Steel Authority of India(SAIL)

Steel Authority of India(SAIL)

EQUINOX

Steel Industry - SAIL

Fundamental Analysis

A top down approach was followed in analyzing the Stock Steel Authority of India (SAIL)Steel Industry Analysis Steel is the backbone of all industries and is one of the basic ingredients of growth and development of a country. Traditionally, the fortunes of the steel industry have been linked to the economic cycle of a country. Steel is also the most commonly traded commodity across the globe. The per capita consumption of steel speaks volumes about the relative position of a country on the development front.Based upon its composition, steel is classified as:

a) Carbon steel and

b) Alloy steel Carbon Steel

Carbon steel is also known as non-alloy, plain carbon, or un-alloyed steel.

These steel types by definition do not contain any alloying element in specified proportions (i.e. beyond the usual proportion present in the commercially produced steel).

Carbon steel is composed simply of iron and carbon and accounts for 90 per cent of the steel production.

ALLOY STEEL

Alloy steel contains varying proportions of carbon and other elements.

Alloy steel comprises a wide variety and grades of steel having varying proportions of carbon and other elements. These elements determine the property of the steel.

The different types of alloy steel are used for diverse purposes, for instance, hard abrasion resistant steel is used for tool steels, heat resistant steel for high temperature applications, and fatigue resistant steel for mechanical applications. These are specific purpose compositions and cannot be generalized as a commodity.

Although this category consists of high value steel alloys, volumes of this segment are very low as compared with those of the mild steel products.

The most widely used alloy steel is the stainless steel.

Stainless steel is a corrosion resistant metal and contains chromium and nickel as major alloying elements in proportions that depend upon the properties required for a particular usage.

Semi-finished carbon steel products are converted into finished carbon steel products, which can be further classified into two basic types according to their shape:

Flat steel and

Long steel

Global Steel Industry

The recovery in the global steel industry became evident from June 2009 when the crude steel production crossed 100 million tones after a gap of 8 months. The capacity utilization which had dropped from 86% in July 2008 to 58% in December 2008, recovered to 80% in February 2010. It has become stagnant around this level for last 6 months. World Steel Association (WSA) in its latest demand forecast has projected a world-wide steel consumption growth of 10.7% during 2010 and 5.3% in 2011. The year 2011 is projected to take the global steel consumption to a new peak of 1.3 billion tonnes.

Company Analysis SAIL is Indias largest steel producing company

The company is among the top five highest profits earning corporate of the country.

It is a fully integrated iron and steel maker, producing both basic and special steels for domestic construction, engineering, power, railway, automotive and defense industries and for sale in export markets.

The company is planning to augment its annual production capacity from 14 million tons in 2008 to 23 million tonnes by 2012.

SAIL seeks full control of Chiria mines. Steel Authority of India (SAIL), the prime stakeholder in Chiria mines, one of the world`s largest source of good quality iron ore, has sought the full control of the over 2 billion ton ore reserve estimated in the region.

The fresh move from the state-owned steel major is expected to dent plans of companies such as ArcelorMittal, JSW Steel, Essar Steel and Tata Steel, which have been eyeing a portion of Chiria mines to serve their proposed steel projects in the state.

The Jharkhand government and SAIL have locked horns over the ownership of the Chiria mines for more than three years.

In fact, the state government terminated three out of six mining lease of IISCO in the Chiria to release iron ore resources for meeting the captive requirements of other steel companies, including Arcelor Mittal.STEEL INDUSTRY A Future OutlookThe medium to long term outlook for steel in India is robust. India has entered the steel intensive phase of economic development, with sustained investment in infrastructure, construction, urban renewal and high activity level in manufacturing. While there may be short term fluctuations in response to domestic and global concerns, the medium to long term prospects appear very bright.CAPACITY ADDITIONS

China alone is expected to account for more than 50 per cent of the total global capacity additions due to the relatively robust demand growth expected in the country over the long term.

