INSTITUTIONAL EQUITY RESEARCH Metalsbackoffice.phillipcapital.in/Backoffice/Researchfiles/PC_-_Metals_Sector_Report...INSTITUTIONAL EQUITY RESEARCH Metals

INSTITUTIONAL EQUITY RESEARCH

Page | 1 | PHILLIPCAPITAL INDIA RESEARCH Please see penultimate page for additional important disclosures. PhillipCapital (India) Private Limited. (“PHILLIPCAP”) is a foreign broker‐dealer unregistered in the USA. PHILLIPCAP researchis prepared by research analysts who are not registered in the USA. PHILLIPCAP research is distributed in the USA pursuant to Rule 15a‐6 of the Securities Exchange Act of 1934 solely byRosenblatt Securities Inc, an SEC registered and FINRA‐member broker‐dealer.

Metals Steel to outperform base metals despite short‐term headwinds INDIA | METALS | SECTOR INITIATION

26 June 2019

Despite recent headwinds, we believe that the domestic steel industry is in a better position than global peers. Though demand‐related issues (weak auto, trade war and possibly below average monsoon) will put pressure on steel companies in the short term, 2H demand will improve on the government’s continued focus on infrastructure, construction, and housing, which represents +50% of India’s steel use. Incorporating auto weakness, Indian steel should grow 6% in FY20 against FY19’s 7.5%; it will pick up pace to 7% in FY21. This growth would still entail multi‐year‐high industry utilisation, as major capacity additions are still over a year away and a large part of incremental production from the resolution of stressed assets has already been absorbed (most plants are running at utilisation levels of c.80%, so further growth would need fresh investments). Ferrous players will perform better than non‐ferrous ones due to the former’s better domestic steel demand dynamics, higher government support, and less reliance on exports.

Indian demand to remain healthy: Indian steel demand growth will be one of the strongest in major producing and consuming countries, primarily fuelled by government spending. With the government’s thrust on infrastructure and a slew of other measures announced (such as National Steel Policy), Indian steel consumption growth should be c.6% in FY20 (incorporating weak auto demand) and 7% in FY21 (on higher government infra spending).

China’s all‐time‐high steel production, trade war to fuel volatility: The fear of ever‐increasing steel production, in the backdrop of perceptions that Chinese consumption is slowing due to the escalating trade war, may trigger some short‐term volatility and put pressure on prices. However, the internal Chinese demand was better than expected since its unorganised market is shifting towards becoming organised. Though the industry sees exports from China increasing, we reckon that they will remain manageable. The impact of the trade war will be negated somewhat by China’s own government stimulus, infra projects, and a proactive credit policy.

Aluminium to report a deficit; zinc markets moving to surplus: Global primary aluminium production is likely to lag behind demand growth for the next couple of years, as no significant supply‐projects will commission outside China. Most market participants believe aluminium will report a deficit of 1.0‐1.9mn tonnes in 2019, which coupled with low inventory levels, will support prices. Zinc saw a deficit of 384KT in 2018. However, we see the demand‐supply gap narrowing in 2019 on higher mine production as the Dugald River Mine ramps up and Gamsberg, New Century Resources, and Hellyer Tailings’ projects commission. International Zinc and Lead Study Group (IZLSG) expects 2019 zinc deficit to come down to c.121KT while we expect a balanced market. It then expects the market to eventually move to surplus in the next couple of years. We see zinc LME hovering around US$ 2,500‐2,600/t in 2019 before falling by US$ 100‐150/t in 2020.

What do we like? We are bullish on the ferrous space and prefer companies that are poised to take advantage of the domestic demand‐supply gap. We favour companies that can provide significant earnings growth in the next couple of years on volume ramp up and de‐leveraging. JSPL, Tata Steel and NMDC are our top picks – on improving domestic profitability and possible significant debt reduction. SAIL is also an interesting pick as it will benefit from demand pull, but volume execution capabilities need to be tested. In the non‐ferrous segment, we are more inclined towards Hindalco, based on stable business and expected continuation of de‐leveraging after the Aleris purchase. Vedanta is also trading at a discount to its historical average and can be a good dividend yield story. However, we are cautiously optimistic on this stock based on recent corporate governance issues, zinc market moving to surplus, and the tricky nature of the oil and gas business.

Companies Tata Steel Reco BUYCMP, Rs 497Target Price, Rs 640

Jindal Steel & PowerReco BUYCMP, Rs 143Target Price, Rs 225

SAIL Reco BUYCMP, Rs 49Target Price, Rs 58

JSW Steel Reco SELLCMP, Rs 267Target Price, Rs 225

National Mineral Development CorporationReco BUYCMP, Rs 110Target Price, Rs 131

Hindalco Reco BUYCMP, Rs 203Target Price, Rs 264

Hindustan Zinc Reco NEUTRALCMP, Rs 231Target Price, Rs 225

Vedanta Reco BUYCMP, Rs 169Target Price, Rs 205

National Aluminium CoReco NEUTRALCMP, Rs 50Target Price, Rs 56 Vikash Singh, Research Analyst (+ 9122 6246 4128) [email protected]

Page | 2 | PHILLIPCAPITAL INDIA RESEARCH

METALS SECTOR INITIATION

Table of Contents

Ferrous: Steel ∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙ 3

Non‐ferrous: Aluminium ∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙ 9

Zinc: Incremental supply to erode deficit ∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙ 12

Companies Section

Tata Steel ∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙ 15

Jindal Steel & Power ∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙ 22

SAIL ∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙ 28

JSW Steel ∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙ 33

NMDC ∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙ 39

Hindalco ∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙ 45

Hindustan Zinc ∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙ 52

Vedanta ∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙ 57

Nalco ∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙ 64



Ferrous: Steel Indian steel demand CAGR to be c.6.4% over FY19‐21 We believe that the Indian steel industry is in a sweet spot vs. other peer countries. According to the World Steel Association (WSA), in their April 2019 short‐rage outlook, India is likely to remain one of the fastest growing steel markets with over 7.1% growth in 2019 and 7.2% in 2020. However, we are building in a lower growth rate of 6% in FY20 to incorporate stress in the auto sector. Overall, we expect Indian steel consumption CAGR at 6.4% over FY19‐21, implying cumulative additional steel requirement of c.14mn tonnes over the next couple of years. This will push up the industry‐wide capacity utilisations to multi‐year highs, which would continue to support operating performance. Consumption and utilisation

We expect production CAGR of 6‐7% over FY19‐21. As new capacity additions are +1 years away, utilisation levels will improve meaningfully

