Bhushan steel in Q3 FY13 reported revenues of Rs25.3bn, lower than our estimate of Rs27.2bn. The underperformance in topline was largely due to lower than expected steel volumes. Steel sales volume of 0.56mn tons during the quarter was higher by 9.9% yoy and 4% qoq, but lower than our estimate of 0.59mn tons. Blended realisations for the company declined by 4.8% on a qoq basis against our expectation of a 3.5% decline. Blended realisations stood at Rs44,832/ton, 4.4% lower on a yoy basis.

Operating profit of Rs7.8bn was higher by 8% on a yoy basis and by 4.3% qoq. Operating profit was inline with our estimate as the impact of lower realisatiosn was offset by a higher than expected decline in raw material and conversion costs. Conversion costs per ton declined sharply by 12.7% qoq and 6.7% qoq to Rs6,689/ton, which was a positive surprise for us. Raw material costs too declined by 5.2% qoq to Rs24,305/ton, lower than our estimate by 1%. EBIDTA/ton remained flat on a qoq basis at Rs13,868. Raw material costs per ton of saleable steel is expected to decline going ahead on the back of a declien in coking coal costs and lower iron ore prices. NMDC had taken price cuts in Q3 FY13 and we expect the local miners in Orissa to follow the same.

The company has announced that backward integration of the company has already been completed. The phase III expansion to increase its HR capacity to 4.4mtpa is expected to be completed in Q1 FY14. The board has now approved setting up a 0.35mtpa Cold Rolling cum Electrical Steel (CRNGO) complex at an estimated project cost of Rs15.6bn. It has also reaffirmed the proposal to setup a 1.8mtpa Picking Line coupled with Tandem Cold Rolling Mill (PLTCM) at an estimated project cost of Rs60bn. We believe this capex would further add pressure on the company’s balance sheet stress.

Bhushan Steel’s structural growth story, driven by strong volume growth and backward integration is encouraging. Yet, we believe the upside from this has already been built in the price. At the CMP of Rs433, the company is trading at 10.1x FY13 EV/EBIDTA and 7.1x 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. Since the stock has corrected sharply over the last one month, we upgrade our recommendation from Sell to Market Performer while maintaining our 9-month price target of Rs413.