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SAIL: The elephant dances...

May 25, 2005

Performance summary
Public sector steel behemoth, SAIL, announced its 4QFY05 results just a short while ago. The results continued to surprise us, as they beat our estimates on the upside. The company has reported a 164% YoY jump in bottomline on the back of a 38% YoY growth in topline. The big surprise has been delivered at the operating level wherein operating margins have leapfrogged. Strong realisations owing to firm steel prices and strict control over costs have helped the company dole out this magnificent performance.

(Rs m) 4QFY04 4QFY05 Change FY04 FY05 Change
Net Sales 67,809 93,703 38.2% 220,346 291,144 32.1%
Expenditure 52,805 53,843 2.0% 174,808 183,043 4.7%
Operating Profit (EBDITA) 15,004 39,860 165.7% 45,538 108,101 137.4%
EBITDA margin (%) 22.1% 42.5%   20.7% 37.1%  
Other income 435 816 87.7% 964 2,872 197.8%
Interest 1,854 1,574 -15.1% 8,994 6,051 -32.7%
Depreciation 2,747 2,839 3.3% 11,226 11,270 0.4%
Profit before tax 10,838 36,263 234.6% 26,282 93,654 256.3%
Tax 695 9,483 1263.7% 1,161 25,484 2094.4%
Profit after Tax/(Loss) 10,143 26,780 164.0% 25,121 68,170 171.4%
Net profit margin (%) 15.0% 28.6%   11.4% 23.4%  
No. of Shares (m) 4,130 4,130   4,130 4,130  
Diluted earnings per share* 9.8 25.9   6.1 16.5  
Price to earnings ratio (x)   2.1     3.3  
(* annualised)            

Company profile
Steel Authority of India Ltd. (SAIL), the domestic public sector steel behemoth, is India's largest steel producer and is the world's 15th largest. The company commands almost 1/3rd of the domestic market share with its 13 MTPA capacity. It operates 4 integrated steel plants and 2 specialty steel plants. After bleeding at the net profit level during the period FY99 to FY03 owing to an unfavourable steel cycle, the company turned around in FY04 and has continued its commendable performance into FY05. Further, going forward, 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.

What has driven performance in 4QFY05?
Riding the steel cycle: SAIL's topline witnessed a robust 38% YoY growth during the March quarter. This could be attributed to strong realisations enjoyed by the company as steel prices continued to rule firm. It must be noted that average domestic steel prices continued their upward journey during 4QFY05 (up about 20% YoY). For the full year also, the topline growth has been rather impressive at 32%. This too was achieved on the back of strong steel realisations. For the year, average domestic steel prices were higher by about 30%. Considering that SAIL's aggregate volume sales growth witnessed a little over 1% growth in FY05, the topline growth has been contributed in its entirety by strong steel prices. It must be noted that while domestic volume sales grew by 8% YoY during the year, it was at the cost of a 58% fall in export volumes, which the company diverted to the domestic markets.

Cost break-up
(% of net sales) 4QFY04 4QFY05 FY04 FY05
Raw materials 22.8% 25.5% 28.5% 30.0%
Staff costs 27.4% 9.6% 21.6% 13.1%
Stores 6.8% 5.6% 7.6% 6.5%
Power & Fuel 7.8% 6.1% 9.8% 7.5%
Other expenditure 7.5% 6.1% 9.6% 7.0%

Operating margins explode (!): This was the key driver of SAIL's performance as the company continued to surprise on this front. While, as expected, while raw materials did put pressure on margins, as can be seen in the table above, it was huge savings on other operating heads that led to the operating margins increasing from 22% in 4QFY04 to over 42% in 4QFY05. The story is the same for the full year. It must be noted that while SAIL meets its iron ore requirements through captive sources, its reliance on imported coking coal has adversely affected its raw materials costing. However, as can be seen in the table above, the massive savings in employee costs has negated the impact of rising input costs. Other operating expenditure heads too witnessed an improvement during the quarter and full year. Further, the company's strategy of improving the product mix by optimizing the output of value-added products and increasing the proportion of special steel, operating at overall higher capacity utilisation (104%), greater usage of the continuous casting process and other measures seemed to have also aided the improvement in operating performance.

Net profits no stopping: Net profits for the company continued to soar with the bottomline registering a 164% YoY growth in 4QFY05 and ending FY05 with a 171% YoY growth. Apart from some contribution by the growth in other income (up 88% YoY in 4QFY05 and 198% in FY05), lower interest outgo (down 15% and 33% respectively) also aided the bottomline growth. Further, it must be noted the splendid performance by the company has come about despite the many-fold rise in tax provisioning. The company has announced a final dividend of Rs 1.8 per share (dividend yield of 3.3%). Thus for the full year, the total dividend given by the company has been Rs 3.3 per share.

What to expect?
At Rs 54, the stock is trading at a price to earnings multiple of 3.3 times its FY05 earnings (over 2x P/BV). While we had upgraded our earnings earlier during FY05 for the full year, the current quarter's performance has been above our estimates, owing to better than expected control over costs (primarily employee costs), thus warranting an upgrade.

Going forward, despite the attractive valuations of the stock (on a P/E basis), though we believe otherwise considering the rich valuations on the P/BV basis, the risks associated to investing in steel sector stocks (including SAIL) at the current juncture remain rather high. With steel prices already having witnessed significant correction over the last couple of months, it is only a matter of time that the same starts to get reflected in the financial performance of steel companies. While the near term prospects for the sector and the company continue to remain favourable, which could keep the stock in favour, we believe that it is fully valued at the current price. We believe that investing in commodity stocks wherein the cycle is at or nearing its peak tilts the risk-reward ratio considerably against the investor.

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