JSW Steel sinks after subdued Q4FY22 report card and export duty; what’s next?

JSW Steel may be an example of a good business model under temporary disruption; strong domestic demand may help despite various global headwinds

JSW Steel plunged over -34% from its lifetime high around 790 (scaled in mid-Apr’ 22) to late May low 520 after subdued Q4FY22 report card (earnings and guidance) and government moves to impose export duties on finished steel and various allied products to rein on domestic price rise (inflation). On 21^st May, Indian Federal Government slashed additional excise duties on petrol & diesel and cut customs/import duties (tariffs) on various plastic products, and essential raw materials/intermediaries for Iron & steel products to rein on surging inflation. And to increase domestic supplies/availability with stable prices, the Indian government also increased/imposed export duties on iron ore and various finished products of iron & steel.

On 21^st May, 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 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. Subsequently, Tata Steel and JSW Steel plunged. But user industries (direct/indirect), like Real Estate, Cement, infra Consumers Durables, and Automobiles may benefit going forward if domestic iron & steel prices go down as expected because of possible higher domestic supplies amid ‘unattractive’ export prices. Europe is now the main exporting market of Indian steel manufacturers after Russia invades Ukraine.

Tata steel exports around 35% to Europe against 57% domestic/India sales. JSW exports around 25% against 75% of the domestic sale. These firms also have overseas manufacturing facilities. But increased domestic supplies from other local manufacturers may dampen price realizations.

JSW said about its outlook in its FY22 Annual Report:

“The headwinds notwithstanding, India is likely to remain the fastest-growing major economy, with the expansion of economic output pegged at 7.2% (Source: RBI). Withdrawal of COVID-19 restrictions and normalization of the economy has led to a broad-based recovery across sectors. Most sectors, excluding services, are now at pre-COVID levels.

Infrastructure and manufacturing initiatives by the government are supportive of growth, and healthy tax collections provide the government with enhanced flexibility. Realignment of global supply chains will continue to provide opportunities to grow exports. Outlook for auto sales, especially Passenger Vehicles, remains healthy with the easing of the chip shortage, and the production of Medium and Heavy Commercial Vehicles is expected to be healthy, driven by infrastructure spending and mining. The real estate market remains strong despite rising interest rates. Healthy power consumption growth is expected to aid the addition of renewable energy capacities.

The vaccination programme having covered majority of the population, massive infrastructure spending, benefits of supply-side reforms, easing of regulations, robust exports, and the availability of fiscal space to ramp up spending across several key sectors, provides a platform for witnessing higher economic growth.

However, a prolonged Russia-Ukraine conflict, higher energy costs, and elevated commodity prices resulting in higher inflation and rate hikes by the Reserve Bank of India (RBI) will be dampeners to growth. The Government has consistently focused on curbing inflation with various fiscal policy measures. In May, the Centre announced a steep cut in excise duty on fuel which effectively brought down petrol prices by ₹9.5 per litre and diesel prices by ₹7 per litre.

In May, the Finance Ministry also imposed an export duty on 11 iron and steel intermediates and lowered import duty on three key raw materials for steel production and on three inputs for making plastic items. In order to reduce the cost of domestic steel production, the Finance Ministry reduced import duty on coking coal and anthracite and also coke and semi-coke. To ensure local availability of iron ore and concentrates, the export duty was raised to 50% and in the case of iron ore pellets, the export duty of 45% was imposed. In the case of nine other classes of iron ore and steel intermediates, a 15% export duty has been imposed. This includes flat-rolled products of iron or non-alloy steel.

The duty revision on iron and steel and their raw materials was initiated to tame prices. As the announcement of the imposition of export duty on steel, made by the Finance Ministry, came in the backdrop of spiraling inflation in the country, the move is expected to be temporary and the industry is hopeful of its withdrawal at the earliest.”