China is followed by India, with 32 million tonnes of capacity expected to be added over the next 5 years on the back of the estimated strong demand growth and the countrys resilience to the recent global economic slowdown.

There is no significant capacity addition in the US, with operating rates already at low levels in the country and no indications of any major demand recovery. However, there is some capacity expansions in other advanced countries such as Europe and Japan.

Although Japan is already facing considerable pressure on operating rates, some of the companies had previously announced capital expansion plans. However, these expansion plans are at advanced stages are likely to get completed, albeit with some delay.

DOMESTIC DEMAND OUTLOOK

ACTUAL EXPECTED CAPACITY ADDITION PLANS

GLOBAL STEEL PRICE FORECAST

SAIL Performance Review Q2FY11 SAIL registered a turnover of ` 43,935 crore.

EBIDTA of ` 11,871 crore - a growth of 8.5%.

Profit before Tax (PBT) of ` 10,132 crore, higher by 8% - second highest since inception.

Profit after Tax (PAT) of ` 6,754 crore, higher by 9.5%.

Highest ever Net Worth of ` 33,317 crore, surpassing previous best of ` 28,148 crore a growth of 18.4%.

Total Dividend payout (including interim dividend of 16%) at 33% (` 1,363 crore).

Earnings Per Share of ` 16.35 as compared to ` 14.94 of 2008-09.

Produced 14.5 million tonnes of Hot Metal, 13.5 million tonnes of crude steel and 12.6 million tonnes of saleable steel.

Cost Reduction initiatives resulted in savings of around ` 1,082 crore.

Share of value added steel in overall production grew to 37% compared to 30% in 2008 09.

Record production of special quality and value added products of 4.62 million tonnes, a growth of 24% over FY'09.

Best ever coke rate at 517 Kg/thm (1% improvement).

Best ever specific energy consumption at 6.72 Gcal/tcs (Previous best of 6.74 Gcal/tcs achieved in FY'09).

Highest ever labour productivity of 226 tonnes/ man/ year.

Highest ever converter lining life of 11,036 blows achieved in a converter at BSP in September'09, surpassing previous best of 10,115 blows.

Best ever sales of 4.45 million tonnes of long products, higher by 3% over last year.

Distribution network expanded to 630 districts of the country with around 2500 dealer in place.

Capex touched 10,606 crore more than twice the previous year (5,223 crore).SWOT Analysis - Indian Steel Sector

Strength

The diversified product mix and multi location production units are an area of strength for the company. SAIL as a single source is able to cater to the entire steel requirement of any customer. Also, it has a nationwide distribution network with a presence in every district in India. This makes quality steel available throughout the length and breadth of the country.

SAIL has the largest captive iron ore operations in India, which takes care of its entire requirement. With plans in place to expand the mining operations, the company will continue to be self sufficient in iron ore after completion of the on-going phase of expansion. SAIL's captive power plants take care of about 70% of its total power need. With augmentation of capacities of power plants operated under Joint Venture, the Company will continue to have security in this key input in future as well.

SAIL's large skilled manpower base is a source of strength. There is emphasis on skill based training in the company. The expanded capacity will be operated with more or less similar number of employees in future. In fact, with selective recruitment and regular attrition on account of superannuation, the number of employees is likely to come down over time; while there will be improvement in overall skill set.

The Company has one of the biggest in-house research and development centers in Asia. SAIL's RDCIS (Research & Development Centre for Iron & Steel) is a source of regular product and process innovation. Low overall borrowings lend strength to the company's balance sheet as it can mobilize resources while keeping the leveraging at manageable levels.

Weakness

SAIL is dependent on the market purchase for a key input coking coal. As India does not have sufficient coking coal deposits, most of the supply is from external sources. As international practice in purchase of coking coal is through annual/quarterly price contract, it exposes the company to market risk if the steel prices crash but input prices remain unchanged.