EBITDA margins to improve

Despite some softening in FY20, overall margins are likely to remain much better than FY16‐18 levels

Source: JPC, PhillipCapital India Research Estimates Consolidation: Top‐5 players to command over 60% market share The IBC (Insolvency and Bankruptcy Code) process has provided Indian steel majors with a once‐in‐a‐lifetime opportunity to increase their dominance in the domestic market with relative ease. In FY17, top‐5 producers accounted for c.55% of India’s supply. This increased to c.63% after Tata acquired Bhushan Steel and Usha Martin and JSW acquired Bhushan Power and Monnet Ispat. These acquisitions of stressed steel assets and subsequent consolidation will help incumbents to strengthen their operating performance with the advantages of logistics and product‐mix. Major players to continue their market dominance mn tonnes FY17 FY18 FY19 FY20E FY21ETata Steel 11.0 12.2 12.7 12.8 12.9JSW 14.8 15.6 15.6 16.0 17.5JSPL 3.5 3.8 5.1 6.3 7.0SAIL 13.1 14.1 14.1 15.6 17.0Bhushan Steel 3.5 3.5 4.2 4.6 5.1Bhushan Power 2.2 2.0 2.3 2.3 2.7Essar Steel 5.3 5.8 5.9 6.0 6.5Rashtriya Ispat Nigam Limited 3.7 4.4 4.9 5.4 6.0Total by major players 57.1 61.3 64.8 69.1 74.7% of Indian demand 67.9% 67.6% 66.4% 66.8% 67.5%

Source: JPC, PhillipCapital India Research Estimates

68%

70%

72%

74%

76%

78%

80%

82%

40

50

60

70

80

90

100

110

120

FY14 FY15 FY16 FY17 FY18 FY19P FY20E FY21E

Mn tonn

es

Steel consumtption Industry utilisation (RHS)

8%

10%

12%

14%

16%

18%

20%

FY14 FY15 FY16 FY17 FY18 FY19 FY20E FY21E

EBITDA Margins



NPA assets sorted; no risk of oversupply As per our estimates, around 23‐25mn tonnes of stressed steelmaking capacity came under the IBC process. However, most of these facilities were already running at 65‐75% utilisation levels before IBC. Except Essar, most larger stressed assets have already been acquired by incumbents and ramped up to 80‐90% utilisation levels. These assets are slated to contribute an additional 3‐4mn tonnes of steel (at best) in the next 12‐18 months, after which they would need more capex to enhance production. Given the huge difficulty in setting up greenfield plants (regulatory hurdles and cost/time overruns) and as brownfield expansions are at least 12‐15 months away, we do not foresee any significant oversupply concerns in the domestic market. Government support – such as National Steel Policy and BIS Standard Certification – will continue to keep some check on imports. Current status of stressed assets

Company Capacity (mn tpa)

Debt FY18 (Rs Bn) Remarks

Essar Steel 10.0 508 NCLT approved Arcelor‐Mittal’s bid; Ruias filed court case against resolution; Matter is sub‐judice Bhushan Steel 5.6 555 Tata Steel has acquired Bhushan at Rs 352bn +12.2% equity Monnet Ispat & Power 1.5 134 JSW Steel ‐ AION Capital won Monnet for Rs 37bn Electrosteel Steels 1.5 122 Vedanta acquired assets for Rs 5bn Bhushan Power & Steel 3.0 470 JSW Steel acquired Bhushan Power for Rs 197 bn. To take over in a month’s time Visa Steel 0.5 42 Promoters challenged NCLT in Orissa Court; Matter is subjudice Adhunik Metalliks 0.5 52 Liberty Group defaulted payments; banks may re‐evaluate Maharashtra Seamless bid. Jai Balaji Industries 1.0 36 SBI approached NCLT.

Source: Company, PhillipCapital India Research

Note: Debt includes unpaid interest Domestic prices close to import‐parity; expect prices to stabilise On a mom basis, most geographies saw steel prices correcting by US$ 30‐50/t (China prices were down US$ 24/t). Indian HRC prices have also fallen by Rs 1,000‐1,500/t in the last one and half month. Current domestic prices are trading at just c.2% discount to imported Chinese prices. However, for South Korea, domestic prices are at a premium of c. Rs 1,000/t. We do not expect any considerable fall in steel prices as iron‐ore and coking‐coal prices are still higher and the global cost curve has increased meaningfully over the last 3‐4 months. For India, given the base case of US$ 489/t (the anti‐dumping reference price), we believe that most of the price correction has already taken place; prices should stabilise at Rs 40,000‐41,000/t. Import‐parity calculation Price China South Korea CIF 505 540Exchange rate 70.0 70.0 Price in INR 35,350 37,800 Landing charges @1% 354 378 Assessable Value 35,704 38,178 Basic custom Duty @ 12.5% 4,463 Nil Total 40,166 38,178 Other charges (warehousing, port etc.) 1,000 1,000 Total landed cost 41,166 39,178 Domestic HRC ‐ Mumbai price 40,250 40,250 Import price ‐premium / (discount) 916 (1,072)




Governments will continue protectionist stance Governments of various countries such as in the US and in countries in Europe have adopted a protectionist stance. After the US’ imposition of Section 232 and Europe’s quota system, India became an easy target for China and some other steel exporting countries, putting pressure on its domestic industry. Now that the election is over, we expect the government to keep an eye on steel inflows and levy a safeguard duty or review the anti‐dumping duty (AD) as well if necessary. The HRC reference rate of US$ 489/t was put in place two years ago when the CoP (cost of production) was much lower with iron ore at US$ 70‐75/t and coking coal at US$ 90‐95/t. Since then, iron ore prices have risen to US$ 110+ and coking coal to US$ 200+, so CoP has jumped US$ 110‐130/t. This, coupled with increased imports, prompted the industry’s demand of a review of the AD. The government would be keen to keep an eye on the health of the steel industry and would protect it if needed because it has just successfully completed IBC for the steel sector, and those assets need some time to ramp up and start paying back dues. China slowdown feared due to escalating trade war The newly escalated tariff war between the US and China has ignited fears of a global slowdown. Till date, the US has imposed tariffs on US$ 250bn worth of goods and threatened to impose tariffs on the remaining US$ 325bn. China has reacted with tariffs on US goods worth US$ 110bn. A positive is that despite fresh rounds of tariff increases, both countries are trying to find solutions. A quick look at the last five years of US imports from China suggests that direct metals (ferrous and base metals) exposure is very limited at an average 2.5% of total gross imports in value terms. However, the weight of indirect imports related to heavy‐metal user industries is higher at c.16.6%; this list includes machines/tools, telecom equipment, auto, railways/aircrafts, and industrial engines. Though it is difficult to assess the exact impact of trade wars, we believe that the effectiveness of new tariffs would be limited, as most of the downside has already been factored in due to different anti‐dumping and other duties/tariff imposed in past. Tariff imposed by different countries against China