In his analyst concall for the Q4FY22 report card, JSW Joint MD/CFO Seshagiri Rao said JSW sees the government step of export duty imposition to contain domestic inflation as a welcome step and also temporary for one/few months as per previous 2008 precedence. But at the same time, JSW also sees the export duty on steel as an opportunity to sell more domestically as Indian steel demand may grow +8MT in FY23, whereas there would be an import of around 5MT. In any way, JSW Steel is committed to fulfilling its export obligations even after some compromises on the price realization front; i.e. JSW Steel will continue to supply its export contract at the pre-agreed price and may absorb the additional export duty as it would like to continue the decades-old trading relationship with its overseas/exporter clients.

Rao said:

“Then the issue which is currently being debated is the imposition of export duty and export of steel from India. In our view, it is a very temporary measure. If we see the last precedence in the year 2008, the Government of India in similar circumstances where inflation was also going up at that time, imposed an export duty on steel, but it was different percentages based on grades of steel, higher the value addition lower the export duty 5% to 15%. But what was important is they withdrew the export duty within a month on flat steel products and for long products, it was there for a few months. Seeing that precedent, we expect the kind of measure which is taken to contain inflation which is good for every one of us. Therefore, we feel it is temporary. It will get lifted soon after things come under control.

But at the same time, if I look at Indian steel demand growth in the current financial year, we expect it would be in the range of around 7.5% on a base of 106 million tonnes. So, there will be incremental demand of 8 million tonnes in India. And also, there is an import of close to 5- million-tonne imports into India is happening. Therefore, it is possible to sell in the domestic market to meet the incremental demand and also to substitute imports. These are the two things which we will continue to focus on and at the same time, it is our duty to service our customers with whom we have a long-term relationship globally, where we have been exporting the steel for over three decades. So, we continue to do that in spite of the duty that is prevalent today.

As far as the capital expenditure program is concerned, whatever we have already undertaken where it is in an advanced stage of implementation, like 5-million-tonne expansion at Vijayanagar or the Coke oven plants or the downstream units, these are all the projects which we have taken up earlier and they are under implementation and orders have already been placed and LCs are opened. I don't think there is any scope for review as far as these projects are concerned. Then if the export duties continue to remain for a very very long time, we have to look at in future what we would like to do. And at the same time, it is definitely a loss for India to leverage the opportunity that is available right now to increase our exports from India and also to meet our domestic demand and create capacities in India.”

Overall as per JSW Steel management, India’s steel consumption is expected to be robust amid huge intra-stimulus, robust housing, and automobile market. India’s steel export may also get an additional boost on supply chain disruptions from Eastern Europe amid the Russia-Ukraine war. But for the time being export duties on various steel products outweighs import duty relaxation on certain key raw materials, negative for the steel producers, having significant export. But JSW Steel also thinks that such export duty revision is temporary and the government will soon roll back the same.

Highlights of Q4FY22 report card: JSW Steel-Consolidated

·         Operating revenue Rs.46.895B vs 38.071B sequentially (+23.18%) and 26.934B yearly (+74.11%)

·         Operating expenses Rs.37.711B vs 28.939B sequentially (+30.31%) and 18.494B yearly (+103.91%)

·         EBITDA Rs.9.184B vs 9.132B sequentially (+0.57%) and 8.440B yearly (+8.82%)

·         EBITDA margin 19.58% vs 23.99% sequentially (-440 bps) and 31.34% yearly (-1175 bps)

·         Net interest paid Rs.1.756B vs 1.283B sequentially (+36.87%) and 1.005B (+74.73%)

·         Core operating profit (EBTDA=EBITDA-INTT) Rs.7.428B vs 7.849B sequentially (-5.36%) and 7.435B yearly (-0.09%)

·         EBTDA margin 15.84% vs 20.62% sequentially (-478 bps) and 27.60% (-1176 bps)

·         Core operating EPS (EBTDA/Share) Rs.24.68 vs 32.47 sequentially (-24.00%) and 30.85 yearly (-20.01%)

Overall, despite a surge in core operating revenue, core operating profit declined -by 5.36% in Q4FY22 sequentially, while almost flat yearly because of higher raw material costs/other operating costs amid elevated commodity prices due to lingering supply chain disruptions even before the Russian invasion of Ukraine; EBITDA margin contracted.

