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SAIL: The going is good - Views on News from Equitymaster
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SAIL: The going is good
Oct 31, 2006

Performance summary
Steel sector behemoth, SAIL, announced its September quarter results yesterday. Net sales have gone up by 21.7% over the corresponding period last year. It must be noted that company has achieved highest ever first-half net profit of Rs 28 bn, a growth of 25.7%. Though operating costs registered a growth of 22.8% YoY, the company has seen margin expansion on account of higher output and improved productivity. Higher other income and lower interest costs enabled SAIL to post higher net profit during the quarter.

Financial performance snapshot
(Rs m) 2QFY06 2QFY07 Change 1HY06 1HY07 Change
Net sales 70,178 85,391 21.7% 124,164 159,555 28.5%
Expenditure 50,551 62,058 22.8% 84624.4 112,837 33.3%
Operating profit (EBITDA) 19,627 23,333 18.9% 39,539 46,718 18.2%
EBITDA margin 28.0% 27.3%   31.8% 29.3%  
Other income 1,385 2,261 63.2% 2,624 3773.3 43.8%
Interest 1,145 924 -19.3% 2,443 1,861 -23.8%
Depreciation 2,802 3,035 8.3% 5,641 5,993 6.2%
Profit before tax/(loss) 17,065 21,635 26.8% 34,080 42,637 25.1%
Tax 5,798 7207 24.3% 11,574 14,345 23.9%
Profit after tax/(loss) 11,268 14,428 28.0% 22,506 28,292 25.7%
Net margin 16.1% 16.9%   18.1% 17.7%  
No of shares (m) 4,130 4,130   4,130 4,130  
Diluted EPS (Rs)*         11.18  
P/E (times)         7.64  
*trailing twelve month earnings

Amalgamation of the Indian Iron & Steel Company Ltd (ISP), with the Company with effect from February 16, 2006, the previous year’s figures for the quarter/half year have been regrouped by including ISP’s figures.

What is the company’s business?
Steel Authority of India Ltd. (SAIL) is India’s largest and world’s 15th largest steel producer. 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 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.

What has influenced performance in 2QFY07?
Higher output aid topline growth: Despite softening of steel prices during the quarter, the company has registered higher topline growth on the back of the growth in production and consequently, sales. During 1HFY07, the company achieved highest-ever saleable steel production of 6.0 million tonnes, a growth of 6% YoY and capacity utilisation stood at 108%. The company has also achieved highest ever sales of 5.4 MT, a growth of 15% YoY. While domestic sales grew by 14.7% YoY, the company also enhanced its exports by 24% YoY (0.03 MT). SAIL was able to enhance production by way of casting route. During the period, the company recorded substantial growth in production of value-added products that enjoy higher margins like pipes (67%), cold rolled products (12%) and plates (11%).

Cost break-up (% of sales) 2QFY06 2QFY07
Increase/Decrease in stock 0.9% 2.7%
Consumption of raw material 35.1% 35.7%
Staff cost 13.9% 12.2%
Consumption of stores and spares 8.0% 7.6%
Power and fuel 8.5% 7.5%
Other expenditure 7.4% 7.0%
Total Cost 72.0% 72.7%

Margins sustained: While higher input costs did have a negative impact on operating margins in 2QFY07, it was not the case at the net level. It must be noted that costs as a percentage of sales have remained more or less the same but have increased on a cost per tonne basis. For instance, total cost as a percentage of sales has increased marginally by 70 basis points (0.7%) but on cost per tonne basis it has gone up by 19%. During the six-month period, SAIL has reduced its manpower, which in turn is reflected in lower staff cost during the quarter. At the net level, higher other income and lower interest costs helped matters.

Over the last few quarters:
As is evident from the table below, it has been a volatile show by SAIL over the last few quarters. 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 the 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. We expect margins to remain volatile in the near future.

  2Q06 3Q06 4Q06 1Q07 2Q07
EBDITA margin 28.0% 21.7% 16.4% 31.5% 27.3%
Net margin 16.1% 10.8% 12.0% 18.7% 16.9%

What to expect?
At the current price of Rs 85, the stock is trading at a price to earnings multiple of 7.6 times its trailing twelve month earnings. While the current valuations of the stock may look attractive, we believe that steel prices are likely to remain weak in the medium-term. This is because steel production in China is expected to outpace consumption for the second year is succession in CY06. While domestic demand for steel has risen sharply in the recent past, over the next three years, we expect steel demand to grow at around 4% to 5% per annum. Given this backdrop and the fact that SAIL is not a globally cost competitive steel manufacturer in the world, we believe that risks outweigh returns at current levels.

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