JSW - Avoid in short term

JSW Steel has acquired 41.3% equity in Ispat Industries by investing Rs 2,157 crore, implying an enterprise value of Rs 12,300 crore (including preference capital) and equity valuation of Rs 5,200 crore. Ispat has HRC and downstream flats capacity of 3.3 mtpa and ~0.5 mtpa, respectively. For 12mFY10, Ispat posted revenue, EBITDA and PBT of $1,733 million, $308 million and $(-60 million), respectively, with sales volume of 2.6 mt.

Ispat achieved Ebitda/t of $118 in 12mFY10. We expect a combination of cost savings, better realisations and cyclical improvement in steel margins to lead to EBITDA/t and EBITDA of USD 175 and USD 525 mn, respectively, by FY13E. Such a turnaround would imply EV/EBITDA of 5.2x which is fair but not cheap. Potential cost savings include those on freight, power, VAT and raw material (leveraging JSW’s existing supplier base and upcoming pellet capacity). The effective cost of Ispat’s term debt, aggregating INR 67.8 bn, is ~12.5%. JSW proposes to refinance this by September 2011, which will bring down interest costs by 200-250bps.

Ispat is planning capex of INR 31.4 bn over the next two years, which includes setting up a 110 MW CPP, 3 mtpa pellet plant, 1 mtpa coke plant and capacity expansion to 4.0 mtpa from the existing 3.3 mtpa. So far, it has spent Rs 400 crore. Of the equity infusion of Rs 2,15,700 crore into Ispat, Rs 700-800 crore will be the required equity capital for this capex; the remaining capex is likely to be funded through fresh debt of ~INR 20 bn over the next two years.

This acquisition will enable JSW to emerge as India’s largest steel player, at 14.3 mtpa, by early FY12. We believe JSW has the financial strength and operational capabilities to effect the turnaround as mentioned above. However, the issue of increased debt of INR 94 bn would act as a drag. Hence, we do not see upside to our fair valuation of INR 1,372/share. We maintain ‘BUY'.

The new shareholding structure, post JSW investment, includes conversion of preference share of INR 4.86 bn into 245 mn shares to promoters (181 mn), lenders (10 mn) and others (54 mn).

Source : FE / Edelweiss

Our Recommendation :

For Long term Investors -

Buy JSW on declines at around Rs.900/- levels for a target of Rs.1400/- holding period of 1 year. The stock is likely to underperform in the short term due to debt overhang and integration problems.

For Traders :

Avoid.

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