Equity Research Report: JSW Steel

JSW Steel may scale around 741-963 by Mar’24-Mar’25 on expected higher demand driven by India and China coupled with better realizations/spreads

Company Overview

JSW Steel is an Indian MNC steel producer based and is a flagship company of the diversified $22B JSW Group. After the merger of ISPAT Steel and Jindal Vijayanagar Steel Limited (JVSL), JSW Steel became India's 2^nd largest private-sector steel producer. JSW Steel's history can be traced back to 1982 when the Jindal Group acquired Piramal Steel Limited, which operated a mini steel mill at Tarapur in Maharashtra, and renamed it as Jindal Iron and Steel Company (JISCO). Soon after the acquisition the group set up its first steel plant in 1982 at Vasind, near Mumbai.

Later, in 1994, Jindal Vijayanagar Steel Limited (JVSL) was set up with its plant located at Toranagallu in the Bellary-Hospet area in the State of Karnataka, the heart of the iron ore belt and spread over 10,000 acres (40 sq. km) of land. It is well connected to both the Mormugao Port and Chennai Port and is 340 KM from Bangalore. It is said to be the 6^th largest steel plant in the world. In the year 2005, JISCO and JVSL merged to form JSW Steel Limited; it also set up a plant at Salem with an annual capacity of 1 MT.

Business Model:

As one of India’s leading business houses, JSW Group also has interests in energy, infrastructure, cement, paints, sports, and venture capital. Over the last three decades, it has grown from a single manufacturing unit to become India’s leading integrated steel company with a capacity of 28.5 MTPA in India and the USA (including capacities under joint control) at present and aiming for 38.5 MTPA by FY25. The Company’s manufacturing unit in Vijayanagar, Karnataka is the largest single-location steel-producing facility in India with a capacity of 12 MTPA.

JSW Steel has always been at the forefront of research and innovation. It has a strategic collaboration with global leader JFE Steel of Japan, enabling JSW to access new and state-of-the-art technologies to produce and offer high-value special steel products to its customers. These products are extensively used across industries and applications including construction, infrastructure, automobile, electrical applications, and appliances (consumer goods).

For JSW Steel, almost 98% of revenue comes from steel & allied products led by HR coils/plates/sheets (32%), long rolled products (18%), galvanized coils/sheets (15%), CR coils/sheets (9%), plates/pipes (5%), other misc. steel products (5%) and iron ore (2%). Almost 70% of revenue comes from India and 30% is international. JSW Steel is the biggest steel producer in India by capacity. Like all other major steel manufacturing companies, JSW Steel is also a major beneficiary of India's growth story, the government's push for infra CAPEX and affordable housing.

Key management: JSW Steel

Board Members: JSW Steel

Key Shareholders: JSW Steel (Promoter: Jindal family led by Sajjan Jindal)

Highlights of Q3FY23 report card: JSW Steel (Consolidated-INR 100 Cr. =1B)

·         Operating revenue INR 391.34B vs 417.78B sequentially (-6.33%) and 380.71B yearly (+2.79%)

·         Net sales realization is down sequentially due to lower steel prices/spreads

·         Operating expense INR 345.87B vs 400.26B sequentially (-13.59%) and 289.39B yearly (+19.52%)

·         Operating costs are down sequentially due to lower cocking coal prices and power/energy costs, while iron ore costs are slightly higher

·         EBITDA INR 45.47B vs 17.52B sequentially (+159.53%) and 91.32B yearly (-50.21%)

·         Net interest paid INR 18.19B vs 15.23B sequentially (+19.44%) and 12.83B yearly (+41.78%)

·         Core operating profit (EBTDA=EBITDA-INTT) INR 27.28B vs 2.29B sequentially (+1091.27%) and 78.49B (-65.24%)

·         Equity share capital INR 2.4172B vs 2.4172B sequentially (0%) and 2.41721B yearly (0%)

·         Core operating EPS (EBTDA/Share) INR 11.29 vs 0.95 sequentially (+1091.27%) and 32.47 yearly (-65.24%)

·         EBITDA margin 11.62% vs 4.19% sequentially (+7.43%) and 23.99% yearly (-12.37%)

·         EBTDA margin 6.97% vs 0.55% sequentially (+6.42%) and 20.62% yearly (-13.65%)

