Bhushan Steel, over the last five years, has transformed itself from a pure converter to an integrated steel producer. It has been one of the largest secondary steel producers primarily catering to the automotive and the white goods industry. With the commissioning of the 2.9mtpa HRC plant, the company can count itself as one of India’s largest primary steel producer.

The 2.9mtpa HRC plant would be commissioned in a phased manner with the complete project operational by end-FY13, raising its finished steel capacity to 4.7mtpa. We estimate finished steel production to jump 3x over FY12-15 to 4.2mn tons from 1.4mn tons in FY12. Domestic flat steel prices would be under pressure due to excess domestic capacity, threat from cheaper imports and subdued demand from automobile and white goods sector.

Niche positioning of its products and being the preferred vendor for major automobile and white goods manufacturers have enabled the company to maintain healthy margins. We believe that the EBIDTA/ton achieved in FY12 would be the peak and see it subsiding over the next two years. The decline is largely due to the change in the product mix, lower flat steel prices and the rising raw material costs for the company.

Bhushan Steel’s structural growth story, driven by strong volume growth and backward integration is encouraging. Yet, we believe this has already been built in the price. At the CMP, the company is trading at 10.8x FY13 EV/EBIDTA and 7.4x FY14 EV/EBIDTA, which is at a premium to its peers. Historically, premium valuation to peers was perhaps due to the high margins enjoyed by its product mix; but with the business model converging with that of its peers, the premium should narrow.

Lack of raw material integration and highly levered balance sheet (D/E of 2.9x) would continue to be an overhang on the stock. While we value Bhushan marginally above its peers at 7x FY14E EV/EBIDTA, the arrived fair value is still 17.1% below the current market price. We initiate coverage on the stock with a SELL rating and a 9-month price target of Rs413.