Source: World Trade Organisation



Chinese steel demand could outperform expectations once again In the last three years, Chinese demand growth has repeatedly outperformed the World Steel Association’s expectations. In its October 2018 short‐range outlook, WSA had predicted Chinese unadjusted consumption growing by 6% in 2018 and demand growth remaining flat in 2019. However, actual demand growth in 2018 turned out to be higher at c.8%. Now WSA is building in a demand growth of 1% for 2019 (higher than its earlier flat prediction) and a 1% fall in 2020. Considering higher than expected demand in 5MFY19, we are building in 3% demand growth for 2019 (higher than WSA’s forecast) and a fall of 1% in 2020 (in line). WSA forecast vs. actual Chinese demand WSA Forecast Year 2016 2017 2018 2019 2020Àpril 2016 (4.0) (3.0) ‐ ‐ ‐Òctober 2016 (1.0) (2.0) ‐ ‐ ‐Òctober 2017* ‐ 3.0 0.0 ‐ ‐Àpril 2018 ‐ ‐ 0.0 (2.0) ‐Òctober 2018* ‐ ‐ 2.0 0.0Àpril 2019 ‐ ‐ ‐ 1.0 (1.0)Actual growth 1.3 3.0* 2.0* ‐ ‐

*China’s demand growth is adjusted for the shift to the organised sector from the unorganised one. Note: 2017 and 2018 unadjusted Chinese demand grew c.12% and c.8% respectively. Infra projects and soft stimulus will aid China’s demand But Chinese appetite for metals will sustain (albeit at a bit lower rate) in 2019 because of investments in infrastructure and railways. In 2018, China spent CNY 803bn on its railways, despite a lower allocated budget of CNY 732bn. In 2019, the country has planned to lay tracks over 6,800km (including c.3,200km high‐speed), which is c.40% higher than its plan for 2018 (as per Bloomberg estimates, each US$ 1mn investment in railways could entail c.34 tonnes of steel). China also plans to invest CNY 1.8tn on construction of roads and highways and has several mega projects lined up – such as the New Silk Road (one belt one road project has the potential of over 250mn tonnes of cumulative steel consumption) and the construction of dams and ports. Last year, while the Chinese government had put several restrictions on its credit channel to limit excess credit growth and control/reduce shady channels, it was also embroiled in a trade war with the US, putting pressure on its economy. This prompted Chinese authorities to rebalance their approach to debt and they took soft stimulus measures such as relaxation of the reserve ratio (twice in 2019 till date) and tax cuts for businesses. Spurred by relaxed government regulations and proactive Chinese monetary measures, China’s property (industry experts peg growth at 8% in 2019), infra, and construction demand has been robust in the first four months of 2019 (which account for +50% of annual demand), although we see a few months of lower demand as the Chinese property market enters a seasonally weak monsoon period. China’s production to peak in 2019; risk of higher steel export is limited Chinese effective production grew 6.6% in 2018 to 928mn tonnes, despite 150mn tpa capacity curtailment since 2016. Though the country has achieved its capacity‐cuts target two years ahead of schedule, it has hinted at continued steel‐sector reforms by bringing down its total capacity even more – to 1bn tonnes in the next 5 years. Hebei, with a 25% share of domestic steel production in China, plans to cut its crude‐steel capacity by 14mn tonnes in 2019; this, after eliminating 12.3mn tonnes last year. We believe that since most of the redundant capacities in China are already eliminated, it may now focus on consolidation in the industry by merging or closing small mills and clamping down on zombie companies.



Chinese demand‐supply expectations Mn tonnes 2017 2018 2019E 2020EChina ‐ reported 832 928 993 983Growth (%) 2.9% 11.6% 7.0% ‐1.0%Induction ‐ unreported 39 ‐ ‐ ‐Total Production 871 928 993 983Increase (%) 1.5% 6.6% 7.0% ‐1.0% Consumption 774 835 860 851 8.2% 7.9% 3.0% ‐1.0% Export 76 70 78 80Import 13 13 13 13 Net Export 62 56 65 67 ‐34.0% ‐9.5% 15.0% 3.1%

Source: WSA, Bloomberg, PhillipCapital India Research Margins under pressure; to check unrelenting production Chinese domestic steel prices have fallen US$ 45‐50/t in the last couple of months on trade‐war fears. During the same period, iron ore prices have jumped by US$ 20‐22/t (24%), squeezing the spreads. Current steel spreads (at c.CNY 170‐180/t or US$ 25‐30/t) are significantly lower than peak spreads (of CNY 1,150‐1,200/t or US$ 175‐178/t) and the last year’s average (CNY 613/t or US$ 89/t); so any further fall in realisations due to demand concerns will erode the profitability of mills and may lead to losses as well. This in turn will prompt mills to curtail supplies – to restore market equilibrium. We expect the profitability of Chinese mills to hover at around CNY 300‐350/t in the longer run. Spreads may get a boost if there is a positive outcome on the global trade‐war front. Chinese steel mill profitability

Current spreads are at c.US$ 25/t, closer to 2‐year lows. A fall from here would translate to production curtailments

Tangshan BF utilisation rate

Relaxed environment norms last winter led to higher capacity utilisation

Source: WAS, Bloomberg, PhillipCapital India Research China’s demand indicators are a mixed bag China’s major ‘real demand’ indicators are showing mixed trends. While automobile demand is clearly under pressure, the steel PMI, calculated on steel‐user‐industry PMI, has improved in March, even as new car registrations kept slowing. While China’s GDP growth rate has moderated in the recent years, it is still hovering at a reasonable 6.0‐6.5%, signalling stable steel demand.

‐800‐600‐400‐200

0200400600800100012001400

Aug‐13

Nov

‐13

Feb‐14

May‐14

Aug‐14

Nov

‐14

Feb‐15

May‐15

Aug‐15

Nov

‐15

Feb‐16

May‐16

Aug‐16

Nov

‐16

Feb‐17

May‐17

Aug‐17

Nov

‐17

Feb‐18

May‐18

Aug‐18

Nov

‐18

Feb‐19

May‐19

CNY/tonn

e

Chinese BoF Steel ProfitabilityYearly Average

40

50

60

70

80

90

100

May‐15

Aug‐15

Nov

‐15

Feb‐16

May‐16

Aug‐16

Nov

‐16

Feb‐17

May‐17

Aug‐17

Nov

‐17

Feb‐18

May‐18

Aug‐18

Nov

‐18

Feb‐19

May‐19

%

Tangshan BF utilisation rate Winter avg.



