mn tonnes

(estimated reserves are 126 mn tonnes). The quality of coal is better than open-cast mine.

MIL started the production of coal in April 2005 and is currently mining at the rate of 0.6

MTPA and plans to ramp it up to 1.2 MTPA in order to meet the increased demand of coal

from Raigarh project. Most of the company’s in-house requirements for coal would be met

from the captive sources.

Iron Ore Mine – Orissa: The mine has estimated 30 mn tonnes of extractable iron ore

reserves which will be entirely for captive use.

0.0

0.1

0.1

0.2

0.2

0.3

0.3

0.4

F Y 0 1

F Y 0 2

F Y 0 3

F Y

0 4

F Y

0 5

F Y

0 6

m t p a

Capacity ProductionSales Captive cons .

Source: Monnet Ispat, annual reports

Over the years, MIL has started increasing the usage of sponge iron for captive consumption.

Sponge iron contributes approx. 25% to the total turnover of the company.

Sponge iron

Production capacity expected

to increase to 0.8 MTPA by

3QFY07

Captive coal mines insulate

MIL from market fluctuations

of coal prices


15/30



Coal based sponge iron producers

Company Present capacity Production Coal cost/ Iron ore cost/ Remarks

(tonnes) (FY05) tonne DRI tonne DRI

Jindal Steel & Power 1,370,000 692,682 1,050 1,575 Captive raw materials, produces steel.

Tata Sponge Iron Ltd. 390,000 223,686 3,750 2,880 Acquired coal mines, get operational by FY09.

Monnet Ispat Ltd.* 300,000 240,133 1,375 2,400 Captive raw materials, iron ore mines getoperational soon. produces steel.

GSAL (India) Ltd. 220,000 68,967 3,479 5,526 No captive resources.

Raipur Alloy & Steel 210,000 91,767 2,800 6,400 Acquired iron ore & coal mines, will get

operational in future, produces steel.

Singhal Enterprises (P) 198,000 134,537 3,450 5,280 No captive resources.

Bihar sponge Iron Ltd. 180,000 140,998 3,250 4,370 No captive resources.

Sunflag Iron & Steel Co. 150,000 134,192 3,103 6,720 No captive resources, produces steel.

HEG Ltd. 120,000 87,141 3,019 5,965 No captive resources, produces steel.

Orissa Sponge Iron Ltd. 100,000 108,116 2,750 4,740 No captive resources, produces steel.

*Increasing its capacity to 800,000 tonnes in FY07.

Source: Industry sources.

The players like Jindal Steel & Power who has captive raw materials incurred approx. Rs.

2,900/tonne variable cost in making sponge iron against approx. Rs. 8,800/tonne for players

having no captive raw material sources. Monnet Ispat has acquired iron ore mines to reduce

its variable cost/tonne of sponge iron further. Tata Sponge is moving towards second level,

as the company has recently acquired coal mines which will insulate the company from the

market fluctuations and helps in reducing coal cost. Increasing prices of raw materials make

small players vulnerable and many players have shutdown temporarily.

Future prospects

The sponge iron industry has been posting strong growth over the last five-six years. The

growth of Indian sponge iron industry will be propelled mainly by coal based sponge iron

producers. This is due to availability of abundant raw material domestically and low capital

required in installing sponge iron plant. There is limited scope for new gas based sponge iron

01000

20003000400050006000700080009000

( R s )

C a p t i v e R a w

M a t e r i a l s ( 1 s t )

C a p t i v e c o a l

m i n e s ( 2 n d )

L i n k a g e - I r o n

o r e ( 3 r d )

N o

L i n k a g e s ( 4 t h )

Plants with

Others

Power

Fuel oil

Dolomite

Non-CokingCoal

Iron Ore

Cost structure (Coal based sponge Iron producers)

Source: B&K Research

Note: Jindal Steel & Power falls in 1 st, Monnet Ispat in 2nd and Tata Sponge in 3rd category.

Secured Future

Struggling to

Survive

Acquired coal

mines

A cq u i red i ro n

o re m i ne s

Players like JSPL having

captive raw materials

produce at a very low cost and

have a secured future


16/30



Demand for sponge ironexpected to grow due to

availability of abundant raw

material domestically,

growth being propelled by

Coal based DRI producers and

the future will belong to the

players who have captive

sources of raw materials

unit coming in near future. The existing 3 players may plan for further expansion but it

depends on the future availability of natural gas which is in short supply currently. The

availability of natural gas is expected to improve for Ispat Industries and Vikram Ispat by end

2007, as the Dahej-Uran gas pipeline is slated to be commissioned by then.

