Stock Fundamentals

This is why you should book profit in JSW Steel stock

Satya Sontanam | Updated on April 10, 2021

Valuation takes sheen off the stock, even as the outlook remains strong for steel players

The stock of JSW Steel has more than quadrupled since its lows in April 2020. The buoyancy in the stock performance is on account of favourable global conditions resulting from capacity cut by Chinese steel plants, increasing demand for the metal globally and domestically, and loose monetary policy measures across the globe that are expected to increase the infrastructure spending.

JSW Steel’s consolidated operating profit in the third quarter of FY21 was about ₹5,946 crore, the highest-ever for the company. This was a sharp turnaround from the performance in Q2 FY20 which saw the EBITDA at just ₹2,451 crore. The net profit for the period went up by a whopping 67 per cent y-o-y to ₹2,669 crore.

With demand increasing and steel prices rising, the outlook for the sector looks positive, at least in the near-future. Also, with JSW Steel’s expansion of Dolvi plant by five million tonnes per annum (mtpa) –– that would be operationalised by the end of Q1FY22 –– and addition of new capacity from recently acquired Bhushan Power and Steel (BPS), the company is well-placed to cater to the expected growth in steel demand.

However, at current levels the stock seems to have already priced in the above factors. The stock trades at 13.7 times its FY22 estimated earnings (Bloomberg Consensus), higher than the 10.5 times average of forward earnings over past three years. Another valuation metric – EV/EBITDA – stood at about 13 times, compared to around ten times multiple even during the best of its times. Needless to say, headwinds to the economic revival with the second wave of Covid-19 and fall in international steel prices are key risks which investors should watch out for.

Considering the high valuations, investors with low-risk appetite can consider booking profits at these levels.

The deal

After a dealy of more than a year, JSW Steel completed acquisition of BPS in March 2021. JSW Steel, through its subsidiary Piombino Steel, along with another JSW group company, JSW Shipping & Logistics, paid ₹19,350 crore for 2.5 mtpa production capacity. Post the deal, JSW Shipping and Logistics and JSW Steel hold 51 per cent and 49 per cent stake, respectively, in BPS.

JSW Steel’s infusion of ₹5,090 crore into BPS would result in a spike in the company’s net debt compared to previous quarters.

Incorporated in 1999, BPSL produces billets, hot- and cold-rolled coils. It has captive non-coking coal, iron ore mines in Odisha and Jharkhand with name plate capacity of three mtpa. These captive mines and power generation capacities reduces the input cost of steel and contribute to long steel products in the product portfolio of JSW Steel. The acquisition will provide JSW Steel with increased presence in the eastern and northern states and raises its installed capacity. Further, BPS plant is strategically located close to the five iron ore mines acquired by the company in Odisha. Even with conservative ₹10,000 to ₹11,000 per tonne of operating profit from the Bhushan plant, the EBITDA contribution to JSW Steel would be more than ₹1,000 crore.

Even after considering an approximate interest cost of about ₹400-450 crore for funding BPS acquisition and other fixed costs, the net contribution to JSW Steel is expected to be positive. While operational synergies do emerge out of these takeovers, given the cyclical nature of the industry, any immediate downturn in the market will exert immense pressure on the balance-sheet.

Note that the Supreme Court (SC) judgment in the Enforcement Directorate’s case against promoters of BPS under the Prevention of Money Laundering Act is pending. The transaction may get reversed as the SC asked creditors to keep the transaction amount only in the escrow account to return to JSW Steel if the order is not in their favour.

Outlook

As far as the business performance is considered, JSW Steel seems promising with expansion plans and cost-cutting measures. In terms of sector, steel demand for now has been robust across sectors, including packaging sector, large infrastructure projects, white goods, warehousing. For example, as per the management, the steel demand in India in the month of April 2020 was just 1 million tonne. In the month of December, it went up by over 10 times to 10.28 million tonnes.

Even on the steel prices front, the more than 50 per cent jump in last one year to ₹ 55,000 per tonne is expected to have little downside from hereon, as the domestic prices are currently at a discount to landed prices.

However, the earnings growth for JSW Steel from the recent additions – both Dolvi and Bhushan – seems to have been priced in the stock already. Earnings growth from these additions are expected to reflect only on or after FY23. Thus, it provides a good opportunity now for investors to book profit partially on their exposure to the stock.

Published on April 10, 2021

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