·         Interest/EBITDA 40.00% vs 86.93% sequentially (-46.92%) and 14.05% yearly (+25.95%)

·         Sales/Deliveries 5.63 MT vs 5.74 MT sequentially (-1.92%) and 4.63 MT yearly (+21.60%)

·         EBTDA/TON INR 4709.58 vs 428.87 sequentially (+998.14%) and 15969.17 yearly (-70.51%)

·         The overall report card was subdued on a yearly (y/y) basis although ‘blockbuster’ sequentially primarily due to a lower base effect

Highlights of the investor presentation, management commentaries, and Q&A (analyst concall): Q3FY23-JSW Steel

·         Overall subdued performances due to lower steel prices (globally), lower spreads/realizations amid various macro headwinds, higher borrowing costs, tepid Chinese demand (ZERO COVID policy), and the imposition of domestic export duty (15% till mid-November)

·         Although RM (raw materials/input) costs also fell, the overall spread dropped sharply

·         Global steel spreads have been subdued especially in Europe, partly due to inflated energy cost

·         Indian prices are now stabilizing at lower levels, while demand is also expected to come back amid robust underlying demand from auto, housing, and various infra-related construction sector

·         Overall domestic demand grew by around +10.5% yearly and +6.0% sequentially to 29.86 MT

·         Captive iron ore self-sufficiency at 41% of standalone operations

·         Exports of Indian steel tumbled by around -55% yearly and -19.2% sequentially to only 1.14 MT due to export duties imposed in May’22 till late Nov’22

·         Now as export duties were completely withdrawn, this will support Indian steel’s competitiveness in the global market

·         Planned CAPEX for expansion is around INR 150.00B for FY23; already spent INR 107.07B till 9MFY23 after spending INR 41.14B in Q3FY23

·         The easing of China’s ZERO-COVID policy and gradual reopening is now supporting higher steel prices/spreads (expect better Q4FY23 and FY24) despite lingering global macro and geopolitical headwinds

·         Indian steel demand is expected to be robust amid huge infra spending and various other targeted fiscal stimulus ahead of various state and general elections (2023-24)

·         Standalone steel sales 4.95MT vs 5.01MT sequentially (-1.0%) and 4.00MT yearly (+24.0%)

·         Consolidated sales are up 24% YoY, due to Dolvi Phase-II ramp-up and healthy domestic demand; down 2% QoQ due to lower exports

·         Exports remained subdued due to export duties (-62% YoY and -31% QoQ); the Removal of export duties in November to improve the competitiveness of the Indian steel industry in the global market

·         VASP (Value added sales product) volumes are up 6% YoY; the share of VASP in total sales is maintained at >50%

·         Supplies to the Auto sector are up 30% YoY but down 6% QoQ; outpacing Auto industry volumes# of +20% YoY and -10% QoQ

·         Sales to the Appliances sector are up 20% QoQ; sales to Solar are up 6% QoQ

·         Retail Sales declined 10% QoQ on higher imports and higher channel re-stocking in Q2 FY23

·         Strong distribution channel of 1,994 points across urban and rural India

·         Branded products across various industrial items including railways and EV

·         Overall, global macro headwinds are affecting global demand and prices for steel; but in India and lately, China demand story is upbeat

·         Additionally, the U.S. policy of the Inflation Reduction Act is restricting global free trade as the U.S. is giving priority to energy transition using local input materials or with friendly countries with whom it has FTA

·         European EV policy of Carbon Border Adjustment Tax is hampering export from India to various European countries despite some targeted subsidies (regionalization of the trade from globalization)

·         But Indian demand is upbeat amid huge infra/transport spending, housing, and EV/green energy sector

·         Indian steel demand surged +11.5% for 9MFY23; i.e. sequentially/incrementally almost 1MT every month; but at the same time imports have also gone up by almost +47% sequentially (q/q), while exports slumped -27% sequentially and -59% yearly, resulting in lower steel prices

·         Indian capacity utilization is around 92.5%

·         Overall, 9MFY23 consolidated performance has been also affected due to higher USDINR and inventory loss

·         Overall overseas EBITDA contributions turned positive in Q3FY23 at +1.12B vs -1.91B sequentially due to upbeat performances in Italy despite subdued activities (operating loss) in U.S. operations

·         Higher interest expenses due to higher borrowing costs, FX headwinds, and higher CAPEX/borrowings

