JSPL is at the cusp of a turn around
Indian steel sector is in the midst of a multi-year upcycle and dynamics are evolving rapidly with spreads rising 50% in the past year and likely to remain strong driven by robust global spreads, Capacity utilization rising with pickup in demand, and limited capacity adds till the resolution of stressed steel assets, Domestic iron ore supply improving further with increase in production caps and auction of mines. We believe these trends are likely to benefit both larger steel mills as well as the secondary steel sector in India.
Jindal Steel & Power Ltd (JSPL) is one of the largest steel manufacturer in India with a total crude steel capacity of 8.6mtpa spread over three locations, namely Raigarh in Chhattisgarh, Angul in Odisha and Patratu in Jharkhand. Company has commissioned its new capacity of 2.5mtpa in December 2017. JSPL has set up a coal-based merchant power plant (3,400 MW) in Raigarh, Chhattisgarh under its 96.4% subsidiary, JPL. It also has 2mtpa steel manufacturing facility at Oman, Middle East under its 100% subsidiary, Jindal Shadeed.
We believe JSPL is at the cusp of turn around with its capex cycle coming to an end. Increased capacity coupled with sectoral tail winds, we believe JSPL is a good opportunity to ride industry upcycle.
JSPL’s Steel business to turnaround:
JSPL’s Indian steel business to turnaround on expected growth in steel volumes, lower operating cost and stable steel prices. Nearly 75% of JSPL’s product mix comprises long steel while ~25% is HR plates. The pricing of long products primarily depends on domestic demand-supply scenario while flat steel prices are dictated more by global price movements. We believe long product prices will remain firm on the back of expected improvement in domestic demand for low cost housing and infra projects and less fear of cheap imports. Primary producers like JSPL will continue to garner premium over secondary manufacturers, as on average, primary steel manufacturers sell long products at an average premium of Rs1,500/t to secondary producers’ price. Moreover, imposition of anti-dumping duty on HR plates (reference price of anti-dumping duty on HR plate at US$576/t until FY21) will restrict cheaper imports.
In December 2017, JSPL expanded its integrated steelmaking capacity by 2.5mtpa (at Angul, Odisha) by commissioning 2.5mtpa Basic Oxygen Furnace (BOF), increasing the company’s crude steel capacity to 8.6mtpa. As the ramp up time for BOF is relatively short, the impact from increase in volumes will be visible from Q4FY18. Once JSPL ramps up capacity, incremental capacity will provide a fillip to volume growth and we expect the company to record more than 25% volume CAGR over next three years.
With increased volumes, company will benefit from operating leverage. For instance, until November 2017, JSPL’s blast furnace was operating at 50% capacity utilisation; the same is expected to improve to 90% in FY19E with the commissioning of BOF in December 2017. As a result, we expect operating cost to reduce by Rs.3000/ton from Rs.16415/ton in FY17 over the next 3 years. EBITDA/t is set to increase from Rs 7,581 in FY17 to around Rs.10000/ton during the same period.
Power business operating performance to improve:
JSPL’s 96.4% subsidiary, Jindal Power (JPL) has set up a coal-based merchant power plant of 3,400 MW in Raigarh, Chhattisgarh. During 1HFY18, JPL generated 5,613m units of power, operating at a combined plant load factor (PLF) of 38% (in FY16, JPL operated at a PLF of 31%) and reported EBITDA of Rs8.1bn in 1HFY18 (FY17 EBITDA at Rs10.5bn). We expect power volumes to grow at higher double digit (15%+) rates on account of improvement in power generation at its both plants.
JPL has reduced its administrative costs by 30% in FY17 along with increase in volumes bringing other expenses down to Rs.0.5/unit. We expect other expenses to slide further to Rs0.4/unit on enhanced operating efficiency. Higher volumes coupled with operating efficiency will boost JPL’s operating profit.
Jindal Shadeed: A successful overseas venture:
JSPL acquired Shadeed Iron and Steel Co (Shadeed), for US$525mn through its 100% subsidiary Jindal Steel & Power (Mauritius) in July 2010, now called Jindal Shadeed (JSL), Oman. At that time, JSL had an installed capacity of 1.5mn tpa gas-based sponge iron plant at Sohar, Oman. Thereafter, JSPL forayed into forward integration and commissioned 2mtpa long steel plant (billets) in April 2014 and 1.4mtpa rolling mill (rebars) in April 2016.
Company has successfully ramped up its steel plant of 2mtpa and operated at 86% capacity utilization in Q2FY18. This is further expected to increase to 90% over next year. Moreover, with the commissioning of 1.4mtpa rolling mill in April 2016, ~70% of the steel products (1.3mt) will be sold as finished products (such as rebars), improving margins by US$40/t.
Higher volumes, firm steel prices along with improved product mix will help Jindal Shadeed record 25% EBITDA CAGR over next three years. We estimate EBITDA/t of US$105 (Rs6,825) for FY18E, which will increase to US$115 (Rs7,475) in FY19E and sustain at similar level in FY20E. Jindal Shadeed recorded EBITDA of US$87m and EBITDA/t of US$110 in 1HFY18. As the company is done with its major capex, positive FCF will help deleverage the consolidated balance sheet.
Deleveraging to start from FY19E onwards:
JSPL is at the fag end of its capex cycle with the successful commissioning of its steel mill at Angul (Odisha). Improving operating performance coupled with lower capex will help JSPL generate positive FCF, which will help the company in reducing its debt from FY19E onwards. We expect consolidated net debt to decline from Rs453bn in FY17 to around Rs.380bn over the next three years.
We expect JSPL to turnaround in FY19E on the back of estimated volume growth and thereby lower operating cost in its steel business and expected improvement in operating performance from its power business. We believe the CMP does not fully capture the value of steel, while power provides added value. We expect the stock to re-rate once visibility of turnaround in the company improves.