China: Newly started floor space

Construction sector accounts for over 50% of Chinese demand. Growth in newly started construction remains decent.

China: Newly registered motor vehicles

Chinese new‐vehicle registrations indicate auto segment demand remains poor.

Source: Bloomberg China Caixin Manufacturing PMI

Chinese manufacturing PMI has bounced back after the Lunar Holidays and stay above 50 (above 50 represents expansion).

China: GDP vs. steel consumption growth

Chinese GDP growth is likely to be 6.0‐6.5%; we expect steel demand to move in tandem with 3% growth

Source: Bloomberg

(40)

(30)

(20)

(10)

‐

10

20

30

40

May‐14

Aug‐14

Nov

‐14

Feb‐15

May‐15

Aug‐15

Nov

‐15

Feb‐16

May‐16

Aug‐16

Nov

‐16

Feb‐17

May‐17

Aug‐17

Nov

‐17

Feb‐18

May‐18

Aug‐18

Nov

‐18

Feb‐19

May‐19

%

‐20%

‐15%

‐10%

‐5%

0%

5%

10%

15%

20%

25%

30%

‐

500

1,000

1,500

2,000

2,500

3,000

3,500

Jul‐1

3Oct‐13

Jan‐14

Apr‐14

Jul‐1

4Oct‐14

Jan‐15

Apr‐15

Jul‐1

5Oct‐15

Jan‐16

Apr‐16

Jul‐1

6Oct‐16

Jan‐17

Apr‐17

Jul‐1

7Oct‐17

Jan‐18

Apr‐18

Jul‐1

8Oct‐18

Jan‐19

Apr‐19

000 un

its

China motor vehicle newly registeredYoY Growth (RHS)

45

46

47

48

49

50

51

52

53

May‐16

Aug‐16

Nov

‐16

Feb‐17

May‐17

Aug‐17

Nov

‐17

Feb‐18

May‐18

Aug‐18

Nov

‐18

Feb‐19

May‐19

5.0

5.5

6.0

6.5

7.0

7.5

8.0

(6.0)

(4.0)

(2.0)

‐

2.0

4.0

6.0

8.0

10.0

12.0

14.0

Mar‐14

Jul‐1

4

Nov

‐14

Mar‐15

Jul‐1

5

Nov

‐15

Mar‐16

Jul‐1

6

Nov

‐16

Mar‐17

Jul‐1

7

Nov

‐17

Mar‐18

Jul‐1

8

Nov

‐18

Mar‐19

%

Steel consumption growth (LHS) China GDP



Non‐ferrous: Aluminium Global market to stay in deficit in 2019 Global primary aluminium production will lag behind demand growth for the next couple of years, as no significant supply project is commissioning outside of China. Most market participants expect 2019 demand to grow at 2‐3% and production at a lower 1‐2%, implying aluminium deficit of 1.0‐1.9mn tonnes in 2019. While China is likely to report balanced to marginal surplus aluminium in 2019, the rest of the world is likely to see significant deficits. As per Rusal, the aluminium markets are staring at 2‐3 years of deficit due to stricter norms and lack of planned capacities. Aluminium markets are likely to be in deficit for the next two years Global aluminium demand‐supply balance Global aluminium inventory days

Source: Rusal Aluminium price downside limited The last six months have been difficult for the aluminium sector, as prices have fallen because of a host of factors such as the end of Rusal sanctions, higher exports from China, increasing fear of a global slowdown, and a fall in input prices (such as of alumina and carbon). However, energy prices (which account for c.30‐35% of CoP) have started inching up again. This, coupled with wafer‐thin margins for Chinese non‐integrated smelters, are likely to arrest a further fall in aluminium prices. We expect LME aluminium to settle at around US$ 1,800‐1,900/t. Aluminium inventories and price trend

Source: LME, Bloomberg

‐164

‐1,569

‐1,356

‐673

‐1,800

‐1,600

‐1,400

‐1,200

‐1,000

‐800

‐600

‐400

‐200

0

2017 2018 2019E 2020E

000 tonn

es

40

50

60

70

80

90

100

110

2015 2016 2017 2018 2019E

Mn tonn

es

1,000

1,200

1,400

1,600

1,800

2,000

2,200

2,400

2,600

2,800

‐

500

1,000

1,500

2,000

2,500

3,000

Jul‐1

6Au

g‐16

Sep‐16

Oct‐16

Nov

‐16

Dec‐16

Jan‐17

Feb‐17

Mar‐17

Apr‐17

May‐17

Jun‐17

Jul‐1

7Au

g‐17

Sep‐17

Oct‐17

Nov

‐17

Dec‐17

Jan‐18

Feb‐18

Mar‐18

Apr‐18

May‐18

Jun‐18

Jul‐1

8Au

g‐18

Sep‐18

Oct‐18

Nov

‐18

Dec‐18

Jan‐19

Feb‐19

Mar‐19

Apr‐19

May‐19

Jun‐19

US$/ton

nes

`000

tonn

es

LME SHFE Other Price (RHS)

Inventories have resumed their downward trend. Considering aluminium deficit projections, we expect further fall in inventories



Falling Chinese smelter profitability to support prices A recent steep fall in aluminium prices has taken a toll on the profitability of Chinese smelters. Current profitability stands at c.CNY 2,300/t for smelters with captive power generation; smelters dependent on grid power are making losses of c.CNY 350/t. The long‐term average spread was CNY 3,600 for captive smelters and CNY 980 for non‐captive grid smelters. As per Rusal, at current SHFE (Shanghai Futures Exchange) price of CNY 14,000/t, nearly 5.6mn tonnes (16%) of Chinese capacities would start making losses. Considering this, we believe that the probability of a further fall in aluminium prices is currently low. China: Aluminium profitability with captive power plant China: Aluminium profitability with grid power