On the raw material front, the supply of basic inputs for coal based sponge iron, iron ore and non-

coking coal are abundant. But increasing iron ore prices and inferior quality of non-coking coal

poses a problem for DRI producers. Increasing freight and power cost also poses problem for

small producers. Therefore, the future of sponge iron will belong to the players who have captive

sources of raw materials which will insulate them from market fluctuations. Presently, only Jindal

Steel & Power and Monnet Ispat have captive resources of both iron ore and coal (production

from iron ore mines of Monnet Ispat will commence soon). Tata Sponge has recently acquired

115 mn tonnes mineable coal deposit in Orissa which will be functional by FY09.

The demand for sponge iron is expected to remain firm, as it directly depends on the demand

of steel which is expected to reach more than 110 mn tonnes by 2020. With increasing share

of secondary producers which uses mix of sponge iron and scrap in making steel and reduced

domestic availability of high quality scrap and its increasing cost, the future demand for

sponge iron looks promising.


17/30



Global scenario

Global production of sponge iron (DRI/HBI) has been strong over the last decade. The steel

industry globally is using about 25% of the alternative iron sources like DRI/HBI to produce high

quality steels in the EAFs. DRI is now recognised as a high purity, top quality charge material

throughout the world which has been reflected by the strong growth of sponge iron (DRI/HBI)

production which has risen to 56 MTPA in 2005 as against about 40 MTPA in 2001.

0

10

20

30

40

50

60

70

1 9 9 6

1 9 9 7

1 9 9 8

1 9 9 9

2 0 0 0

2 0 0 1

2 0 0 2

2 0 0 3

2 0 0 4

2 0 0 5

2 0 0 6 E

( M t )

World DRI production

Source: Midrex Technologies, Inc & B&K estimates

EAF production – Increasing share in steel making

The production through the EAF route has gone up from about 26.6% in 1988 of the global

production to about 31.7% in 2005. Outside China, very few new blast furnaces have been

built in recent years. EAF steelmaking continues to grow because of its capital and operating

cost advantages vis-à-vis the integrated route. This growth results in increased demand for

EAF charge materials which includes scrap, DRI/HBI and pig iron. Since world steel production

was essentially flat from 1980-95, the growth rate of the obsolete scrap supply leveled off

which led to increase in their prices. Amidst these limitations, demand for DRI increased and

its use in EAFs increased by almost 12 MT in 2000-05. We expect this trend to continue in

future.

Geographical distribution

Sponge iron producers are mainly concentrated in Latin America (including Mexico), Middle

East and Asian region. Latin America is still the largest producers of DRI in the world but over

the last three years, their share has declined from 36% of total world DRI production to 34%

in 2005. This is due to increasing prices of natural gas and larger growth in the coal based DRI

production by Indian producers which led to overall increase in India’s share to 20%.