Highlights of Q4FY22 analyst concall:

·         The company was expecting stability and recovery is supply chain disruptions in Q4FY22 as the global pandemic has turned into endemic

·         But unexpected geopolitical events between Russia and Ukraine coupled with China’s ZERO COVID lockdown policies disrupted the commodity supply chain significantly globally

·         Despite various global headwinds, Indian steel consumption grew over +7% sequentially and JSW Steel had performed quite well with lifetime high productions and sales

·         On a standalone basis, crude steel production was around 5.01MT in Q4 (+13% sequentially); sales 5.13MT (+31% sequentially); reduced inventory by almost 0.386MT in Q4

·         Standalone production was 17.62MT and sales 16.35MT in FY22, almost 95% of guidance

·         EBITDA was adversely affected by volatile raw materials and finished product (steel) prices both globally and domestically

·         Net realizations came down -by 3%, while costs went up +3% sequentially due to higher coking coal prices

·         Standalone EBITDA/TON was around Rs.13505/T, down -3475/T

·         But there was a substantial improvement in global operations; the U.S. subsidiary made an EBITDA of $39M, while the Italian subsidiary reduced losses to €1M

·         Consolidated EBITDA at Rs.9.184B up almost +1% sequentially despite lower EBITDA/T as the sales volume jumped

·         Exceptional impairment costs –Rs.0.741B on account of Virginia and Jharkhand coal mines

·         Net profit was down sequentially despite higher EBITDA due to exceptional impairment costs coupled with higher interest and depreciation provisions (amid Dolvi plant expansion)

·         Net debt was around Rs.56.723B after repayment of Rs.9.589B in Q4; DEBT/EBITDA and DEBT/EQ ratios improved to 1.46 and 0.86; weighted average cost of debt also come down to 5.67%

·         Total capex guidance will be around Rs.20B in FY23 (against Rs.10.091B in FY22)

·         Highest ever consolidated EBITDA Rs.39.007B; net profit Rs.20.938B

·         FY22 dividend @17.35/share- in line with 15-20% consolidated net profit guidance

·         Net equity dilution for the merger of Ispat Specialty Steel with JSW Steel would be around 1.15% in FY23

·         FY23 guidance: crude steel production 25MT (+16% growth yearly); sales: 24MT (+20% growth yearly)

·         JSW sees the government step of export duty imposition to contain domestic inflation as a welcome step and also sees it as temporary for one/few months as per the previous 2008 precedence

·         But at the same time, JSW also sees the export duty on steel as an opportunity to sell more domestically as Indian steel demand may grow +8MT in FY23, whereas there would be the import of around 5MT

·         In any way, JSW Steel is committed to fulfilling its export obligations even after some compromises on the price front; i.e. JSW Steel will continue to supply its export contract at the pre-agreed price and may absorb the additional export duty as it would like to continue a decades-old trading relationship with its overseas/exporter clients

·         In Q3 and Q4, the cost of cocking coal was increased by $52 against a guidance of $50; in Q1FY22, the impact will be around $125 as global prices surged

·         In FY22, exports were 28% of total sales; but the company aims it between 15-20% on average depending on the market situation. In Q4FY22, export was 21% of total sales

·         The company will be flexible depending on the market dynamics and the FY23 export target continues to be around 15-20% of total sales irrespective of semi and finished products (no export duty or export duty) as per client’s orders

·         JSW is confident it to meet the guidance for FY23 despite export duties headwinds as domestic demand will be strong for huge infra demand; JSW’s guidance for FY23 is about 3.5MT incremental sales

·         The management sees 7MT incremental demand domestically as the government announced various infra projects which should consume around 20MT over 2.5-3 years