A large manpower base results in higher manpower cost as a proportion of turnover for the company. Although there has been significant reduction in manpower through natural and other separations, the manpower strength in SAIL is still higher than the industry average.

A part of the operations in the company continues to be from energy inefficient processes viz. open hearth and ingot route of production, which will be eliminated only after the completion of the current expansion program.

At present around 20% of the products are in the form of semi-finished steel, resulting in lower value addition. This will continue till new rolling mills planned under expansion plan contribute to value addition as almost all semis will be converted to finished steel.

Opportunities

India is likely to emerge as the fastest growing steel market globally. This will provide opportunities for steel companies to grow and acquire scale of global giants. SAIL being the dominant producer of steel in India is suitably poised to avail opportunities offered by the expanding market.

Threats

Global economic recovery is fragile. The developed economies are under pressure for reconstructing their financial sectors and achieving fiscal consolidation without impacting growth.

Emerging economies, on the other hand, have to contend with the threat of inflation. A slowdown in global economic recovery will impact overall steel demand adversely. With significant excess capacity in the global steel industry during 2009-10.

Cheap imports from China and CIS continue to pose threats for domestic suppliers. With growth in developed countries somewhat shaky, India could become the target for cheap steel exports.

Delays in environmental clearances and renewal of mining leases could lead to uncertainty with regard to raw material linkages and delay fresh capacity becoming operational.Valuation

Reccomendation

Target PriceINR 237

Current Market PriceINR 189

Upside/Downside (%)25.6%

Rating Buy

M Cap 9,80,336

Valuation using Net Asset Value method & Price multiple ratios

Net Asset Value Per ShareINR 145.60

Current P/NAV 1.30

Target PriceP/NAVIntrinsic Value

Implied Target Price (Peak) 2.00 INR 291.19

Implied Target Price (Base) 1.50 INR 218.39

Implied Target Price (Trough) 1.00 INR 145.60

Valuation MethodologyMultiple Intrinsic Value

DCF Valuation1.25%INR 249.37

EV/Sales Exit Multiple 1.00 INR 236.04

EV/EBITDA Exit Multiple 2.50 INR 242.48

P/E Exit Multiple 1.00 INR 240.44

Asset Based Valuation (P/NAV) 1.50 INR 218.39

Valuation using Discounted Cash Flow & Sensitivity AnalysisTerminal ValueIntrinsic Value

Sum of PV of FCF for explicit forecast 4,76,643 Enterprise Value 9,52,998

WACC19.6%-Debt 1,65,113

Terminal Growth1.25%+Cash 2,24,364

Present Value of terminal value 4,76,355 Net Debt (59,251)

Terminal Value as % of Total Value50%Equity Value ( Market Capitalisation) 10,12,249