Source: Bloomberg Cost dynamics are supportive of aluminium prices Current prices for major raw materials such as alumina anode and coal are down by c.US$ 125/t, US$ 90/t and US$ 17/t over their CY18 averages, while aluminium prices have moderated by US$ 345/t over the same period. At the same time, as per CRU (a commodity research company), most carbon‐based raw material prices are likely to remain range‐bound for longer than previously anticipated, due to supply‐side reforms in China. Since the fall in realisations is steeper than fall in costs, spreads for non‐integrated players have reduced significantly. Many Chinese players are still making lower‐than‐average long‐term margins, which we believe should support aluminium realisations. Carbon‐based raw material price trend Alumina and caustic soda price trends

Source: Bloomberg

‐

1,000

2,000

3,000

4,000

5,000

6,000

7,000

8,000

Jun‐11

Dec‐11

Jun‐12

Dec‐12

Jun‐13

Dec‐13

Jun‐14

Dec‐14

Jun‐15

Dec‐15

Jun‐16

Dec‐16

Jun‐17

Dec‐17

Jun‐18

Dec‐18

Jun‐19

CNY/tonn

e

Profitability ‐ Captive power 8 year average

(3,000)

(2,000)

(1,000)

‐

1,000

2,000

3,000

4,000

5,000

Jun‐11

Dec‐11

Jun‐12

Dec‐12

Jun‐13

Dec‐13

Jun‐14

Dec‐14

Jun‐15

Dec‐15

Jun‐16

Dec‐16

Jun‐17

Dec‐17

Jun‐18

Dec‐18

Jun‐19

CNY/tonn

e

Profitability ‐ GRID power 8 year average

20

30

40

50

60

70

80

90

100

110

120

100

200

300

400

500

600

700

800

Jun‐15

Oct‐15

Feb‐16

Jun‐16

Oct‐16

Feb‐17

Jun‐17

Oct‐17

Feb‐18

Jun‐18

Oct‐18

Feb‐19

Jun‐19

US$/ton

ne

US$/ton

ne

China Anode (Ex works) Indonesia coal 6300 Kcal

10

110

210

310

410

510

610

710

810

100150200250300350400450500550600

Jun‐15

Oct‐15

Feb‐16

Jun‐16

Oct‐16

Feb‐17

Jun‐17

Oct‐17

Feb‐18

Jun‐18

Oct‐18

Feb‐19

Jun‐19

US$/ton

ne

US$/ton

ne

China Alumina 98.5% EXW Caustic Soda (RHS)



Winter cuts? China continues to add capacity at a net level China has imposed capacity cuts for the aluminium sector, as it did for steel, to curb pollution during the winter season – effectively for four months. As per an estimate, 3‐4mn tonnes of capacities were shut down, which depressed annual aluminium production by 1.0‐1.2mn tonnes. Out of this, over 1mn tonnes have resumed production. Overall, China continues to add more efficient capacity mainly in provinces such as Inner Mongolia, which has coal‐based cheap captive power. We estimate that China has actually added 500KT of net capacity in 2018, and will add another 1‐2mn tonnes of new smelting capacities over the next couple of years, which would more than offset a large part of the illegal capacity that it trimmed during the last one year. However, given that the Chinese demand is likely to grow at around 3%, incremental demand is likely to absorb a large part of the capacity addition. Chinese capacity movement

Source: Antaike Rusal, PhillipCapital Chinese exports remained higher… but we don’t feel concerned yet For the last 2‐3 years, China’s average monthly exports were close to 400KT. However, in 2018, its aluminium exports rose to record high levels of 5.8mn tonnes, a 21% yoy increase, as US sanctions on Rusal spurred demand for Chinese metals. Even in 2019, Chinese monthly exports continued to stay c.500KT, as Chinese smelters tried to export maximum quantity to capture the market vacated by Rusal and to frontload the shipments, as tariffs increased to 25% from 10%. Given the intensifying trade war, we expect Chinese exports to remain elevated in the short term, before stabilising later in the year. Moreover, domestic demand‐supply may rebalance on falling profitability and stimulus packages by the Chinese government. China’s aluminium exports trend

Source: Bloomberg

36.1 36.437.6

36.01.4

2.2

1.2

30

31

32

33

34

35

36

37

38

39

40

2016 2017 Idled ResumedNew addition 2018 Additions 2019E

Mn tonn

es

‐3.2

‐40%

‐30%

‐20%

‐10%

0%

10%

20%

30%

40%

50%

200

250

300

350

400

450

500

550

600

May‐15

Jul‐1

5Sep‐15

Nov

‐15

Jan‐16

Mar‐16

May‐16

Jul‐1

6Sep‐16

Nov

‐16

Jan‐17

Mar‐17

May‐17

Jul‐1

7Sep‐17

Nov

‐17

Jan‐18

Mar‐18

May‐18

Jul‐1

8Sep‐18

Nov

‐18

Jan‐19

Mar‐19

May‐19

`000

tonn

es

China Aluminium exports Yearly average YoY growth (RHS)



Zinc: Incremental supply to erode deficit Zinc deficit may narrow on increasing mine supply Global zinc demand growth remained flat in 2018 while mine supply improved 1.3% because of early commissioning of the Dugald River Project in Australia. We expect the demand‐supply gap to narrow in 2019 because of higher mine production due to a ramp up of the Dugald River mine and the commissioning of Gamsberg, New Century Resource, and Hellyer Tailings’ projects. IZLSD expects 2019 zinc deficit at c.121KT, down from 384KT last year (we expect deficit to be lower), eventually moving to a surplus in 2020‐21. Industry expects 2019 zinc demand growth at just 1% and supply to c.6% to 13.5mn tonnes. Majority of the incremental supply is expected be driven by a 29% increase from Australia and c.3% increase from China. India’s supply is also set to jump c.10%. Zinc market balance

Source: Vedanta The recent sharp jump in spot TC (treatment charge) also indicates an easing concentrate market. However, considering that major zinc supply is controlled by 2‐3 large players, we expect them to apply some supply‐side discipline to arrest the fall in zinc prices beyond a point. We are building in FY20 zinc prices at US$ 2,600 and US$ at 2,500 for FY21, with an estimated swing of ±US$ 50/t depending on market sentiment. Zinc deficit Spot TC at up sharply