Increasing steel production

through EAF route and low

availability of scrap boost

demand for sponge iron


18/30



Production – Geographical distribution

(Mn tonnes) 2000 2001 2002 2003 2004 2005

Latin America 16.0 14.1 16.0 17.0 19.0 19.3

Argentina 1.4 1.3 1.5 1.7 1.7 1.8

Brazil 0.4 0.4 0.4 0.4 0.4 0.4

Mexico 5.8 3.7 4.9 5.6 6.5 6.0

Peru 0.1 0.1 0.0 0.1 0.1 0.1

Trinidad & Tobago 1.5 2.3 2.3 2.3 2.4 2.1

Venezuela 6.7 6.4 6.9 6.9 7.8 9.0

Middle East/N. Africa 12.1 12.1 13.0 13.9 15.3 15.9

Egypt 2.1 2.4 2.5 2.9 3.0 2.9

Iran 4.7 5.0 5.3 5.6 6.4 6.9

Libya 1.5 1.1 1.2 1.3 1.6 1.7

Qatar 0.6 0.7 0.8 0.8 0.8 0.8

Saudi Arabia 3.1 2.9 3.3 3.3 3.4 3.6

Asia/Oceania 10.1 10.6 11.3 13.8 14.7 15.3

Australia 0.6 1.4 1.0 2.0 0.7 –

Myanmar 0.0 0.0 0.0 0.0 0.0 –

China 0.1 0.1 0.2 0.3 0.4 0.4

India 5.4 5.6 6.6 7.7 9.4 11.1

Indonesia 1.8 1.5 1.5 1.2 1.5 1.4

Malaysia 1.3 1.1 1.1 1.6 1.7 1.4

New Zealand 0.9 0.9 0.9 1.0 1.0 1.0

North America 2.7 0.1 0.7 0.7 1.3 0.8

Canada 1.1 – 0.2 0.5 1.1 0.6

US 1.6 0.1 0.5 0.2 0.2 0.2

Former USSR/Eastern Europe 1.9 2.5 2.9 2.9 3.1 3.3

Russia 1.9 2.5 2.9 2.9 3.1 3.3

Sub-Saharan Africa 1.5 1.6 1.6 1.5 1.6 1.8

South Africa 1.5 1.6 1.6 1.5 1.6 1.8

Western Europe 0.5 0.2 0.5 0.6 0.6 0.4

Germany 0.5 0.2 0.5 0.6 0.6 0.4

World Total 44.7 41.3 46.0 50.5 55.6 56.8

Source: Midrex Technologies, Inc.


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34%

28%

7%

20%

6% 3% 1%1%

36%

29%

10%

14%

6% 3% 1%1%

Major DRI Producing Blocs (2002) Major DRI Producing Blocs (2005)

Latin America( including Mexico) Middle East/ North AfricaAs ia/ Oceania(excluding India) India

Former USSR/Eas tern Europe Sub-Saharan AfricaNorth America(US & Canada) Wes tern Europe

Source: Midrex Technologies, Inc

Production processes

Globally, about 85% of the sponge iron is produced through gas based process mainly in large

gas rich areas like Middle East, Latin America and Russia. Coal based process has increased

from less than 10% in the 1990s to about 15% in 2005 due to the proliferation of small rotarykiln plants in India. Among different production processes, Midrex Technology continues to

dominate the world scenario with more than 60% market share since 1987.

0

5

10

15

20

25

30

35

40

Midrex HYL Finmet Coal-based

C a p a c i t y & p r o d u c t i o n

0

2040

60

80

100

120

140

U

t i l i s a t i o n ( % )

Capacity(Mt) Production(Mt) Utilisation (%)

World DRI capacity utilisation by process (2005)

Source: Midrex Technologies, Inc

India leads the way

Sponge iron growth in 2005 was entirely due to a number of small capacity rotary kilns

started in India. India led the world in sponge iron production with 11.1 million tonnes

followed by Venezuela with 8.9 million tonnes, Iran with 6.9 million tonnes and Mexico with

6.0 million tonnes in CY05.

85% of sponge iron produced

through gas based process in

gas rich areas like Middle

East, Latin America and Russia

Growth in Indian sponge iron

industry due to setting up

large number of small capacity rotary kilns


20/30



0

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8

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12

14

16

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2 0 0 3

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2 0 0 6 E

P r o d u c t i o n ( M t )

India Vanezuela Iran Mexico Saudi Arabia

Top 5 Global DRI producers

Source: Midrex technologies, Inc & B&K estimates

New capacity on the way

Even though very little sponge iron capacity has been added over the past few years outside of

India, the strong surge in its price has encouraged investment in new capacity. As at the end of first

quarter 2006, over 15 million tonnes of new gas based DRI capacity has been contracted (Midrex

process), the first of these plants will begin operation by late 2006. The newly contracted capacity

has been focused in areas where inexpensive natural gas is abundant, including the Middle East

and South America, as well as projects in Malaysia and Russia. This new investment was driven by

sustained high prices of alternate iron and of low residual, high quality scrap steel.


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0

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150200

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Tata Sponge Iron

(Actual)Sensex

Tata Sponge Iron (Rs. 113) Not Rated

Tata Sponge Iron (TSIL) is the largest coal based sponge iron producer in Eastern India with

total installed capacity of 390,000 TPA. The company is ideally located in close proximity of

iron ore mines in Keonjhar, Orissa. Recently, the company has acquired a coal block on a 30-

year lease basis in Orissa along with two more associates and is expected to become operational

by FY09 which will help reducing the company’s coal cost significantly. The company has alsoincreased its power generation facility from 7.5 MW to 26 MW which insulates its dependence

on state electricity boards and increase earnings by selling surplus power. We spoke to the

management recently. Following are the key highlights:

• Increasing production through the secondary route

Increase in steel production through the secondary route (EAF, IF), which uses hot metal

(pig iron), sponge iron/scrap as their basic raw materials, accounts for 48% of the total

steel output. It has grown at a CAGR of 18% during FY01-05. The trend is expected to

continue due to rising availability of coal based sponge iron produced from domestically

available raw material.