Diluted Shares 4,130

Total Value 9,52,998

Intrinsic ValueINR 245

Sensitivity-Varying WACC and Terminal growth

PV of Terminal ValueIntrinsic Value

WACCPV of FCF0.3%1.3%2.3%0.3%1.3%2.3%

17.6% 5,50,066 6,29,218 6,67,800 7,11,423 300 309 320

18.6% 5,11,852 5,41,929 5,73,239 6,08,389 269 277 286

19.6% 4,76,643 4,68,513 4,94,103 5,22,650 243 INR 249 256

20.6% 4,44,173 4,06,445 4,27,495 4,50,844 220 225 231

21.6% 4,14,201 3,53,724 3,71,141 3,90,363 200 204 209

Sensitivity - EV/Revenue Exit Multiple

PV of Terminal Value (EV/Revenue)Intrinsic Value

WACCPV of FCF0.81.01.30.81.01.3

17.6% 5,50,066 4,55,679 5,87,821 7,19,964 243 275 307

18.6% 5,11,852 4,20,410 5,40,797 6,61,183 226 255 284

19.6% 4,76,643 3,88,537 4,98,299 6,08,061 209 INR 236 263

20.6% 4,44,173 3,59,708 4,59,860 5,60,013 195 219 243

21.6% 4,14,201 3,33,611 4,25,064 5,16,517 181 203 225

Sensitivity - EV/EBITDA Exit Multiple

PV of Terminal Value (EV/EBITDA)Intrinsic Value

WACCPV of FCF233233

17.6% 5,50,066 5,07,738 6,19,860 7,31,982 256 283 310

18.6% 5,11,852 4,67,839 5,69,985 6,72,132 237 262 287

19.6% 4,76,643 4,31,780 5,24,912 6,18,044 220 INR 242 265

20.6% 4,44,173 3,99,165 4,84,143 5,69,121 204 225 245

21.6% 4,14,201 3,69,640 4,47,237 5,24,834 190 209 227

Sensitivity - P/E Exit Multiple

PV of Terminal Value (P/E)Intrinsic Value

KePV of EPS112112

20.4%244 18 24 36 262 268 281

21.4%232 17 22 33 248 254 265

22.4%220 15 20 30 235 INR 240 251

23.4%210 14 18 28 223 228 237

24.4%199 13 17 25 212 216 225

Per Share Data & Key Ratios

FY 2007A FY 2008A FY 2009A FY 2010A FY 2011E FY 2012E FY 2013E FY 2014E

EPS diluted (reported)15.0218.2515.2617.4220.8744.2347.4458.17

EBITDA/sales (%)23%25%19%23%20%27%26%27%

EBIT/sales (%)20%22%16%20%16%22%20%22%

Net income/sales (%)16%17%13%16%15%18%18%19%

ROE22%21%32%26%25%

EV/Sales 1.8 1.4 0.8 0.7 0.6

EV/EBITDA 7.1 6.1 2.7 2.5 2.1

P/E 10.9 9.1 4.3 4.0 3.2

P/Sales 2.3 2.0 1.8 1.9 1.5

P/BV 4.5 3.4 2.8 2.3 1.9

All the analysis are done in the excel sent along with the report. Assumptions are made by going through the financial statements & call transcripts published by the company.Technical Analysis

Volume & Open Interest

Price is the most important measure of the trends. Volume and Open Interest (OI) are of secondary importance. They are needed as confirming indicators. Volume is more important among the two as OI is generally used in case of FUTURES market.

Best known & simplest volume indicator is OBV (On Balance Volume)On Balance Volume Technical Indicator (OBV) is a momentum technical indicator that relates volume to price change. OBV attempts to detect when a financial instrument (stock, bond, etc.) is being accumulated by a large number of buyers or sold by many sellers.

When the security closes higher than the previous close, all of the days volume is considered up-volume. When the security closes lower than the previous close, all of the days volume is considered down-volume.

Traders will use an upward sloping OBV to confirm an uptrend, while a downward sloping OBV is used to confirm a downtrend. Finding a downward sloping OBV while the price of an asset is trending upward can be used to suggest that the "smart" traders are starting to exit their positions and that a shift in trend may be coming.

Here, we see that the price has been trending downwards over last few months which is again been confirmed by the OBV. This performance in spite of SENSEX moving up can be attributed to the below expectation performance of SAIL over the last two quarters. The expectation of the performance over the next few quarters is positive one and we will probably see a rally in coming days, which can be later then strengthened by the OBV indicator.Price Indicators1) Moving averages:

Purpose is to track the trend. MA is the follower, not the leader. It never anticipates, it only reacts. Shorter term averages are more sensitive to price action as compared to longer term. For, short term view with high volatility the short term MA gives clear picture. When trend is in process of reversing, two methods generally used are

Double crossover method

Triple crossover method

We have used Triple Crossover Method to identify trend reversals (as it is more accurate and confirms the trend reversal), as seen below:

MA signals trend reversal when the short term MA cuts the long term MA. As in, we can see that the 4 day MA cuts the 9 day MA around 28th October, signalling the downtrend. This is strengthened by the fact that 9D MA also cuts 18D MA from above, thus confirming the trend reversal. As of now, we can see that all the 3 Moving Averages are aligned in the order and we may see the cuts in future. So, the investors need to hold on and wait for any reversal pattern to take their position on the stock.

