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SAIL: Helped by the tailwind - Views on News from Equitymaster

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SAIL: Helped by the tailwind

Oct 30, 2007

Performance summary
  • Topline grows by 7.3% YoY as the company’s output reaches record levels of 3.3 m tonnes during the quarter.
  • Expenses grow at a lower rate than the topline, resulting into an EBITDA margin expansion of 140 basis points (1.4%) in 2QFY08.

  • Net margins improve by 170 basis points (1.7%) as bottomline grows 18% YoY, led by higher other income and lower interest expenses.

  • For the half yearly period, the company has recorded a 14% jump in bottomline on a YoY basis and this has come on the back of an 8% YoY growth in topline.

(Rs m) 2QFY07 2QFY08 Change 1HFY07 1HFY08 Change
Net sales 85,391 91,635 7.3% 159,555 172,030 7.8%
Expenditure 62,058 65,344 5.3% 112,837 121,910 8.0%
Operating profit (EBDITA) 23,333 26,291 12.7% 46,718 50,120 7.3%
EBDITA margin (%) 27.3% 28.7%   29.3% 29.1%  
Other income 2,261 3,043 34.6% 3,773 6,112 62.0%
Interest (net) 924 594 -35.8% 1,861 1,390 -25.3%
Depreciation 3,035 3,012 -0.7% 5,993 6,024 0.5%
Profit before tax 21,635 25,728 18.9% 42,637 48,818 14.5%
Tax 7,207 8,726 21.1% 14,345 16,564 15.5%
Profit after tax/(loss) 14,428 17,002 17.8% 28,292 32,254 14.0%
Net profit margin (%) 16.9% 18.6%   17.7% 18.7%  
No. of shares (m) 4,130.4 4,130.4   4,130.4 4,130.4  
Diluted earnings per share (Rs)*         16.0  
Price to earnings ratio (x)**         16.5  
(* annualised, ** on trailing twelve months earnings)

What is the company’s business?
Steel Authority of India Ltd. (SAIL) is India’s second largest steel producer. The company holds nearly one-third 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.

What has driven performance in 2QFY08?
Buoyancy industry environment continues: While the company has not provided the exact break-up, we believe that the growth has been both volume as well as price driven. Further, increased sales of value added products, 20% growth to be precise, also helped support the topline growth. During the quarter, the company achieved best ever second quarter production of 3.25 MT with substantial growth in production of products like high corrosion resistant TMT bars for coastal areas (64%), quality wire rods (53%), LPG grade steel (38%), SAILCOR (100%), rails (11%), tinplate (59%) etc. Furthermore, strengthening of the dealer network saw the sales through dealers jump more than five fold during the quarter and reach 69,000 tonnes. Efficiency too has continued to rise with the capacity utilization touching 117%, another record for the quarter. On the prices front, while the company has not said anything on the issue, if the results of its peer Tata Steel are any indication, SAIL too seems to have benefited from the firm prices of steel in the domestic market.

Cost pressures ease: Helped by lower raw material costs, the company has been able to expand its operating margins by 140 basis points (1.4%) during the quarter. It has to be remembered that the company remains insulated from fluctuations in iron ore prices as it has its own captive mines. Thus, while other non-captive producers struggle to maintain margins, SAIL has gone ahead and recorded an improvement in margins. Infact, this has even helped it absorb high wage costs, which were otherwise threatening to pull down the operating margins, like they did in the first quarter of the current financial year. With other cost heads remaining largely under control, operating margins witnessed expansion during 2QFY08.

cost break up
(Rs m) 2QFY07 2QFY08 Change
Raw materials 32,811 30,198 -8.0%
% sales 38.4% 33.0%  
Staff cost 10,412 14,911 43.2%
% sales 12.2% 16.3%  
Consumption of stores and spares 6,478 6,778 4.6%
% sales 7.6% 7.4%  
Power and fuel 6,373 6,889 8.1%
% sales 7.5% 7.5%  
Other expenses 5,984 6,567 9.8%
% sales 7.0% 7.2%  

Robust cash flows have helped SAIL pare down its debt considerably and this quarter was no different as it was able to reduce its debt equity ratio to 16% as compared to 24% at the end of FY07. This was also reflected in the interest expenses, which stood lower by 36% YoY. Further, the higher amount of cash diverted towards investments helped the company bring about a 35% YoY growth in other income, which along with better asset utilisation, helped the company post a decent 18% YoY growth in bottomline during the quarter.

Over the last few quarters
As seen from the table below, while topline growth has tended lower, due largely to stable prices, growing balance sheet strength and improved productivity has helped the company keep margins at high levels.

over the last few quarters
  2QFY07 3QFY07 4QFY07 1QFY08 2QFY08
Net sales (YoY growth %) 21.7% 29.0% 15.7% 8.4% 7.3%
OPM 27.3% 28.5% 29.1% 29.6% 28.7%
NPM 16.9% 17.2% 18.3% 19.0% 18.6%

What to expect?
At the current price of Rs 262, the stock is trading at a multiple of 3.5 times our FY10 estimated book values. This is significantly higher than the 2 times book value we consider ideal for a company like SAIL. Although the company is embarking on a huge capex plan, we believe that the benefits are likely to accrue in the long-term. Furthermore, it is the largest expansion plan that the company has taken to date and given the past track record of cost overruns, we advise investors to remain cautious at the current juncture.

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