The Hindu Business Line : Jindal Steel and Power: Buy

(Left to Right): MR VIKRANT GUJRAL, Vice-Chairman, Jindal Steel and Power; Bolivia's Planning Minister, Mr Carlos Villegas, and Finance Minister, Mr Luis Arce... Signing an agreement to exploit one of the largest iron ore deposits at El Mutun site.

Firm outlook for prices, healthy growth in volumes, greater contribution from the power business, improved product mix and attractive valuations lend credibility to the stock of Jindal Steel and Power (Jindal Steel). Investors can consider buying the stock in small lots with a one/two-year perspective.

Firm outlook for prices

Steel prices over the last couple of months have staged a smart recovery after their decline early this year. Lower inventory levels in the global markets, coupled with buoyant demand from user segments, are likely to ensure that steel prices remain firm over the medium term. Costs of iron ore and zinc (major raw materials) have been rising continuously over the last few years, pushing steel-makers to follow a firm pricing structure. The costs are showing no signs of cooling, thereby necessitating an upward revision in their prices. On the other hand, the demand is expected to remain strong, particularly in the domestic market on the back of huge infrastructure spending proposed by various players. On the global front, the threat of China continuing to remain a net exporter of finished steel now appears bleak.

Beijing is taking steps to curtail production as its steel-makers are struggling to protect margins. One-third of the steel capacities in China have high-cost structures, making it difficult for them to compete with their low-cost global peers. The Chinese National Steel Policy, with a focussed approach to consolidation, is also likely to ensure stability in prices in the medium/long-term.

Muted first quarter

Jindal Steel's performance in the June quarter has not been encouraging. Lower realisations, which fell 15 per cent on a year-on-year (Y-o-Y) basis, dragged down the performance. Revenues recorded Y-o-Y growth of about five per cent while earnings rose two per cent. However, this has been the phenomenon across the steel sector. Price-cut effects of the second and third quarters of last fiscal have shown up in the Q1 numbers. This is, however, likely to change over the next few quarters as steel companies have announced an upward revision of prices in the last few months.

Lower realisations were, however, offset by higher volumes across all product categories. Volumes in sponge iron, steel products and power rose by 64 per cent, 24 per cent and 13 per cent respectively, Y-o-Y. Volume growth is expected to remain strong, thereby protecting the earnings from possible price fluctuations.

Jindal Steel has fared better than most of its peers in containing costs. Commissioning of coke oven batteries in the last quarter of FY-06 helped replace a part of its coke purchases with captive coke, thereby reducing costs. Further, the company has commissioned another 25 MW power plant at Raigarh, which has reduced the power bill.

As a result of these factors, Jindal Steel's operating profit margin has expanded sharply by about 640 basis points, Y-o-Y. This is in stark contrast to most of its peers whose OPMs have dipped or, at best, remained flat.

During the quarter, the company saw an 140 per cent rise in its interest charges mainly on account of payment of Rs 20 crore towards forex fluctuation and pre-payment of a part of its debt. This impacted its profit-after-tax, which rose marginally by 2 per cent. If this component is excluded, the rise in interest costs would have been about 50 per cent, which is not unusual for a company that has added capacities in the previous quarter.

Capacity expansion

Jindal Steel is pursuing its capacity expansion projects across all its businesses. It commissioned a 25 MW power plant in the first quarter, taking the total capacity to 310 MW now. It expects to add another 30 MW by September 2006 and 100 MW by 2008, taking its total captive power capacity to 440 MW. The augmentation of its blast furnace capacity from 0.2 million tonnes per annum (MTPA) to 1.2 MTPA is expected to be completed by September.

Jindal Steel proposes to set up a 1,000 MW merchant thermal power plant, which is likely to go on stream in four equal quarterly tranches of 250 MW each beginning June 2007.

The work on the project has already begun with the company having spent about Rs 600 crore till date out of a total cost Rs 4,000 crore. It has already entered into agreements to sell 65 per cent of power on contract basis, while the rest will be sold in the spot market. On the back of robust demand and the ongoing reforms, the power business is likely to drive the earnings growth in the long term.

Currently, Jindal Steel derives about 85 per cent of its revenues and 70 per cent of earnings from its steel business. We expect this proportion to decline gradually and power business to drive profitability in the long term.

Bolivian mines

Jindal Steel has won the mining rights for 20 billion tonnes of iron ore of Mutun mines of Bolivia. This entitles it to use the iron ore to produce steel and other metal products at plants it proposes to build in Bolivia. This will entail an investment of $2.3 billion over an eight-year period, and setting up a 1.7-MTPA integrated steel plant there. Although it may be pre-mature to comment on the impact of this on its operations, we view it as a strategic development that is likely to have a significant bearing on its future business initiatives abroad.

Attractively valued

Jindal Steel trades at about seven times its likely FY-07 earnings. Considering its performance and the rich prospects in the power segment, the stock appears attractively valued.

The return on equity at about 35 per cent is healthy and offers comfort. Delays in project implementation and cost over-runs are the principal risks to our recommendation.

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