- JSW Steel (JSW) has announced a merger with its 46.75% associate entity JSW Ispat (Ispat) in a share swap deal of 1:72. The merged entoty will have a total capacity of 14.3mtpa thus making it the largest steel producer in the country. Down stream facilities at Vasid, Tarapur and Kamleshwar with a combined capacity of 1.2mtpa will be spun into a wholly owned subsidiary so that the VAT benefits available to Dolvi can be retained. JSW would also issue cumulative redeemable preference shares worth Rs485mn to the preference shareholders of Ispat. The appointed date for the merger is 1st July â€™12 and is expected to be closed by end-FY13.
- The transaction values Ispat at an equity value of Rs24.2bn on Fridayâ€™s closing price of JSW and would result in an 8.3% equity dilution of JSW. After the merger, promoterâ€™s stake in JSW would reduce from 38.1% to 35.1% and that of JFE would reduce from 16.2% to 14.9%. The management expects the merger to bring in synergy benefits worth Rs3-5bn over the next two years and would allow JSW to expand its steel making capacity at Dolvi. The benefit of accumulated losses at Ispat would not be felt over the next 2-3 years as JSW is already a MAT paying company.
- The merger would reduce interest cost at Ispat as it had a weak balance sheet. Ispatâ€™s cost of debt stood at 10.9%, which is 360bps higher than the cost of debt of 7.3% at JSW. With the merger the company would be able to renegotiate the interest rates at a lower level at Ispat. As per the management, net debt (ex acceptances) for JSW would increase from Rs18.4bn at the end of June â€™12 to Rs25.2bn. As a result, net debt/EBIDTA would increase to 3.25x from 2.81x and net debt/equity to increase to 1.15x. The company intends to maintain net debt/EBITDA below 3.25x and net debt/Equity below 1.5x.
- Ispat at the end of June â€™12 had accumulated losses worth Rs87bn. The benefit of accumulated losses at Ispat to the merged entity would not be felt over the next 2-3 years as JSW is already a MAT paying company. As a result, the benefits of the accumulated losses would be utilised over a period of 6-7 years.
- Post the merger, JSW Steel plans to leverage the infrastructure of Dolvi unit to add another 3-4mtpa of capacity through brownfield expansion. This would aid the company to achieve its targeted capacity addition, as the JSW Bengal project has not picked up resulting into slower growth of JSW. JSW still maintains its targeted expansion to 40mtpa by 2020.
- JSW saw a sharp 30% increase in book value (20% in BVPS to Rs906/share) on account of this merger. We believe that this is higher on account of addition of revaluation reserve.
- The Supreme Court has agreed on Centrally Empowered Committee report's recommendation on resuming mining activities for category â€˜Aâ€™ mines in Karnataka. The A category mines are those who are either free of any illegality or had committed marginal illegalities in their mining operations. The Supreme Court has allowed 18 mines to resume iron ore mining in Karnataka, the country's second-largest supplier, after a suspension of over a year on environment concerns. As per JSW management, the capacity of category â€˜Aâ€™ mines currently stands at 8mtpa and would take 3-6months to restart. Till that time, JSW would source iron ore from NMDC and it currently has two months of iron ore inventory left which was bought from e-auctions. The court's statement has come when the statutory clearances in respect of some A category mines were coming to end in October and the statutory clearances for the renewal of leases has not come so far, despite applications for renewal made more than a year back.
- We maintain our FY13 volume estimates for as the iron ore supply in the region would continue to remain tight leading to lower volume growth than that expected by the company. In addition to this, the iron ore sourcing cost is expected to increase as the new system allows the seller to determine the base price and all the taxes are to be paid by the buyer. Ispat continues to remain a drag in the near term as we do not expect any meaningful improvement in profitability till the modernization initiatives are completed by FY15 and the supply of iron ore from Karnataka is ramped up. We expect consolidated debt/equity would stay high over the next two years as free cash flow remains negative due to the capex for the 2mtpa expansion at Vijaynagar. We marginally lower our 9-month price target on JSW to Rs680; while maintaining our Market Performer rating on the stock.
Proforma Financial information
(LTM June '12)
|Net turnover (Rs mn)||365,930||10,724||439,400|
|EBIDTA (Rs mn)||65,180||1,176||77,130|
|PAT (Rs mn)||7,070||(264)||9,600|
|Net Debt (Rs mn)||183,890||67,760||251,640|
|Outstanding shares (mn)||223||25,170||242|
|Net worth (Rs mn)||168,560||11,810||218,960|
|Net debt/EBIDTA (x)||2.81||5.76||3.25|
|Net debt/Equity (x)||1.09||5.74||1.15|
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