SAIL-BUY


Ongoing capex
Low leverage
Improving product mix
SAIL's ongoing capacity expansion programme, backward integration to source iron ore and its wide product mix and distribution reach favour investment in the stock.






The company is focusing on improving its product mix by increasing the proportion of value-added products.

C. N. M. Lavanya

Investors can consider buying the SAIL India stock, now trading at a price-earnings multiple of about 8.2 times its 2007-08 earnings. The valuation is at a discount compared to Tata Steel (9.4 times) and global steel majors. SAIL's ongoing capacity expansion programme, backward integration to source iron ore and its wide product mix and distribution reach, amid a good long-term demand environment for steel, favour investment in the stock.
Business Overview

SAIL has five integrated steel plants at Bhilai, Durgapur, Bokaro, Rourkela and Burnpur and special steel plants as well. SAIL's production capacity of 14 million tonnes (MT) is slated to increase to 26 MT by 2010-11, due to ongoing greenfield and brownfield expansion projects. The expansion plan is expected to address technology obsolescence, achieve energy savings and enrich the product-mix, while addressing the expected global deficit in steel.
The programmes entail an investment of Rs 54,000 crore (factoring in recent cost overruns). The financing is to be done in such a manner that SAIL's debt-equity ratio remains within 1:1. The total capex for 2007-08 was Rs 2,181 crore and the estimated capex for 2008-09 is Rs 5,000 crore.
These requirements may not impose any fresh borrowings on SAIL in the current high interest cost environment, given the comfortable cash position and internal accruals. The debt-equity ratio has fallen from 0.18 in FY-07 to 0.11 in the latest June quarter, as internal accruals were used to steadily reduce borrowings. This suggests room for the balance-sheet for future leveraging.

Integration moves




On the inputs front, as of now, the company's captive iron ore mines feed its entire requirements and SAIL plans to expand its existing mines to meet the rising demand for iron ore as output grows.
Its current mining capacity is 26 MT and it will need 43 MT by the end of 2009-10. The iron ore linkages for FY-2010 and beyond would come from the mines in Raoghat, Chiria, Taldih and Thakurani, apart from the existing mines.
Linkages have been formulated between each of SAIL's plants and specific mines, with plans put in motion for the development of the mines. It has envisaged a Rs 13,000-15,000-crore brownfield expansion programme in the next eight years.
As regards coal, the current import component of 70 per cent (out of which 80 per cent is through long-term contracts from Australia, New Zealand and US and 20 per cent from spot market) is slated to increase from 2010 onwards. Further, the long-term component is likely to go up to 90 per cent from FY-09, which may shield margins to a greater extent from short-term spikes in price.
SAIL has also seen a significant improvement in its operating efficiencies with reductions in coke and fuel rates and energy consumption.
Product mix

The company is focusing on improving its product mix by increasing the proportion of value-added products. The production of value-added products has increased from 1.26 MT (2005-06) to 3.36 MT (2007-08).
The hot-rolled (HR) coils constitute 24.1 per cent, plates 21.2 per cent and semis 17.9 per cent of the sales mix for the year ended 2007-08. The proportion of rounds/bars is slated to increase from 10.2 per cent to 23.3 per cent, structurals from 5.2 per cent to 15 per cent and cold-rolled coils from 8.7 per cent to 10.4 per cent by 2010-11.
This has been accompanied by an expansion in the dealer network, from 653 in March 2007 to 1801 in June 2008.
Financials

SAIL's net sales registered a Compounded Annual Growth Rate (CAGR) of 16.95 per cent over a four year period coinciding with the upturn in the commodity cycle.
Net profits witnessed a better CAGR of 31.6 per cent during the same period. In the latest June quarter, SAIL's operating profit margins suffered a setback on account of wage revisions and higher raw material costs. SAIL appears more vulnerable to constraints on domestic steel prices than Tata Steel, which has a globally diversified presence. Domestic steel producers, who agreed to a moratorium on prices in May for three months, have once again acceded to holding the price line in August.
Despite this, SAIL clocked strong Q1 numbers, which can be attributed to the thrust on value-added products and improvement in operating efficiencies.
Going forward, while the policy pressures on steel prices and softening global steel prices may limit margins in the near term, prospects for strong demand growth, expansion in volumes and improving product mix augur well for SAIL's earnings over the medium-long term.
Some primary and secondary steel producers have taken a 4 per cent cut in steel prices recently. However, this is to be viewed only as a temporary phenomenon in the light of lower global prices of steel.
Notwithstanding the economic slowdown, the domestic demand scenario for steel continues to be sanguine, given the growth potential of infrastructure and construction sectors



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