2) Bollinger Bands:

The bands capture 20-days Moving average & (+/-) 2 standard deviations above and below the price line. It represents the band within which 95% of the data will fall. Prices are over-bought when they touch the upside and are over-sold when they touch the lower band.

If prices bounces of the lower bound and crosses MA, the upper band becomes the target.

In strong uptrend, price will fluctuate between upper band & 20 day MA. In that case crossing below 20-day average warns of a trend reversal to the downside.

We can see that the encircled portions in the chart above have followed the pattern as mentioned above. As soon as the price crosses the MA, upper band becomes the target & the crossover of lower band signals down trend.

Currently we can see that the price lies between the down band and the MA. We need to wait and see the pattern brewing up. Going ahead the price chart may cross the MA, giving us the BUY signal with upper band as target. Hence, in the absence of any clear signal again we need to wait and then make the Buy or Sell as per the pattern. The findings of Bollinger Bands confirm those of the Moving Average.3) Relative Strength Indicator (RSI)

Momentum measures the velocity of the price changes, but it doesnt take care of the abrupt price change & also there is need for constant range for comparison. Hence, to overcome the issues, RSI is used, where RSI is ratio of Avg of X days up closes & Avg of X days of down closes. This indicator is better for small time period and not that affective when used over a large period of time.

RSI over 70 ( Overbought

RSI below 30 (Oversold

Divergence between RSI and price line when RSI is above 70 or below 30 is a serious warning that should be heeded. Also, the mid-value of 50 acts as SUPPORT during pullbacks & RESISTANCE during bounces.

Herein, we see that currently the RSI is hovering around the lower limit of 20%, which signals the OVERSOLD. The stock has always respected the RSI and has been synchronised with it. Hence the current signal hints us at the possible uptrend. We need to wait for some time and when the correct signal is shown along being strengthened by other indicators, the BUY action can be taken. Also, the chart below (with RSI being below the 30% mark) clearly shows the OVERSOLD signal. Hence, the investors can go for BUY position once RSI is supported by other indicators.

4) Stochastic (K%D)

A technical momentumindicator that comparesa security's closing priceto its price range over a given time period. The oscillator's sensitivity to market movements can be reduced by adjusting the time period or by taking a moving average of the result. This indicator is calculated with the following formula:

%K = 100[(C- L14)/(H14- L14)] C = the most recent closing price L14 = the low of the 14 previous trading sessions H14 = the highest price traded during the same 14-day period.

%D = 3-period moving average of %K

The theory behind this indicator is that in an upward-trending market, prices tend to close near their high, andduring a downward-trending market, prices tend to close near their low. Transaction signals occur when the %K crosses through a three-period moving average called the "%D"

We should watch out for the divergence between D Line and price when line is over-bought or over-sold.

Buy or sell signal signals occur when the D-Line is crossed by the faster K-Line.

Buy: K-Line crosses from below the D-Line below 20 Level.

Sell: K-Line crosses from above the D-Line above the 80 Level.

Here, the signal is judged by the crossovers between %K and %D lines as mentioned above. The encircled portions show the BUY and SELL signals being generated by the same. Currently we can see that there has been a Buy signal recently and the stock has advanced to some level, but again we can see that the lines are moving towards the lower level of 20%. Hence, there may be another BUY signal, which again suggests investors to wait for the moment.

5) WILLIAM'S % R

Williams %R (pronounced "percent R") is a momentum indicator that measures overbought/oversold levels The scale ranges from 0 to -100 with readings from 0 to -20 considered overbought, and readings from -80 to -100 considered oversold.