Source: IZLSG, Bloomberg, PhillipCapital

‐128

‐442

‐368

‐121

10

‐500

‐400

‐300

‐200

‐100

0

100

2016 2017 2018 2019E 2020E

000 tonn

es

Actual

0

50

100

150

200

250

300

May‐14

Sep‐14

Jan‐15

May‐15

Sep‐15

Jan‐16

May‐16

Sep‐16

Jan‐17

May‐17

Sep‐17

Jan‐18

May‐18

Sep‐18

Jan‐19

US$/DMT

Imported Spot TC



Inventories‐to‐consumption ratio is still very low Prolonged zinc deficit has translated into a significant fall in inventory levels in major stock exchanges, which led to multi‐year low inventory‐to‐stock ratios. As the zinc deficit will continue in 2019 too, we do not expect any significant improvement in inventory levels. Global supply should improve throughout 2019 and 2020. This, coupled with subdued demand growth, will improve inventories at warehouses and put some pressure on prices. Zinc inventories at major exchanges and prices Zinc: Inventories‐to‐consumption ratio

Source: Bloomberg, PhillipCapital India Research

Conclusion: Zinc supply to increase at a higher pace than demand We expect zinc supply to increase at a higher pace than demand over the next 2‐3 years, which may impact inventories and prices. Central banks across the globe are trimming growth forecasts while relaxed Chinese environment norms could lower the country’s appetite for imported zinc concentrate, which would depress prices. Our per tonne zinc price forecast for FY20/21 is US$ 2,550/2,450.

1,000

1,500

2,000

2,500

3,000

3,500

4,000

‐

200

400

600

800

1,000

May‐14

Sep‐14

Jan‐15

May‐15

Sep‐15

Jan‐16

May‐16

Sep‐16

Jan‐17

May‐17

Sep‐17

Jan‐18

May‐18

Sep‐18

Jan‐19

May‐19

US$/ton

ne

`000

tonn

es

LME SHFE Price ‐ RHS

‐

5

10

15

20

25

30

Apr‐14

Aug‐14

Dec‐14

Apr‐15

Aug‐15

Dec‐15

Apr‐16

Aug‐16

Dec‐16

Apr‐17

Aug‐17

Dec‐17

Apr‐18

Aug‐18

Dec‐18

Apr‐19

Days



Compa

nies Sectio

n



Tata Steel (TATA IN) Quest to regain the top spot INDIA | METALS | INITIATING COVERAGE

26 June 2019

Tata Steel is the oldest and still most profitable steel manufacturer in India due to access to captive raw material. It controls close to 20mn tpa capacity in India through owned and subsidiary companies, and c.12mn tonnes in Europe. The Indian mill is backed by captive iron‐ore and coking‐coal mines, which fulfil 100% and 30% of its requirements, respectively. European businesses tend to depend on purchased raw material. Tata lost its top place to JSW Steel a few years ago, as the latter expanded very aggressively, but the IBC process has presented Tata with the unique opportunity to tap stressed assets and quickly increase its capacities. Today, Tata, along with its steel‐producing subsidiaries, is at par with JSW in terms of production capabilities. It is also undertaking a 5‐mn‐tpa expansion at its Kalinganagar facility to consolidate its market‐leadership position. Recently it sold majority stake in its South East Asia operations, where it used to execute volumes of 2.6mn tonnes. Consolidating market position in India Tata Steel’s domestic capacities jumped c.50% on its Bhushan Steel (5.6mn tpa) and Usha Martin acquisitions (1mn tpa), which will not only help it strengthen its position in eastern India, but also help it to consolidate its market leadership in value‐added products, especially in the auto segment. Both plants are in eastern India, which is closer to Tata’s existing plants, which will drive synergies. Both plants also have provisions to enhance capacities, which should take care of future growth. Focus on India to improve profitability The profitability of Tata Steel’s Indian operations has always been significantly better than its global ventures due to access to captive raw material. Over the last couple of years, Tata has partially or fully exited loss‐making or low‐margin businesses and diverted its investments to grow its India business. Exiting South East Asia would alone have improved consolidated EBITDA/t by c.8%. The possibility of hiving of its European steel business will significantly improve consolidated EBITDA/t and return ratios. Debt peaked out; expect leverage to go down by c.10% in a couple of years Organic/inorganic acquisitions have pushed debt to c. Rs 1tn in FY19. Though, Tata has plans to increase its Kalinganagar facility by 5mn tpa with a capex of Rs 235bn (spread over 4‐5 years) consolidated debt is set to reduce by c.Rs 100bn over FY19‐21, aided by Rs 10bn on the sale of a majority stake in Nat Steel, and Rs 70bn debt repayment guidance on incremental cash flow in FY20. Overall, we expect net debt to reduce by 10% to Rs 850bn in FY21 on repayments and businesses hive offs, thus bringing down interest costs. Outlook and valuation We re‐initiate our coverage on Tata Steel with a Buy rating and an SOTP target of Rs 575. Renewed focus on the Indian market and exiting poor performing overseas subsidiaries will allow the company to improve its operating performance and return ratios meaningfully. Better access to captive resources, already strong brand equity in the value‐added products basket, and incremental cash flows will help improve performance and reduce debt. Key risks • Outlook for the European business has deteriorated of late. Challenges: Failure to find a

buyer or a sale at poorer terms than the Thyssen JV. • Indian demand is likely to remain high aided by government spend. Any fall in this and

delays in demand picking up may play spoil sport for the company.

BUY CMP RS 497 TARGET RS 640 (+29%) COMPANY DATA O/S SHARES (MN) : 1146MARKET CAP (RSBN) : 548MARKET CAP (USDBN) : 7.952 ‐ WK HI/LO (RS) : 647 / 442LIQUIDITY 3M (USDMN) : 75.3PAR VALUE (RS) : 10 SHARE HOLDING PATTERN, % Mar 19 Dec 18 Sep 18PROMOTERS : 33.1 33.1 33.1FII / NRI : 14.7 15.2 15.2FI / MF : 29.1 29.0 29.8NON PRO : 5.9 5.5 5.2PUBLIC & OTHERS : 17.2 17.2 16.7 PRICE PERFORMANCE, %

1MTH 3MTH 1YRABS 0.5 ‐6.2 ‐13.3REL TO BSE 0.4 ‐6.2 ‐13.5 PRICE VS. SENSEX

KEY FINANCIALS Rs bn FY19 FY20E FY21ENet Sales 1,576.7 1,538.2 1,561.1EBIDTA 293.8 253.0 276.3Net Profit 93.1 71.4 86.0EPS, Rs 81.3 62.3 75.1PER, x 6.6 7.8 6.5EV/EBIDTA, x 5.3 5.7 5.1P/BV, x 0.9 0.7 0.7ROE, % 13.5 9.6 10.6Debt/Equity (%) 146.3 126.3 108.8

Source: PhillipCapital India Research Est. Vikash Singh, Research Analyst (+ 9122 6246 4128) [email protected]

