The Hindu Business Line : SAIL: Buy

SHAREHOLDERS can consider fresh exposures in the stock of Steel Authority of India Ltd (SAIL). Attractive valuations, improved financial profile, gains from capacity expansion, positive earnings outlook, synergies from its merger with Indian Iron and Steel Company (IISCO) and an improved product mix offer scope for considerable appreciation in the medium term.

Relatively cheap

At the current price of Rs 53, the stock trades at about 3.5 times its consolidated earnings for FY-05. This is at a discount vis-à-vis most of its peers, which are trading at about six-seven times. With a dividend of 33 per cent for FY-05, the SAIL stock offers a yield of about six per cent, making it a good dividend yield play.

Improved financial profile

The company has been able to consolidate its fundamentals in the past few years because of various measures such as financial restructuring, replacement of high cost debt with low-interest-bearing ones and improvement in operational parameters. The revenues for FY-05 rose 31 per cent to Rs 31,287 crore, driven by higher price realisations. The earnings growth during the period was also the highest at 167 per cent.

This was mainly on account of high steel prices and substantial reduction of interest outgo during the year.

The company has been able to bring down the level of debt from about Rs 14,000 crore in 2000-01 to about Rs 5,500 crore, while maintaining the cash deposits almost equivalent to the outstanding loan, thus attaining the status of a virtual debt-free company.

Improved product mix and rising realisations can support profit growth.

SAIL's strong cash flow position is likely to minimise the risk of expansion in equity as it could be released for partly funding the proposed capacity expansion.

Consistent reduction in manpower, coupled with reduced energy consumption, has helped the steel giant improve productivity and reduce operating costs.

This is reflected in its operating profit margins (OPMs), which expanded to 37 per cent in FY-05 from 21 per cent the previous year. SAIL has already begun to use sponge iron as a substitute for coking coal and this is likely to result in further reduction of input costs.

Growing share of value-added products

The company's thrust on enhancing revenue from value-added products has paid rich dividends. Production of special steels from the integrated plants rose 1.9 million tonnes in 2004-05, recording a 25 per cent growth over the previous year. Continued focus on this segment and the branding exercise are expected to improve the earnings outlook on account of higher realisations.

Gains linked to capacity expansion

The company has embarked on a Rs 25,000-crore capacity expansion and upgradation programme that would raise its output to 20 million tonnes by 2011-12 from 12 million tonnes now. Apart from improving the efficiency of the existing plants, the expansion is likely to boost volume growth in the long term.

Positive earnings outlook

Steel prices have fallen by about 20 per cent from the October 2004 peaks and may recover by about 10 per cent and stabilise by the third or fourth quarter.

SAIL's average realisations are likely to show a modest 5-6 per cent Y-o-Y increase, while the volumes are expected to grow by 4-5 per cent.

On account of these factors, we expect the FY-06 earnings to rise a modest 5-10 per cent that would well support the current valuations.

Synergies from merger with IISCO

Greater synergies are likely to accrue to the company from its merger with IISCO. An integrated steel plant, this fully-owned subsidiary of SAIL had accumulated losses of Rs 955 crore and a negative net worth of Rs 620 crore as on March 31, 2004. It began making profits after 2003-04 and recorded a provisional profit of about Rs 125 crore for the first nine months of FY-05.

Apart from the steel-making units, IISCO has captive iron ore and coal mines, a captive foundary and a pipe-making plant. With SAIL's financial and managerial capabilities and IISCO's large infrastructure, there would be greater synergy for capacity expansion and technological upgradation of the plant.

Synergies in mining, sourcing of raw materials, production and marketing augur well for SAIL's growth plans.

Major concern

SAIL imports about 60 per cent of coking coal and this is likely to rise to 70-75 per cent. Till the company taps captive sources or gets fresh leases, control over input cost may become difficult, bringing pressure on its margins.

If the company's ongoing talks of merging Nilachal Ispat fructify, it would give SAIL access to IISCO's mines and coke plant, thereby reducing the dependence on imports. It has also tied up with BHP Billiton for investing in mines to feed its growing capacity basket.

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