William %R, sometimes referred to as %R, shows the relationship of the close relative to the high-low range over a set period of time. The nearer the close is to the top of the range, the nearer to zero (higher) the indicator will be. The nearer the close is to the bottom of the range, the nearer to -100 (lower) the indicator will be. If the close equals the high of the high-low range, then the indicator will show 0 (the highest reading). If the close equals the low of the high-low range, then the result will be -100 (the lowest reading).

Typically, Williams %R is calculated using 14 periods and can be used on intraday, daily, weekly or monthly data. The time frame and number of periods will likely vary according to desired sensitivity and the characteristics of the individual security.

It is important to remember that overbought does not necessarily imply time to sell and oversold does not necessarily imply time to buy. A security can be in a downtrend, become oversold and remain oversold as the price continues to trend lower. Once a security becomes overbought or oversold, traders should wait for a signal that a price reversal has occurred. One method might be to wait for Williams %R to cross above or below -50 for confirmation. Price reversal confirmation can also be accomplished by using other indicators or aspects of technical analysis in conjunction with Williams %R.

In the chart above we can see that the Williams %R is hovering around the -80 level and the level between -80 to -100 is considered to be over-sold. Hence we can see that the BUY signal is approaching and we should wait for some time to confirm the signal and then take the position.

6) Moving Average Convergence-Divergence (MACD)

Divergence (MACD) is one of the simplest and most effective momentum indicators available. MACD turns two trend-following indicators, moving averages, into a momentum oscillator by subtracting the longer moving average from the shorter moving average. As a result, MACD offers the best of both worlds: trend following and momentum. MACD fluctuates above and below the zero line as the moving averages converge, cross and diverge. Traders can look for signal line crossovers, centre line crossovers and divergences to generate signals. Because MACD is unbounded, it is not particularly useful for identifying overbought and oversold levels.

Standard MACD is the 12-day Exponential Moving Average (EMA) less the 26-day EMA. Closing prices are used for these moving averages. A 9-day EMA of MACD is plotted alongside to act as a signal line to identify turns in the indicator. The MACD-Histogram represents the difference between MACD and its 9-day EMA, the signal line. The histogram is positive when MACD is above its 9-day EMA and negative when MACD is below its 9-day EMA.

MACD oscillates above and below the zero line, which is also known as the centreline. These crossovers signal that the 12-day EMA has crossed the 26-day EMA. The direction, of course, depends on direction of the moving average cross. Positive MACD indicates that the 12-day EMA is above the 26-day EMA. Positive values increase as the shorter EMA diverges further from the longer EMA. This means upside momentum is increasing. Negative MACD indicates that the 12-day EMA is below the 26-day EMA. Negative values increase as the shorter EMA diverges further below the longer EMA. This means downside momentum is increasing.

Signal line crossovers are the most common MACD signals. The signal line is a 9-day EMA of MACD. As a moving average of the indicator, it trails MACD and makes it easier to spot turns in MACD. A bullish crossover occurs when MACD turns up and crosses above the signal line. A bearish crossover occurs when MACD turns down and crosses below the signal line. Crossovers can last a few days or a few weeks, it all depends on the strength of the move.

Centreline crossovers are the next most common MACD signals. A bullish centreline crossover occurs when MACD moves above the zero line to turn positive. This happens when the 12-day EMA of the underlying security moves above the 26-day EMA. A bearish centreline crossover occurs when MACD moves below the zero line to turn negative. This happens when the 12-day EMA moves below the 26-day EMA.

The encircled part shows the correct crossover and hence the respective price action taken up by the stock. We see the price uptrend when MACD cuts from below and the price downtrend as MACD cuts from the above. Thus, the stock follows the pattern as suggested by the MACD lines. Now currently we see that the MACD is moving along and there might be a cut from below signalling the uptrend. Hence, the investors need to wait for the exact BUY signal to occur, which when strengthened by other indicators will provide an exact position to be taken.

2Equity Research Report - Team Chakravyuh