306090120150180210240270

Apr‐16 Apr‐17 Apr‐18 Apr‐19

Tata Steel BSE Sensex


TATA STEEL INITIATING COVERAGE

Consolidating its market position in India Tata Steel has successfully acquired Bhushan Steel and Usha Martin (through a subsidiary) under the IBC process, strengthening its product profile as well as geographical position in eastern India. The combined capacity of both the plants is around 6.6mn tonnes, translating to a c.50% increase in Tata Steel’s domestic capacity to almost 20mn tonnes. Both plants have provisions to enhance capacities in the future, which would have the potential to take total capacity to 30mn tpa by 2025 at a relatively lower capex. Bhushan Steel (BSL) has a predominantly value‐added flat‐steel product portfolio, supplying to the auto/white goods and construction industry. Usha Martin provides Tata an opportunity to flex its muscles in the long‐products portfolio (infra‐driven demand expected for the next couple of years). Tata Steel group capacity trend

Note: Tata Steel India also includes subsidiaries’ capacities (Tata Sponge and Tata Metaliks)

Market share trend

Note: Tata includes its subsidiaries; JSW includes Bhushan Power and Monnet Ispat

Source: PhillipCapital India Research Raw material security to remain intact till 2030 Tata Steel has Environment Clearance (EC) of 29mn tonnes for iron‐ore mines, which are currently sufficient for its entire capacity, and for c.25% of Bhushan Steel’s (to supply 2mn tonnes). It is planning to take its iron‐ore mining capacity to 49mn tonnes for it to remain 100% captive. Simultaneously, it plans to raise its coking coal capacity to maintain 25% self‐sufficiency (the West Bokaro open‐cast mine will expand to 6mn tpa from c.3mn now). Its manganese ore mines are also valid till 2030. While the Sukhina chrome‐ore mine is due to expire in 2020, we expect the company to win the mines back; we do not expect this to have a significant bearing on its overall profitability. Higher integration to benefit Tata Steel amid rising input costs Current iron ore prices at US$ 119/t jumped c.37% in the international market following a supply crunch after the Vale Dam accident. Given that the seaborne market could report a deficit this year, we expect iron‐ore prices to remain strong in 1HFY20 before softening in 2H. We expect steel prices to start inching up with a lag because of the cost‐push. Tata Steel meets 100% of its iron‐ore requirement from captive mines in Orissa and Jharkhand and 25‐30% of its coking‐coal needs. We expect steel prices to move up again (after monsoon) before stabilising at higher levels, benefitting Tata Steel the most (because of captive ore).

14

20 25

5

1 5

0

5

10

15

20

25

30

Tata ‐India

Bhushan Steel

Usha Martin

Tata India total

KPO ‐ II Post expansion

13% 14% 14% 19% 19% 18%

15% 18% 17%19% 19% 19%

15%16% 16%

14% 15% 15%4%4% 4%

5% 6% 7%

5%6% 6%

6% 6% 6%

4%4% 5%

5% 5% 5%

0%

10%

20%

30%

40%

50%

60%

70%

80%

FY16 FY17 FY18 FY19E FY20E FY21E

Tata JSW SAIL JSPL Essar RINL



Overall profitability will improve and so will return rations The profitability of Tata Steels’ Indian operations has always been significantly better than its global ventures due to access to captive raw material. Over the last couple of years, Tata has partially or fully exited loss‐making or low‐margin businesses and aggressively renewed its interest in the growing domestic business. Tata expects the synergies of acquiring BSL and USM to be Rs 80‐90bn each over 24‐36 months. It expects most of the benefits to come from raw‐material integration (BSL receives a part of its raw materials from Tata Steel and USM has its own iron‐ore mine) and sales and marketing harmony. Tata’s consolidated profitability and its return ratios are set for a meaningful jump, as these facilities replace loss‐making international ventures. Domestic profitability has always been higher

Source: PhillipCapital India Research Consolidated EBITDA/t and return ratios to jump Standalone business contributes c.70% of Tata Steel’s consolidated EBITDA in FY19. The standalone business is its most profitable one, followed by Bhushan (see table below), while TSE and SE‐Asia remain a drag. Tata Steel has already found buyers for its SE Asia operations and is in talks with a Chinese company to sell a part of or the entire European assets. As per our calculation, hiving off the SA Asia business would lead to an 8% improvement in its blended EBITDA. Similarly, if Tata Steel is able to hive off its European assets, its blended EBITDA would jump significantly. Consolidated profitability improving Pre deconsolidation Post SE Asia sale Post TSE sale EBITDA/tonne FY19P FY20E FY21E FY19P FY20E FY21E FY19P FY20E FY21E Standalone 16,110 14,247 14,893 16,110 14,247 14,893 16,110 14,247 14,893 Bhushan 8,498 7,545 8,963 8,498 7,545 8,963 8,498 7,545 8,963 Europe 5,616 3,479 3,784 5,616 3,479 3,479 5,616 South East Asia 1,749 1,500 1,800 Consolidated 10,344 8,461 9,038 11,178 9,276 9,886 11,178 12,475 13,174

Source: PhillipCapital India Research Estimates Debt peaked out; expect leverage to go down by 10% in a couple of years Tata Steel saw a significant increase in its overall debt in FY19, primarily because of BSL and USM acquisitions. Its net debt has increased to Rs 950bn at the end of FY19 from Rs 692bn at the end of FY18. At the same time, it has announced a capex of Rs 235bn (spread over 4‐5 years) to enhance its Kalinganagar capacity to 8mn tpa (from 3) along with a 2.2mn tpa downstream CRM project. However, despite huge capex plans, we believe Tata Steel’s debt is set to reduce significantly over FY19‐21 because of good domestic cash flows (it is guiding for a US$ 1bn net repayment) and partial reduction in net debt on sale of majority stake in Nat Steel (Rs 10bn). Overall, we

(4,000)

(2,000)

0

2,000

4,000

6,000

8,000

10,000

12,000

14,000

FY15 FY16 FY17 FY18

EBITDA

Rs/tonn

e

Tata Steel India Tata Steel Europe South East Asia Bhushan Steel Usha Martin



expect debt to reduce by c.Rs 100bn to touch Rs 850bn in FY21, primarily on repayments. Kalinganagar Phase 2 expansion to improve product mix Phase 1 is fully ramped up. Phase 2 has begun (the Kalinganagar Project (KPO) – a Rs 235bn, 5mn‐tpa expansion). This entails Rs 160bn for hot metal and HRC, Rs 550bn for a 2.2mn tpa CRM, and the rest for raw material projects. Given that KPO is a more advanced project, Tata would derive significant savings from it, which would probably make it the most profitable plant in the country as its coke rate at 421 KG will come down further and labour productivity will double. Additionally, Tata will manufacture high‐end products in Phase 2 with a CRM mill width of 1870mm, which will help it to improve its product mix. Tata steel capacity trend