• Sponge iron is fast replacing imported steel scrap in secondary steel making

Production of steel scrap in India is low at 15-20% of its consumption due to longer

product life cycle, as the country is in developing phase and the consumption pattern is

tilted in favour of infrastructure and construction rather than consumer durables.

Therefore, secondary steel makers have to depend on imported steel scrap. Coal based

sponge iron is fast replacing imported steel scrap due to low cost of production, as non-

coking coal and iron ore (two critical raw materials) are domestically available and its

production is rising.

• Own power generation

By realising the importance of captive power plant for having an edge in the cost competitive

markets, recently TSIL has expanded its power generation facilities by installing two more

power plants (18.5 MW) in Kiln 1 and Kiln 3 increasing total capacity from 7.5 MW to 26

MW. The new 18.5 MW power plant is expected to get operational by October 2006.

TSIL’s total power requirement is about 10 MW for the current capacity. Sale of surplus

power (made an arrangement to sell 10-12 MW of power @ Rs. 3.15/unit) will contribute

additional revenue (approx. 160 mn per year) from FY07 itself.

• Captive coal block: A reality

Recently, TSIL has acquired a coal block on a 30-year lease basis in Orissa along with two

more associates. The estimated mineable coal deposit is about 115 mn tonnes. TSIL’s

share is 51%. The coal block is expected to become operational by the end of FY09. This

will insulate the company from volatility in non-coking coal prices and reduce its coal cost

significantly which presently constitutes about 44% of total expenses.

• Strategic location

TSIL is located at Bilaipada near Joda, in the Keonjhar District of Orissa. The plant is

ideally located in the close proximity of iron ore mines (25 kms away from plants) and

sponge iron consumers of Eastern region which saves on transportation cost.

Relative performance

Share Data

Reuters code TTSP.BO

Bloomberg code IPIT IN

Market cap. (US$ mn) 36

6m avg. daily turnover (US$ mn) 0.3

Issued Shares (mn) 15.4

Performance (%) 1m 3m 12m

Absolute (4) (1) (36)

Relative (10) (19) (56)

Major shareholders (%)

Promoters 41

Institutions 3

Public & Others 56


22/30



• Over capacity due to smaller players

The situation of over capacity exists due to emergence of many small coal based players

which keep a cap on the prices of sponge iron.

• Increasing prices of iron – ore and non-coking coal

Though, the company has leased out some mining assets to Tata Steel Ltd. for operation

of its Khondbond iron ore mine for its captive use and are better placed than the playershaving no captive sources but then also the prices are expected to increase further due to

high demand both at domestic as well as global level, particularly from China which

squeezes the margin of the company. Non-coking coal prices are also increasing and we

expect the prices to be firm in near future.

0200400600800

1,0001,2001,4001,6001,800

2,0002,2002,4002,6002,800

F Y 0 0

F Y 0 1

F Y 0 2

F Y 0 3

F Y 0 4

F Y 0 5

F Y 0 6

F Y 0 7 E

F Y 0 8 E

Coal (Rs/ton)Iron Ore (Rs/ton)

Raw material cost

Source: Company & B&K research


23/30



Business background

Tata Sponge Iron (TSIL) was incorporated in 1982 as a Joint Venture of Tata Steel and

Industrial Promotion & Investment Corporation of Orissa Ltd. (IPCOL) for the production

of sponge iron, based on TISCO-Direct Reduction (TDR) Technology. The plant is located

at Bilaipada near Joda, in the Keonjhar district of Orissa. In 1991, Tata Steel acquired

IPICOLs stake and TSIL became its subsidiary.Growth path

Source: Company

The plant was initially designed for a production capacity of 90,000 TPA and subsequently

the capacity was enhanced to 120,000 TPA in 1990-91 by entering into foreign collaboration

with Lurgi, Germany in 1987-89. The company later to meet the growing demand of sponge

iron doubled its capacity by adding another Kiln of equivalent capacity in 1998-99, bringing

the capacity to 240,000 TPA.

