Domestic brokerage firm Kotak Institutional Equities maintained its 'sell' rating on Steel Authority of India (SAIL) with a target price of ₹50 apiece. This target price indicates a significant downside of 44% from the current trading price of SAIL.
The brokerage finds SAIL’s valuation expensive, considering its declining market share and weak growth prospects, a depressed margin profile due to inflated fixed costs, and the risk of rising leverage in case it starts a growth capex.
Among integrated steel producers, Kotak Institutional Equities identifies SAIL as particularly vulnerable to the impact of rising coking coal prices, primarily due to its high-cost and lower-margin steel business.
The brokerage has stated that seaborne met coal prices (HCC) have rallied by over US$100 per tonne in 2QFY24, led by a combination of higher demand and supply issues. It notes supply-side issues including the limited availability of spot HCC cargoes due to strikes in Australia, coal rail network issues, and reduced supply from other markets, including Canada and Russia.
On the demand side, it said, the drier-than-normal monsoon season in India has led to a surge in post-monsoon restocking demand from Indian steel mills. In light of these dynamics, the brokerage expects the met coal market to remain in a structural deficit in the medium term, keeping prices elevated.
The brokerage points out that SAIL remains one of the highest-cost steel producers among large integrated players, resulting in lower margins. Despite having access to captive iron ore, the brokerage said, SAIL faces cost inefficiencies primarily due to its high usage of coking coal (0.95–1 tonne of steel compared to peers at 0.7–0.8X) and elevated employee costs ( ₹7,450 per tonne in FY2023 versus peers at ₹1,500–4,000 per tonne).
The recent rally in coking coal prices should impact SAIL the most, given its low-margin structure and higher use of coking coal. The brokerage estimates that 1% higher coking coal prices impact SAIL’s fair value and EBITDA by around 8% and 3%, respectively, implying the highest sensitivity among peers.
Further, the brokerage highlights the company's rising debt levels, which has jumped significantly to ₹284 billion, 72% YoY in FY2023, and has risen further in 1QFY24, mainly led by the normalisation of working capital. The company's management is actively considering various brownfield expansion projects and debottlenecking expansions, totaling 10 mtpa, to be executed in the medium term.
During the previous expansion phase spanning from 2010 to 2020, SAIL saw negative FCF in 9 out of 10 years, resulting in net debt rising to ₹534 billion in FY2020 from net cash of ₹60 billion in FY2010. As SAIL stands on the cusp of the next expansion phase, the brokerage identifies the risk of an extended period of high capex, negative FCF, and rising leverage.
The brokerage estimates SAIL’s EBITDA at ₹4,968 and ₹5,076 per tonne in FY2024 and 25E versus ₹4,241 per tonne in 1QFY24 and sees downside risk in 2HFY24 in case coking coal price strength sustains. The brokerage finds the valuations rich at 7.4X EV/EBITDA both on an absolute and relative basis, given the weakest volume growth profile, RoE/RoCE of 3-4%, and negative FCF over FY2024–26E.
21 analysts polled by MintGenie on average have a 'hold' call on the stock.
Disclaimer: The views and recommendations made above are those of individual analysts or broking companies, and not of MintGenie. We advise investors to check with certified experts before making any investment decisions.