·         Installation of a coke oven plant at Vijayanagar and 60MW power plant at Dolvi will reduce costs for these plants in the coming days (after partial benefit in Q3)

·         Taking benefit of PLI schemes by the government (industrial subsidies)  in various projects; planned CAPEX in 9-approved projects under PLI is around INR 167.51B; already committed around INR 53.50B

·         Notice of Rs.7.02B from Joda Mines is not legally tenable and the court has put a stay on the demand; thus there is no provision made in the P/L account for this demand

·         The overall cost of cocking coal and iron ore expected to be flat sequentially in Q4FY23

·         BPSL (Bhushan Steel)  performance has suffered due to lower production amid a lack of sufficient iron ore, high-cost inventory, and large NRV losses; but going forward, as capacity expansion expended from 2.7 TO 3.5MTA and also costs are now under control, performance should be much better in Q4FY23 onwards

·         Overall energy cost-benefit was around Rs.600/T in Q3FY23; will reflect the same in Q4FY23; RM cost should be flat sequentially

·         Cost-benefit was around Rs.7880/T in Q3FY23; sequentially -14% down

·         Global steel prices are recovering from January due to China reopening; domestic steel prices are also recovering at a sustainable level and may go higher further due to expected elevated demand amid infra, construction, automotive sector, and other CAPEX (spending)

·         Revised production guidance for FY23: 23.6MT vs 25.0MT earlier due to unexpected maintenance and subdued global demand; so far achieved 17.25MT in 9MFY23; rest will be achieved in Q4FY23

·         Revised sales guidance: 22.6MT vs 24.0MT earlier; so far achieved 15.51MT in 9MFY23; expected to achieve rest in Q4FY23; the focus is now on liquidating existing huge inventory domestically as well as globally (through higher export as export duty has been removed)

·         Expecting better spread/realization from Q1FY24 amid flat cocking coal prices/energy and surging steel spot prices

·         Domestic prices will also increase in tandem with the imported landing cost of steel & allied prices

·         After the removal of export duty, expect better export volume and also realization (in line with higher global prices/spread); also domestic prices are now recovering; thus expecting far better Q4FY24 than Q3 despite some NRV loss (higher cost old inventory may be sold at lower/current market prices)

·         Expected WC (Working Capital) released around Rs.42B in the coming quarters (as a result of old inventory liquidation) and out of that 75% may happen in Q4FY23

·         Although deleveraging guidance was 3.75 (net debt/EBITDA), the target is to bring it down lower than 3.5 by FY23; expect better cash-flow management/debt repayment in Q4FY23 amid expected lower USDINR (?) and old inventory liquidation

·         As there is a time lag between international/Chinese and domestic spot prices, expecting higher domestic prices (in line with higher Chinese prices) in the coming days

·         Expecting better performance from export-savvy JSW Coated in Q4 on a consolidated basis as there will be no export duty and no/lower inventory loss

·         Expecting upbeat FY24-25 (next two years) amid production hike (from around 28 MTA to 37 MTA by FY24), lower RM cost (including energy), and better realizations (through various new downstream projects)

·         Targeted export will be 10-25% of salable deliveries; so far achieved around 12% in 9MFY23 amid the headwind of export duty; now expect higher export after the removal of the export duty

·         Aiming at higher captive iron ore utilization to 50% by FY24 from the present 41% for India/standalone operations amid expected higher iron ore procurement from Odisha mines

·         Expecting better U.S. operations at breakeven levels in Q4FY23 amid lower/no inventory loss

·         Expecting bright Italian operations amid Italian rail orders and export market

·         Expecting higher capacity utilization in Q4FY23 sequentially

·          Better regulatory environment for iron ore procuring through auction route under the new NMDR Act (by Modi/BJP admin); thus whatever happened in the past (under UPA/INC admin), today there is a proper regulatory mechanism/auction route for all existing and new players for captive iron ore and JSW is increasing its capacity as per available opportunity

·         The Indian steel industry is urging the government for RoDTEP (Return of Duties and Taxes on Exported Products)

·         Expecting more rebalancing of steel demand and supply in FY24 and stable prices amid expected elevated domestic demand from China along with limited exports and robust demand in India; overall global production ex. China and India expected to be on the lower side due to various macro headwinds