In December 2001, TSIL commissioned a 7.5 MW captive power plant to produce electricity

from the waste heat of exit gases of its Kiln No.2.

Capacity expansion

• Recently, TSIL expanded its capacity by installing 3rd Kiln having a capacity of 150,000

TPA. As a result, the company’s sponge iron making facility has increased from 240,000

TPA to 390,000 TPA. The facility commenced production from March 2006. Also, TSIL

has set up power generation facilities of 18 MW by recovering the waste heat of the kilns

which is expected to be operational from October 2006. The total cost incurred was

approx. Rs. 1.9 bn.

• Recently, TSIL has acquired a coal block on a 30 year lease basis in Orissa along with two

more associates (SPS Sponge Iron Ltd. and Messrs Scaw Industries Ltd.). The estimated

mineable coal deposit is about 115 mn tonnes. TSIL’s share is 51%. The coal block is

expected to become operational by the end of FY09. The total expected cost incurred on

coal mines is approx. Rs. 3 bn.

In-house TDR Technology

Tata Steel developed in-house technology based on Coal to produce sponge iron. It was the

first sponge iron plant in India to receive the ISO-9002 and the ISO-14000 certifications.

0

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200

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300

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400

450

F Y 8 6

F Y 9 1

F Y 9 8

F Y 0 6

( 0 0 0 t o n s )

Production Capacity

Increased installed capacity

of sponge iron to 390,000 TPA

and captive co-power

generation facilities to 26 MW

Acquired a coal block on 30

year lease basis in Orissa


24/30



Iron ore (hematite) and non-coking coal are charged into a rotary kiln in requisite proportion

with dolomite to produce sponge iron. Coal plays a dual role in the process by acting as a

redundant as well as fuel for providing heat to maintain the requisite temperature inside the

kiln at 950°-1050°C. The reduction process occurs in solid state. In this reduction process,

coal is combusted in a controlled manner and it converts to carbon monoxide to remove

oxygen from the iron ore. At the end of the process, iron ore is optimally reduced and

discharged to a rotary cooler for cooling below 120°C and finally sponge iron comes out of

the kiln. Power is generated by using the waste heat of the hot spent gases of the kiln.

Valuations

Full ramp-up of 3rd kiln by October 2006 would provide volume CAGR of 38% during

FY06-08E. 26 MW of captive power and sale of approx. 10-12 MW surplus power would

add to earnings. Coal mines (expected to start by FY09) would reduce coal cost (currently

form 44% of total cost). At the current price of Rs. 113, the stock is trading at 6.2x FY07E

and 4.1x FY08E earnings. We feel that the company has potential to grow earnings in long-

term. We don’t have rating on the stock.

Process

Source: Company

Source: Company

Rotary kiln cross-section

Potential to grow earnings in

long-term


25/30



Financials

Production

The company is poised for major growth in the production of sponge iron in the coming two

years post increasing its installed capacity to 390,000 TPA.

Production

Source: Tata Sponge, Annual Reports, B&K estimates

Net sales and growth


Cost

The average cost of iron ore is expected to remain firm in the next two years. More of non-

coking coal is required due to higher % of ash content in it which needs to be washed to

reduce the ash content to an acceptable level which will increase its prices.

Revenues

Revenues of TSIL are expected to increase at 40% CAGR over the next two years due to

recent capacity expansion from 240,000 TPA to 390,000 TPA. The company has shown a

decline of 20% in its revenue in FY06 due to lesser production (due to higher ash content in

non-coking coal received by Coal India Limited which reduces productivity and increasing

prices of both iron ore and non-coking coal) as well as due to pressure on realisation front.


26/30



Margins

Margins of the company have declined in FY06 due to lower realisation coupled with the

higher input prices. The company is targeting high growth in revenues to improve margins.

We expect realisation to be comparatively better in the next two years. Margins will be under

pressure due to higher iron ore and coal prices. The company has been allotted a coal mine in

Orissa but will be able to get advantage only from FY09.

Raw Material Cost


EBITDA and Margins


EBITDA/ton, Cost/ton, Price/ton

Capex

Recently, TSIL added a 150,000 TPA sponge iron unit and 18.5 MW waste gas recoverybased captive power plant with an investment of approx. Rs. 1.9 bn (expected to be fully

ramped up by October 2006). TSIL has also acquired a coal block on a 30 year lease basis in

Orissa along with two more associates. The company will use its reserves as well as take debt

to finance projects. The total expected cost incurred on coal mines is approx. Rs. 3 bn. The

company plans to spend approx. Rs. 400 mn for development of colliery in FY07.


