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SAIL: Another ‘stain’less performance! - Views on News from Equitymaster

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SAIL: Another ‘stain’less performance!
Jan 29, 2007

Performance summary
Steel sector behemoth, SAIL, announced robust results for the quarter ended December 2006. Net sales swelled by 29% over the corresponding period last year. It must be noted that the company has achieved highest ever nine month net profit of Rs 43 bn, a growth of 48% YoY. Though operating costs registered a growth of 16% YoY during the quarter, the company reported 124% YoY growth in operating profits on account of higher output, improved productivity, improved sales realistion and better product mix. The 730 basis points (7.3%) net margin expansion is the result of EBITDA margin expansion, higher other income and lower interest costs.

Financial performance snapshot
(Rs m) 3QFY06 3QFY07 Change 9mFY06 9mFY07 Change
Net sales 66,165 85,371 29.0% 197,789 246,411 24.6%
Expenditure 52,675 61,054 15.9% 144707.7 175,377 21.2%
Operating profit (EBITDA) 13,489 24,316 80.3% 53,082 71,035 33.8%
EBITDA margin 20.4% 28.5%   26.8% 28.8%  
Other income 1,204 2,231 85.3% 4,048 6,004 48.3%
Interest 1,086 906 -16.6% 3,618 2,767 -23.5%
Depreciation 3,243 3,299 1.8% 9,032 9,293 2.9%
Profit before tax/(loss) 10,364 22,342 115.6% 44,480 64,980 46.1%
Tax 3,804 7,630 100.6% 15,382 21,976 42.9%
Profit after tax/(loss) 6,561 14,712 124.2% 29,098 43,004 47.8%
Net margin 9.9% 17.2%   14.7% 17.5%  
No of shares (m) 4130 4130   4130 4130  
Diluted EPS (Rs)*         13.1  
P/E (times)         8.5  
*trailing twelve month earnings            

The previous year’s figures for the quarter/9mth year have been regrouped by including ISP’s (Indian Iron and Steel Plant) figures.

What is the company’s business?
Steel Authority of India Ltd. (SAIL) is India’s largest and world’s 11th largest steel producer. The company holds nearly 1/3rd of the domestic market with its 13 MTPA capacity. It operates 5 integrated steel plants (post merger of IISCO steel plant) and 2 specialty steel plants. After bleeding at the net profit level between FY99 and FY03 owing to an unfavorable steel cycle, the company turned around in FY04 and reported an astounding performance in FY05. Further, the company has embarked on a massive expansion plan (split into two phases), which will take its steel production capacity to 20 MTPA by FY12. The company accounts for nearly 26% of domestic finished steel production. It is the largest player in the flat products and second largest player in the long products segment and uses the BOF process to manufacture steel.

What has influenced performance in 3QFY07?
Improved operational efficiency: During 9mFY07, the company achieved highest-ever saleable steel production of 9.3 million tonnes, a growth of 6% YoY and the capacity utilisation stood at 112%. SAIL enhanced production through the casting route. Apart from improved operational efficiency, 29% YoY growth in topline was achieved on account of better sales realisations and improved product mix. During the period, the company recorded substantial growth in production of value-added products that enjoy higher margins. The production of value added products has been higher by almost 16% YoY.

Cost break-up (% of sales) 3QFY06 3QFY07
Consumption of raw material 53.1% 34.4%
Staff cost 13.3% 14.4%
Consumption of stores and spares 8.5% 7.8%
Power and fuel 9.2% 7.7%
Other expenditure 9.0% 7.3%
Total Cost 93.0% 71.5%

Margin expansion: In spite of increase in input costs and rail freight, the company reported 80% YoY growth in operating profits on account of improved productivity. It must be noted that costs not only as a percentage of sales have reduced but also on cost per tonne basis (considering saleable steel production) were lower (declined by almost 7% YoY) compared to corresponding period last year. During the quarter and 9mFY07, the company also benefited from higher sales realisation. Being a commodity player, the company enjoys high operating leverage and therefore, any significant improvement in realisations flows directly to the bottomline. As mentioned earlier, company achieved highest ever production and sales during 3QFY07 and 9mFY07. This has been the key reason for improvement in profitability of the company apart from operational efficiency and favourable pricing scenario.

Over the last few quarters:
As is evident from the table below, SAIL’s performance over the last few quarters has been volatile. Margins dipped during 3rd and 4th quarter of FY06 on account of more than 30% correction in steel prices in the international markets. This was perpetuated by concerns of slowdown in China and the general softening of commodity prices in the global markets. Even as China continues to remain a net exporter of steel, prices strengthened in the first quarter, which is the key reason for the margin improvement. Margins improved in 1QFY07 on account of increase in production and sales but were lower by 420 basis points YoY (4.2%) in 2QFY07 as cost of production increased by 22.2% during the same period. During 3QFY07 margins expanded by 120 basis points on a sequential basis on account of all round improvement in performance. The company not only reported highest ever production and sales but managed to cut costs and also reaped benefits of improved sales realisations. Going forward, we expect margins to remain volatile as increased availability of steel reflected from rising inventories is likely to put downward pressure on prices.

Particulars 3Q06 4Q06 1Q07 2Q07 3Q07
EBDITA margin 20.4% 16.4% 31.5% 27.3% 28.5%
Net margin 9.9% 12.0% 18.7% 16.9% 17.2%

What to expect?
At the current price of Rs 111.5, the stock is trading at a price to earnings multiple of 8.5 times its trailing twelve month earnings. While the current valuations of the stock may look attractive, it should be remembered that commodity stocks always look attractive on a P/E basis at the peak of the cycle. Moreover, we believe that steel prices are likely to remain volatile in the medium-term. Thus, while there may be no issues on the volumes front, given the risks involved in a falling price scenario, we continue to remain cautious on the stock.

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