Company Name – Steel Authority of India Limited (SAIL) Current Share Price – INR 91 (January 24, 2023) Market Cap – INR 37,588 cr |
1. What is interesting about the stock?
‘My countrymen should have nerves of steel, muscles of iron, and minds like a thunderbolt.’ This statement from Swami Vivekanand could be applied to anyone investing in the stock market also. And especially for people investing in cyclical commodities like steel. The largest Central Public Sector Enterprise (CPSE) in this space is Steel Authority of India Limited competing with large private players like Tata Steel, JSW Steel, and Jindal Steel and Power.
Steel Authority of India (SAIL) is a “Maharatna” CPSE with hot metal, crude steel, and saleable steel production capacity of 23.5 mtpa, 21.4 mtpa, and 20.2 mtpa respectively across 5 integrated steel plants at Bhilai (Chattisgarh), Rourkela (Odisha), Durgapur (West Bengal), Bokaro (Jharkhand), Burnpur (West Bengal) and 3 alloy steel plants at Durgapur (West Bengal), Salem (Tamil Nadu) and Bhadravati (Karnataka). These plants are supplied by 8 owned mines that are sufficient for its iron ore requirements currently. For future growth prospects, 2 more mines are under development. For coal requirements, the Company has long-term contracts for importing as well as buying from Coal India Limited.
SAIL has a diversified product mix in the mild steel business with higher exposure to long products. This makes the Company a big beneficiary of infrastructure and construction demand. The Company’s sales are predominantly domestic (~90%) but exports are increasing at a fast pace (5% to 9% in the last 3 years).
Railways and defense remain key customer focus areas
SAIL has been fulfilling the Indian Railways’ demand for steel tracks for decades, and supplied about 1mt of rails during FY22, of which, 71% was for 260 m long-welded panels. The Company also supplied 16,000 locomotive wheels and developed LHB axles, wide parallel flange beams for railway sleepers, etc. SAIL secured its first commercial order for special DMR grade steel plates from the Indian Navy. The Government has placed special thrusts on Indian Railways and the defense segments, and SAIL would be a key beneficiary of this.
Growth plans
The Company is finally seeing the completion of a nearly ~15 years’ long expansion and modernization plan and should see the benefits in the coming years. This capex was marked with delays and cost overruns. However, the Company in line with the National Steel Policy is likely to embark on another expansion project to increase capacity from 20 mtpa to 50 mtpa and is likely to start in the next 2-3 years.
Industry dynamics
Steel uses iron ore and coal (coking or other kinds) as raw materials. Both are volatile commodities. Additionally, the industry goes through a cycle of investment and over-production – typically of 5-7 years. Freight rates and import/export duty at a country level increase the complexity of the industry.
The Indian steel industry had its last downturn in the 2015-17 period. The last couple of years (FY21 and FY22) have been quite healthy for the industry with high EBITDA/ton of finished products for the following reasons:
Industry was coming in an upcycle after the downturn
COVID-19 impacted the global supply chain and Chinese players leading to lower raw material prices and higher-end-product prices
However, the cycle turned in FY23 when the coking coal price jumped and end product prices cooled driving lower EBITDA/ton of finished steel products.
China factor – Winter is coming!
For China's steel industry -- the world's largest -- winter has arrived early and is shaping up to be one of the harshest in years, with a slowing economy and escalation of the property market crisis tanking demand and evaporating profits.
The property sector, which accounts for over one-third of the country's steel consumption, has been squeezed by a liquidity crunch and sliding sales since the end of last year.
Compounding the woes is decreasing population which would impact the property sector in long term. Additionally, China will be moving more towards consumption-led growth vs investment-led growth which has been the case for the last 30-40 years as the debt level in the economy are quite high. All these will lead to surplus capacity in the Chinese steel industry keeping the finished product prices down in the medium to long term.
2. Key Historical Financials
Company revenue and profit have been growing 19% and 48% on a CAGR basis respectively in last 5 years. However, the revenue fell by 2% in Q2FY23 on a YoY
EBITDA has peaked at 21% in FY22 and has fallen in H1FY23. EBITDA margin sharply fell in Q3FY23 to 3% vs 26% in Q2FY22
Deleveraging over last the few years led to higher growth in net profit but the bulge in working capital has led to higher debt in H1FY23
Cash flow conversion (CFO/EBITDA) has been excellent in FY21 and FY22 with a decrease in working capital
ROE/ROCE increased to 24%/25% - an extremely high level for a cyclical industry
3. What is my view on company valuation?
SAIL has traditionally traded at a median P/E level of 4.5x and is currently trading at 8x. On a median EV/EBITDA level, the median levels are 7.5x, while it is currently at 5.5x. Tata Steel is trading at an EV/EBITDA of 4x and P/E (TTM) of 5x.
The Company’s debt has ballooned in the last couple of quarters due to higher working capital. In that context, the current price is reasonable and not much headroom exists for appreciation. It would be prudent for long-term investors to wait for a correction in the share price and time the cycle appropriately before committing.
4. What are the risks to the investment analysis?
Risks to the analysis are:
Continuous loss of market share to aggressive private players like JSW Steel, Jindal Steel and Power, and Tata Steel
High fixed cost structure, primarily due to high employee costs and increased royalty costs under the Mines and Minerals (Development and Regulation) Act (MMDR Act)
As the Company is dependent on commodity markets for coking coal and is not the most efficient producer of steel, any variability in international prices directly affects the profitability
About the Author
I have over 17 years of experience in private equity and public markets. I am an engineer by background an MBA from a premier institute in India.
Disclosure
I have had no stock, option, or similar derivative position in any of the companies mentioned in the last 30 days, and shall not initiate any such positions within the next 5 days. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from SocInvest). I have no business relationship with any company whose stock is mentioned in this article.
I am not a SEBI registered advisor. This article is purely for educational purposes and is not to be construed as investment advice. Please consult your financial advisor before acting on it.
I have used publicly available information while writing this article.