Steel Authority of India (SAIL), which accounts for 15 per cent of Indian steel production, is at a juncture where the demand outlook is healthy but the current margins are at a trough. The stock has corrected 23 per cent last year; a period where realisations have rolled off peaks and raw material costs continued to grow unrelentingly. In the medium term of five years, domestic demand should remain strong amidst structural tailwinds from international steel prices, and input costs can correct from peaks.
We recommend that investors with a medium-term view can buy SAIL, based on reasonable valuation and scope for earnings growth following the current trough.
Narrowest spreads post Covid
In Q2FY23, SAIL reported EBITDA per tonne of ₹1,750 compared to an average of ₹10,400 in the previous four quarters. From the first quarter of FY21 (Covid year), realisations have grown by 20 per cent CAGR and raw material costs grew by an overwhelming 40 per cent CAGR. This came about as realisations and raw material costs rallied post-Covid while only realisations were trimmed by Government intervention in the form of export duty taxes by Q2FY23. Raw material costs, on the other hand, rallied, led by coking coal costs.
The company can expect 10-15 per cent correction in coking coal costs in Q3FY23 itself, going by commodity costs. International coal rallied from $65 per tonne in January -2020 to $450 per tonne in September 2022 and recently declined 10 per cent to $400 per tonne in January 2023.
With central banks’ concerted efforts to tame economic overheating and Europe’s energy amassing drive cooling post-winter, the commodity costs should further correct. The same may not be applicable to steel prices, which have structural tailwinds to overcome central bank actions. Internationally, steel is facing lower supply from China (the largest producer) and Europe, on pollution concerns (in the form of direct regulation for China and carbon credit costs for Europe).
India is the only major producer that has witnessed growth in steel production compared to others during January-November 2022 as per World Steel Association. The government has also removed the export duty taxes, which should drive the export uptake gradually (SAIL has 10 per cent export contribution). Domestic demand from real estate, automobile and government capex is in a positive cycle currently. The Central government’s National Infrastructure Pipeline is a strong support to domestic demand as well.
Nominal capex drive
SAIL has not gone for significant capex plans and is planning to debottleneck its facilities to reach maximum capacity utilisation by FY23 end. It produced 16.2 million tonnes compared to potential capacity of saleable steel at 18.5 million tonnes. The company’s current exercise should add 5-6 per cent by FY24 atleast. SAIL has also improved production efficiency and has regulated its employee expenses, which are expected to decline gradually to industry range of 10-11 per cent of sales from 12-14 per cent currently.
On the other hand, SAIL has deleveraged significantly in the period. From debt of ₹52,000 crore in Q1FY21 (debt to equity of 1.35 times) the company reported a debt of ₹13,400 crore (.26 times) by Q4FY22 and is currently at ₹27,470 crore (0.53 times in Q2FY23). Apart from bumper profits in FY22 adding to networth, SAIL managed working capital by reducing debtor outstanding, which led to the initial decline in debt outstanding. Increasing cost of coal purchases drove the recent increase. With cooling commodity costs, the company expects to control leverage, going ahead.
Financials and valuation
The company reported revenues of ₹26,246 crore in Q2FY23, which is 1 per cent decline from Q2FY22. With steel realisations hovering above last decade averages of ₹45,000 per tonne, the current realisations moderating at ₹58,000-60,000 should provide comfort to SAIL. Consensus revenue estimates are at a moderate de-growth of 2 per cent CAGR till FY22-24.
On the margin front, compared to an EBITDA margin of 2.8 per cent reported in Q2FY23, consensus estimates are expecting EBITDA margin of around 12 per cent by FY24, which is below the 20 per cent reported in FY22 but in line with SAIL historical range. The company is currently trading at 4.1 times one-year forward EV/EBITDA, which is a 15 per cent discount to its past five-year range. Considering the commodity play involving softening coal costs and structurally strong steel costs, SAIL should generate decent stock returns in the medium term.
While not predictable, the stock has generated 10 per cent dividend yield in FY22. As SAIL regains strong profitability, and depending on its capex plans, the company may generate 2-4 per cent dividend yield in the next two years as well.
