JSW Steel - BUY (Target Price Rs1,357, Upside 41.3%)

We met the management of JSW Steel to understand its strategy to offset the impact of rising raw material costs. The management was confident of maintaining its EBIDTA/ton of US$150/ton even though the increase in steel prices would be lower than that in raw material costs. It expects capacity utilization rates to remain high over the next two years and expects production to rise from 6mtpa in FY10 to 7mtpa in FY11. The impact of jump in raw material costs in FY11 would be partially negated by the commissioning of beneficiation plant and the HSM mill. The company has managed to increase steel prices by Rs2,500/ton since December ‘09. We expect JSW’s sales volume to witness 25% CAGR over the period FY10-12E. Robust volume growth coupled with increase in raw material integration will lead to earnings CAGR of 66.2% over FY10-12E. We maintain our BUY recommendation on the stock with a price target of Rs1,357.

The management plans to gradually increase its raw material integration to 50% over the next three years. It expects iron ore integration to increase from the current 20% to 40% by FY11E and 55-60% by FY13E. The company has also commissioned the 10mtpa beneficiation plant in December ‘09, reducing the procuring cost of iron ore. Captive coking coal mine in Jharkhand will be operational by FY13 and will meet ~25% of the company needs in the first year, which is expected to increase to 50% as the mine operates at its rated capacity of 5.5mtpa.

JSW to meet its EBIDTA/ton target despite rising raw material costs

The management was confident of maintaining its EBIDTA/ton target of US$150/ton even though the increase in steel prices would be lower than that in raw material costs. JSW expects savings of ~US$15/ton on iron ore consumption with the commissioning of its 10mtpa beneficiation plant. The beneficiation plant will allow the company to consume low grade iron ore, which is available cheaply in the domestic market. The commissioning of the 3.5mtpa HSM mill will increase the EBIDTA/ton to increase by US$15/ton, as sale of semis will fall from the 23% in 9M FY10 to zero in FY11E.