Steel Authority of India Ltd (Q4 FY14)

• SAIL continues to report weak numbers due to an increase in raw material costs and a one-time hit due to repricing of previous year sales to railways

• Topline of Rs135.1bn was marginally higher than our estimate on the back of strong steel sales volume

• Steel sales volume for the quarter stood at 3.5mn tons against our expectation of 3.4mn tons

• Excluding the impact of Rs2.76bn, realisations improved by 2.7% qoq

• Operating profit of Rs12.2bn was quite lower than our estimate of Rs16.9bn

• The current run up in the stock builds in too much optimism; maintain SELL with a revised price target of Rs72

Write-offs restrict the growth in topline

Topline of Rs135.1bn was marginally higher than our estimate on the back of strong steel sales volume. However, the outperformance was curtailed by a one-time hit of Rs2.76bn due to repricing of previous year sales to railways. The company sells steel to the railways at cost plus basis and the pricing is decided by a committee. Sales volume of 3.5mn tons was higher by 7.7% yoy and 18.7% qoq on the back of some inventory liquidation during the quarter. Blended realisations for the quarter were lower by 0.7% qoq due to the negative impact of previous year sales. Excluding the impact, realisations for the company improved by 2.75% qoq. The company has reduced its prices in Q1 FY15 due to subdued demand and due to the appreciation of the rupee. The company expects Q1 FY15 realisations to be lower by 2% qoq.

Operating performance impacted by selling of high cost inventory

Operating profit of Rs12.2bn was lower than our estimate of Rs16.9bn due to an increase in raw material costs and a one-time hit due to repricing of previous year sales to railways. Raw material costs per ton increased on a qoq basis due to sales of high cost inventory. Raw material costs per ton increased from Rs16,014 in Q3 FY14 to Rs17,919 which was a negative surprise for us since coking coal prices have been lower on a qoq basis. Employee costs too increased by 11.1% qoq to Rs25.2bn, as previous quarter was aided by write back of provisions. EBIDTA/ton declined from Rs3,850 in Q3 FY14 to Rs3,498 in Q4 FY14 was quite lower than our expectation of Rs4,995.

Depreciation and interest costs shoot up due commissioning of new capacities

Reported PAT for the quarter was lower by 15% qoq due to higher interest costs and higher depreciation.  Interest costs increased by 45.7% yoy and 26.7% qoq to Rs3.1bn as the company continued to commission new capacities. Depreciation too was higher by 26.3% qoq to Rs5.1bn. The company expects depreciation to increase by Rs4bn annually in FY15 and interest costs to increase by Rs3bn due to the commissioning of the new capacities at ISP and RSP.

The current run up in the stock builds in too much optimism; maintain SELL

The company’s margins have been hit on account of high fixed costs and degrading product mix. Margins have been further impacted by the high costs involved in the stabilization of the new capacities. Though we expect margins to improve going ahead, we believe it would remain below its 5-year historical average. Earnings growth would be constrained by rising interest costs and depreciation. SAIL has bounced back sharply over the last one quarter on expectations of a faster revival in domestic steel prices. We believe the company would be an underperformer in the near term on account of delays in the commissioning of new plants, muted margins and subdued demand environment in the domestic market. At the CMP, the stock is trading at 7.2x FY16 EV/EBIDTA, higher than its domestic as well as international peers. We maintain our SELL rating with a price target of Rs72.