·         There is an opportunity to replace 5MT import with domestic production

·         Higher export duties on finished products will be also neutralized to some extent by input (RM) cost reduction amid higher export duty on iron ore and lower import duty on cocking coal

·         Both global and domestic prices of steel were correcting even before the May announcement of export duty; JSW has already reduced price by more than Rs.2000/T on 1^st May against April price and expects more reduction in June

·         JSW will pay export duties on all shipments at ports under protest whether consignments are customs cleared or not, but the company sees exemption of paying export duties on shipments that are already cleared by the custom as per the previous precedent

·         Despite price reduction, JSW sees better net price realizations on an average over a y/y basis

·         Domestic prices of steel are dependent upon the landed cost of import rather than export realization and Indian steel prices were almost equal to the landed cost of import even before the imposition of a 15% export duty

·         Exports of iron ore and pellets from Karnataka mines are ineffective despite SC exemption because of the imposition of the latest export duty by the government

·         JSW is ramping up its captive iron ore capacity both in Karnataka and Orissa to achieve the FY23 guidance of 25MT crude steel production and aiming to source around 53% of the total iron ore requirement from captive sources

·         JSW had already finalized auto contracts with some major automakers at around Rs.11500-12000/T increase for H1FY23 as per some pre-agreed formula; discussions are on with others and will be finalized soon

·         JSW was importing Russian coal even before the Russia-Ukraine conflict and continues to import because changing the coal blend overnight is very difficult, but despite cheaper prices, there is no planning for higher imports because of logistical difficulties at present

·         Both iron ore and steel prices are correcting due to lower demand from China

·         JSW has fully provisioned Rs.1.050B for the IBM notified case as it lost in Orissa HC; the company will now approach SC; the FY23 impact will be almost the same (over Rs.1B)

·         JSW is quite confident that like in 2008, this also the export duty will be withdrawn shortly

·         Domestic steel prices mainly depend on prevailing global prices and landed cost of import, not realized export prices, which may be higher or lower than domestic prices from time to time for various reasons

·         But higher export duty may increase domestic supply, which may depress prices to some extent; in FY22, India exported around 18.4MT

·         CAPEX will be unchanged for advanced-stage projects like 5MT expansion at the Vijayanagar plant or Coke Oven plant or any downstream units even if export duty will remain for a long time

·         But going forward, in FY24, JSW may review its expansion plan/projects if export duty stays on

·         Generally, the government decides on export or import duty based on market feedback without actual consultations with stakeholders, but JSW supports the government's decision of export duty to rein in domestic inflation, which would be good for all

·         JSW strongly believes that export duty is temporary and transitory

·         Although immediate price correction was around Rs.6000-7000/T after the announcement of export duty, JSW is in wait & watch mode to announce its prices as it sees current volatility is very extreme and may not be reflecting the hard reality

·         JSW is aiming for production of around 25MT crude steel in FY23 and for that, the requirement of iron ore would be around 50MT and at 53% captive usage; i.e. around 26.5MT iron ore would be 100% of all JSW’s captive mines

·         For Karnataka, which has only 7MT captive mines operational, JSW is buying the rest requirement from the local market rather than transporting from Orissa and thus overall average captive mine usage will be around 53%

·         Although the official import duty on finished steel is 7.5%, in reality, 70% of imports are from FTA countries, having a 0% tariff. Even the balance 30% are importing into India under advanced license with 0% import duty (tariff) and thus, practically there is no scope for the government to remove import duty and to reduce prices further domestically

·         JSW sees no export duty on semi-finished steel in the future as per the global trend

·         The automobile industry needs special grade of steel for various parts of auto bodies and thus overnight replacement of order is not possible/feasible. So the overall price negotiation process will be a win-win for both the steel and auto industry; pricing is usually around the landed cost of import rather than export realization of steel; price negotiation is a part of the overall business process

·         JSW expects robust demand from the auto industry in FY23 despite chip shortages headwinds

·         Global steel prices are correcting fast and there is margin pressure on every producer because raw materials do correctly with a lag

