Steel Authority of India: Sailing in troubled waters

From the lows of February, the stock of Steel Authority of India (SAIL) has gained 40 per cent. This is after the 6 per cent decline in the stock price after the company posted poor June 2016 quarter results last Thursday.

A host of import protection measures for the sector since February have buoyed the stocks of many steel companies such as SAIL. Introduction of minimum import prices (MIP) in February on a wide range of steel products for a six-month period boosted sentiment.

This was followed by extension of safeguard duty on some steel imports (where MIPs don’t apply). Further extension of the MIP on certain products and imposition of anti-dumping duty on others in August came as another shot in the arm for steel manufacturers.

Despite the gains in recent months, at ₹51, the SAIL stock trades at 0.5 times its consolidated book value for 2015-16, cheaper than its five-year historical average price-to-book value of 0.8 times. Still, investors can consider selling the stock given the lack of potential for a sustained upside.

Hurt by the slump in the global steel industry, SAIL has posted seven consecutive quarters of declining revenue (year-on-year) since the December 2014 quarter. And while the recent import protection measures are expected to provide succour, concerns remain.

One, the continuing weakness in the global steel market still poses a risk. Two, unlike other steel majors, SAIL is burdened by significant outgo on employee cost, which accounts for about a quarter of the company’s revenue. SAIL’s recent voluntary retirement scheme will not make a significant dent on its employee cost. Apart from that, with SAIL undergoing a large expansion and modernisation programme, its depreciation and finance cost have been on the rise. This has been eating away into its operating profit since the June 2015 quarter.

In the June 2016 quarter, helped by lower raw material cost, SAIL posted operating profit of ₹233 crore, over two-and-a-half times that in the year-ago period. But high fixed costs pushed the company’s net loss to ₹536 crore, over double that in the same period last fiscal.

In fact, SAIL has seen its operating profit decline every year (except in 2014-15) since 2010-11. In 2015-16, hurt by a sharp decline in revenue, SAIL posted operating loss of ₹3,607 crore. Lower realisation on every tonne of steel despite better sales volume impacted revenue.

With higher depreciation and interest expense bumping up costs, the company reported net loss of ₹4,297 crore in 2015-16 as against profit of ₹2,035 crore in the previous year. That apart, SAIL has also been lagging peers such as JSW Steel. For the June 2016 quarter, SAIL posted operating profit margin of 3 per cent as against JSW Steel’s 25 per cent. The companies’ performance has diverged in the past too.

About a quarter of the company’s production is accounted for by the low-margin semi-finished steel products (semis). The rest is finished (flat and long) products that enjoy better margins.

The company plans to lower the share of semis and raise that of value-added products following the completion of its ongoing modernisation and capacity expansion.

While this should boost the company’s sales realisation in the coming years, there is still no clarity on when the process will be completed.

So far, SAIL has faltered on many deadlines. In the meanwhile, its substantial employee cost and rising fixed costs continue to dent its profitability.

Also, SAIL’s consolidated debt-to-equity ratio has been inching upwards — from 0.4 times as of March 2012 to 0.8 times as of March 2016.

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