·         Chinese demand for steel in FY24 may not jump substantially due to the policy of consumption-led growth rather than investment/CAPEX-led growth coupled with a fragile property market, which is structural

·         European demand will be muted

·         Indian demand will be upbeat

·         Looking ahead realization/spread may improve amid higher steel prices due to expected higher Chinese and Indian demand (huge infra stimulus), while raw material costs are likely to be range bound

·         All this may ensure subdued RM /raw material and energy cost and elevated domestic price/realization in Q4FY23

JSW Steel fair Valuations: Rs.741-963 by Mar’24 and Mar’25; current fair value around Rs.529

JSW Steel reported a core operating EPS of Rs.113.09 in FY22 against 67.15 in FY21, 31.70 in FY20, 62.65 in FY19 (pre-COVID), and 46.03 in FY18. FY22 was a golden year for almost all major Indian steel producers including JSW Steel on higher steel prices/realizations/spreads amid pent-up demand as the pandemic turned into endemic not only in India but almost globally. But steel prices/spread began to fall in late 2022 and tumbled further after the Russia-Ukraine war erupted on the concern of synchronized global stagflation/recession and Chinese ZERO COVID policy, resulting in sporadic lockdowns in the world’s biggest producer and consumer of steel. Prices of steel corrected almost CNY 6000 to 3500; now recovered to around 4320, while 3275 is strong technical support.

For JSW Steel, India's operation/prospect is now quite upbeat due to huge infra demand and cheaper sources of iron ore (partial captive mining). In late May’22, to control domestic inflation, the Indian government imposed a 15% export duty on finished steel, which put pressure on export realizations and impacted domestic prices. Also, there will be a 20% additional export duty on iron ore and a 45% export duty on iron pellets, while the import duty of cocking coal was reduced to 0% from 2.5% (small 700/- per ton benefit).

All of these are negative for the Indian iron & steel industries including JSW Steel (India standalone), which exports around 30% of its revenue. As a result of lower exports, domestic supply increased, resulting in lower spot prices/net realizations also in India. Thus almost all major Indian steel producers including JSW Steel has a terrible 9MFY23. But this export duty/windfall tax on Indian steel producers also ended in mid-Nov’22. Now expect around 25% export revenue for JSW Steel.

Thus considering all pros & cons of Indian as well as overseas operations as discussed above, present stable steel prices/realizations (after China reopening), synchronized global/local infra/EV stimulus, and also expected upbeat performance from Q4FY23, JSW Steel may report a decline of around -48% core operating EPS in FY23 after FY22 Golden Year’ core operating EPS Rs.113.09 (lifetime high). And JSW Steel may report +50% growth in core operating EPS in FY24 and an average +40% CAGR in FY25-26 amid expected higher domestic demand, stable realizations, and higher production.

Thus the FY23-24 core operating EPS may come to around Rs.58.80-88.21 (in line with the current quarterly run/trend rate) against FY22 Rs.113.09. JSW Steel’s pre-COVID (FY19) core operating EPS was Rs.62.65 against FY18 Rs.46.03; i.e. growth of +36.10%.

Now assuming +40% average CAGR (lower base effect, expected robust local/global demand, planned production hike, and cost-cutting), JSW Steel may report core operating EPS around Rs.123.49-160.54 in FY: 25-26. Further assuming an average core operating PE of 6, the fair value of JSW Steel may be around Rs.529-741-963 in FY: 24-26.

As the financial market always discounts at least 1Y projected earnings in advance, JSW Steel may scale around 529 by Mar’23 and 741-963 by Mar’24-Mar’25. And there is also an upside risk in JSW Steel's valuation as the projected core operating PE is around 4, a very low considering the stable prospect of high double digits CAGR in core operating EPS.

Technical View: JSW Steel (LTP: 679; EOD: 10/03/23)

Looking ahead, whatever may be the narrative, technically JSW Steel now has to sustain over 660 levels for 700/725-740/790* and 825/900-975 zones. On the flip side, sustaining below 650, it may further fall to 630/614-590/555*-520*/475-400 levels. Investors may buy/accumulate around 660/590-555/520 levels.

P/L Analysis: JSW Steel (consolidated)-QLY

P/L Analysis: JSW Steel (consolidated)-YLY

B/S Analysis: JSW Steel (consolidated)-YLY

C/F Analysis: JSW Steel (consolidated)-YLY

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