• JUNE 12, 2008

SAIL: A peep into the past II

In the last article , we saw the lows of 1999-2003. Now let us have a look at the period of 2003-2007, where backed by growing economies of emerging markets, notably the BRIC nations and the declining trade barriers among the countries of the world, the steel cycle witnessed one of its best phases ever in recent times. On the domestic front, increased spending on development of infrastructure, and robust demand from fast growing sectors like construction, automobile and capital goods brought back smiles on the faces of steel producers and SAIL was no different.

Revenues: Winds in its SAIL
The company registered robust revenue growth during this period. Its topline grew at a CAGR of 19.1%. Revenue showed growth in all years except FY06, where it marginally declined by 1.8%. This growth was mainly due to rising steel prices, which in turn increased realizations. The volumes grew at a CAGR of 4.3% while the realizations from saleable steel grew at a CAGR of 14.9% in the period under consideration. As we can see from the graph, the growth in realisations was significant in FY05 where it grew by 34% on a YoY basis. There has been a rising trend in realisations except for FY06 where it declined by 6.0%. This was caused due to a steep fall in steel prices by around 9.0%. As far as volumes are concerned, had it not been for the capacity constraints faced by the company, growth in topline could have been even higher.

The operating leverage kicker
On the operating performance front, operating profits grew at a whopping CAGR of 60.2% in the period under consideration. Operating profits have been growing at a rising rate continuously except in FY06, where it had fallen by 41%. This was caused due to rising prices of coking coal, which put pressure on margins and also, lower prices of steel on a YoY basis. In FY05, the company recorded the highest operating profit of the four-year period. This significant rise can be attributed to the increased realizations (34.5%) and lower than usual growth rate in expenditure (5.5%).

It is interesting to note that unlike other industries where volumes play an important role in profit growth, SAIL was able to increase its operating profits at a CAGR of nearly 60% despite growing its volumes by just 4.3% annually. Furthermore, the growth in operating profits came about despite a 13% CAGR in its operating expenses. This phenomenon could be attributed to the enormous power of operating leverage, where the lower the operating margins, the higher the profits during an upturn. Since SAIL's operating margins stood at rather lower 8% in FY03, increase in steel prices helped it grow its operating profits at an exponential rate. However, it should also be borne in mind that the reverse also works true for such companies i.e. the lower the operating margins, the further your profits fall when realisations are on a decline.

It flows to the bottomline
As far as net profits are concerned, they grew at a CAGR of 35.2% between the periods 2004 to 2007 (we have considered FY04 because FY03 was a loss making year for the company). The company registered profits for the first time in FY04 after a long gap of five years! The interest coverage ratio of the company significantly improved from 0.2 in FY03 to 23.3 in FY07, as strong cash flows helped the company reduce its debt and save on the interest charges. Moreover, a marginal growth in depreciation i.e. CAGR of 1.4% also boosted the bottom line in the period under consideration.

After having looked at both the phases of the steel cycle through the performance of SAIL, it can be inferred that while a windfall awaits the investor who is able to time the cycle properly and enter at the right time, the possibility of suffering huge losses if the downturn prolongs cannot be denied as well. Hence, one needs to exercise utmost caution when planning one's investments in a highly 'sensitive to cycle' company like SAIL.

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