27/30



PAT and Margin

We expect PAT to increase by 38% CAGR in the next two years driven by higher volume

growth (due to capacity expansion) and sustainability on realisation front.

PAT and margin


Improving quarterly results

Net sales

Source: Tata Sponge, Annual Reports

First quarter of FY07 shows some sign of improvement. Net sales starts increasing due to

installation of 3rd kiln of 150,000 tonnes capacity in the last two quarters. EBITDA and PAT

margin also improved on q-o-q basis. With improvement in prices, we expect the trend to

continue.


28/30



Raw material cost

Source: Tata Sponge, Annual Reports, B&K Estimates

EBITDA and margin

Source: Tata Sponge, Annual Reports

PAT and margin


29/30



Balance Sheet

Yr. ended 31 Mar. (Rs. m) FY05 FY06 FY07E FY08E

Current assets 799 498 1,017 1,758

Investments 8 8 8 8

Net fixed assets 1,165 2,384 2,930 3,525

Total assets 1,972 2,890 3,955 5,292

Current liabilities 440 477 510 672

Total Debt 7 707 1,532 2,357

Other non-current liabilities 205 235 235 235

Total liabilities 652 1,419 2,277 3,264

Share capital 154 154 154 154

Reserves & surplus 1,166 1,317 1,524 1,874

Shareholders’ funds 1,320 1,471 1,678 2,028

Total equity & liabilities 1,972 2,890 3,955 5,292

Income Statement


Net sales 2,304 1,852 2,720 3,618

Growth (%) 36.2 (19.6) 46.9 33.0

Operating expenses (1,375) (1,546) (2,380) (3,127)

Operating profit 929 306 340 491

Other operating income 80 160

EBITDA 929 306 420 651

Growth (%) 75.1 (67.1) 37.4 54.9

Depreciation (72) (76) (95) (106)

Other income 94 113 120 125

EBIT 952 344 445 670

Interest paid (1) (1) (16) (20)

Pre-tax profit 951 343 429 650(before non-recurring items)

Pre-tax profit 951 343 429 650

(after non-recurring items)

Tax (current + deferred) (342) (121) (152) (230)

Net profit 609 221 278 420

Adjusted net profit 609 221 278 420

Growth (%) 77.2 (63.6) 25.3 51.3

Net income 609 221 278 420

Cash Flow Statement


Pre-tax profit 951 343 429 650

Depreciation 71 75 93 105

Chg in working capital 358 (54) 44 (16)

Total tax paid (552) (88) (171) (230)

Cash flow from oper. (a) 828 276 396 509

Capital expenditure (300) (1,294) (639) (700)

Cash flow from inv. (b) (300) (1,294) (639) (700)

Free cash flow (a+b) 528 (1,018) (243) (191)

Debt raised/(repaid) (1) 700 825 825

Dividend (incl. tax) (92) (116) (132) (70)

Cash flow from fin. (c) (93) 583 693 755

Net chg in cash (a+b+c) 434 (434) 450 563

Valuations

Yr. ended 31 Mar. (x) FY05 FY06 FY07E FY08E

PER 2.8 7.8 6.2 4.1

PCE 2.5 5.8 4.7 3.3

Price/Book 1.3 1.2 1.0 0.9

Yield (%) 6.2 3.6 3.6 3.6EV/Net sales 0.6 1.3 1.0 0.8

EV/EBITDA 1.4 7.9 6.6 4.7

Key Ratios

Yr. ended 31 Mar. (%) FY05 FY06 FY07E FY08E

EPS (Rs) 39.5 14.4 18.0 27.3

EPS growth 77.2 (63.6) 25.3 51.3

EBITDA margin 40.3 16.5 15.0 17.2

EBIT margin 41.3 18.5 15.9 17.7

ROCE 73.2 17.4 15.2 16.6

Net debt/Equity (34.4) 46.3 62.9 65.0

Du Pont Analysis – ROE

Yr. ended 31 Mar. (x) FY05 FY06 FY07E FY08E

Net margin (%) 26.4 12.0 10.2 11.6

Asset turnover 1.3 0.8 0.8 0.8

Leverage factor 1.6 1.7 2.2 2.5

Return on equity (%) 56.6 15.9 17.6 22.7


30/30

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sponge iron industry b k oct 06

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