·         China has an edge in lower cocking coal prices, but also has regulatory/environmental issues of prohibition of some of the manufacturing hubs to manufacture/operate; in any way, the Chinese government is now prioritizing economic growth over-regulation again and thus demand in China will be elevated, resulting in lesser exports from China and thus global prices will be stable

·         JSW sees the so-called commodity super cycle as intact despite the chorus of the synchronized recession on both sides of the Atlantic and rate hikes by major Central Banks (tighter global financial conditions)

·         JSW sees robust demand for steel globally as well as locally amid additional demand being emanated from energy transition, higher defense spending by many countries after the Russia-Ukraine war, infra spending, and EV automobiles

·         Chinese steel demand and supply both are increasing sequentially quite robustly due to infra/fiscal stimulus

·         Although there is a slight reduction of global demand outside China, especially in advanced economies, production is also hampered due to energy crisis, labor shortages, and certain other issues. So overall global demand and supply are expected to be in balance

·         The Alloy steel category is exempted from export duty and JSW is also exporting this

·         JSW expects U.S. operation to recover in the coming days (made $200M EBITDA in FY22)

·         Although EBITDA loss in Italian operation has reduced, the plant is dependent on Italian railways orders. As the order is now not regular/almost stopped and if such a trend continues, JSW may decide to exit in future

·         JSW will try its best for a turnaround of any global asset, but if it’s not fine, then will exit as a strategy; JSW will focus more on Indian operation

·         Domestic prices of Indian iron ore and pellets are expected to fall further after the imposition of export duty; in FY22, India exported 11MT of iron ore and 14MT of pellets

·         As China is now increasingly using scrap rather than iron ore for steel production, prices of iron ore are expected to be subdued going forward

Finally, Rao said in his concluding remarks:

“What we expect in this quarter is that there will be some volatility in the overall steel prices because of global factors and also the imposition of export duty and the adjustment in the local markets, but as far as JSW Steel is concerned, we continue to meet our guidance whatever we have mentioned about 25 million tonnes of production and 24 million tonnes of sales volume.

Then we also see that the ramp-up at Dolvi is fastened further and there is a captive power plant of 175, another 75 megawatts, they are getting commissioned just now in Dolvi. That will reduce the cost further down. It is the significant reduction in the cost which is going to happen because of this commissioning and also the downstream has become fully operational. With all this, we will be able to improve our product mix, we will be able to reduce our costs and we will be able to increase our volumes. So, with that, I feel we should be okay going forward. Thank you.”

Conclusions:

JSW steel is quite confident about its FY23 guidance of 25MT crude steel production and 24MT sales volume despite various global headwinds and export duty. Looking ahead, JSW expects lower operating costs amid captive new energy/power sources coupled with the operationalization of various downstream projects. Thus JSW is expected to improve its product mix with higher volumes and margins going forward despite the government’s action of a windfall tax. JSW also expects robust demand in India.

Valuations: Rs.814-1407 by FY23-26

JSW Steel sinks after the Q4FY22 report card on the subdued report card, export duty, and the concern of tepid demand amid the chorus of the synchronized global recession. JSW Steel reported a core operating EPS of Rs.113.09 in FY22 vs FY21 Rs.67.15 and FY19 Rs.62.65 (pre-COVID). In FY20, the core operating EPS plummeted to Rs.31.70 due to COVID disruptions. Now looking ahead, as per the company’s guidance and various factors (pros & cons) as discussed above, JSW may report a 20% CAGR in core operating EPS for FY23-26. Thus the core operating EPS is expected to be around Rs.135.70-162.84-195.41 and 234.50 for FY23-26. And considering an average core operating PE 6, the fair valuation may be around 814-977-1172-1407 for FY23-26.

Technical outlook:

Looking ahead, whatever may be the narrative, technically, JSW Steel has to sustain over 520-490 levels for any bounce back; otherwise sustaining below 480, expect further corrections as above.

P&L A/C analysis: JSW Steel (consolidated)

Articles

Comments