Labour productivity to improve significantly after Phase 2

Market share trend


Bhushan has the potential for 8mn tpa capacity and synergy potential of Rs 90bn+ Bhushan’s value‐added facilities are complementary to Tata Steel’s existing portfolio. Because of inadequate funds, its facilities were not utilised properly so far. Tata will have to spend some money on balancing facilities to increase this facility’s production to its full 5.6mn tpa by next year. Bhushan has other provisions in place to increase the capacity to 8‐9mn tonnes at comparatively lower capex intensity. This would not only help Tata in increasing its capacity beyond 25mn tpa, but would also provide significant synergy benefits. There will be saving of US$ 15‐20/tonnes from freight alone due to ‘joint buying’ with Tata Steel. Tata expects cumulative synergy benefits of over Rs 90bn in a couple of years. Bhushan Steel (Rs crore – 1 crore rupees = 10 million rupees)

Source: Company

738 918

1951

0

500

1000

1500

2000

2500

Jamshedpur Kalinganagar Phase I Post Phase II

Tonn

es

Productivity (TCS/FTE/year)

13%23%

9%

24%

65%

38%

5%13% 10%

0%

20%

40%

60%

80%

100%

Phase I Post Phase II

Auro BPRS IPP Downstream Exports



Bhushan merger to hasten synergy benefits Tata Steel is merging Tata Steel BSL (erstwhile Bhushan Steel) with itself to quickly capitalise on synergies. The swap ratio Tata Steel‐to‐Bhushan is set at 1:15, which seems slightly favourable for Bhushan’s minority holders. Through optionally convertible shares, Tata Steel’s shareholding has the scope to increase to 92.6% from current 72.65%. We do not expect these merger plans to face any problems. Thyssen JV called off, but we remain hopeful Thyssen and Tata decided to call of the JV since European Commission’s proposed resolution was undermining the potential synergies and profitability estimates of the JV. This has once again brought back the issues of elevated debt, possible cash drain from the standalone entity, and the profitability drag. However, Tata remains committed to sell its European assets (partly or fully) to focus on the growing Indian business. Media reports indicate that it is in talks with the Hesteel Group, China's second‐largest steel producer (which has already acquired 70% stake in Tata Steel's South‐East Asia operations). Though the outlook for the European business has deteriorated since talks with Thyssen failed (trade war impact, higher costs, Brexit uncertainty), we remain hopeful of some resolution; we have not factored sale in our estimates. Focus on value addition and new segments Tata Steel is focusing on developing its services and solutions portfolio (steel doors, windows, house structure) which has a huge future potential with a market size of c.Rs 1tn and expected revenue potential of c.Rs 100bn in the next 5‐6 years. It is leveraging its existing dealership network and educating architects to push volumes. It expects this business to contribute 25% of total sales by 2025. Margins are c.10‐20% higher than in the steel business. Tata Steel is even trying to partner with other foreign players to sell new‐age material such as graphene and carbon fibres, for which it has set a revenue share target of c.10% by 2025. Under this initiative, the company plans to implement the following: • At least 30% volumes from downstream projects:

→ Derive 2/3rd sales from construction and auto segments. → Improve presence in value‐added industrial segment and replace imported

high‐end auto segment demand. → Increase branded and retail sales: Plans to leverage its pan‐India distribution

network, which has touched 18 warehouses and 12,000 dealers after the Bhushan acquisition.

• 20% revenue contribution from service and solutions by 2025 → Carved out a new division to offer specialised customized products in

construction in FY16. → Targets pre‐build houses/offices, door/windows, and customized

construction solutions – replacing wooden doors with steel ones (better durability and lifecycle), pre‐fabricated homes that can be assembled in 2‐3 days to provide shelters (useful in natural disasters or for project‐based needs).

→ Rs 20bn+ annualised FY19 revenue from Rs 1.2bn in FY16. → Margins are usually Rs 10,000/t more than other steel products.

• Investing in developing and using modern materials

→ Such as graphene, carbon‐fibre polymers, and ceramics. → An alternative to steel products in certain usage → Target revenue contribution is 10% by 2025.



Rooftop housing

Furniture

Modular toilets and water‐vending kiosk

Pre‐fabricated houses

Estimates Rs mn FY17 FY18 FY19P FY20E FY21ETata Steel India Volumes (mn t) 11.0 12.2 12.7 12.8 12.9 Realisation (Rs/t) 46,500 47,419 54,270 51,828 51,828EBITDA (Rs/t) 9,409 12,987 16,110 14,247 14,839Tata Steel ‐ Bhushan Volumes (mn t) 3.5 3.5 4.2 4.6 5.1 Realisation (Rs/t) 39,181 48,607 51,038 48,486 48,486EBITDA (Rs/t) 8,351 6,298 9,150 7,545 8,963Tata Steel Europe Volumes (mn t) 9.9 10.0 9.6 9.6 9.7Realisation (US$/t) 783 924 946 900 880 EBITDA (US$/t) 71 58 79 50 55 South East Asia Volumes (mn t) 2.6 2.5 2.5 Realisation (Rs/t) 31,590 38,016 43,718 EBITDA (Rs/t) 2,023 1,741 1,749 Consolidated EBITDA/tonne 5,274 6,678 8,709 9,276 9,886

Source: Company, PhillipCapital India Research SOTP valuation

EBITDA Multiple EVTata Steel India 191,424 6.0 1,148,545Tata Steel Europe 37,241 5.0 186,206Bhushan Steel 45,713 5.5 251,424Target EV 1,586,175Net Debt 850,862Available for Equity holders 735,312Target Price 640


Blended EBITDA/t can improve significantly once TSE gets de‐consolidated



Financials

Consolidated Income Statement Y/E Mar, Rs bn FY18 FY19 FY20e FY21eNet sales 1,321.6 1,576.7 1,538.2 1,561.1Growth, % 18 19 ‐2 1Total income 1,321.6 1,576.7 1,538.2 1,561.1Raw material expenses ‐521.6 ‐607.8 ‐612.7 ‐606.0Employee expenses ‐176.1 ‐187.6 ‐171.9 ‐174.9Other Operating expenses ‐1,102.0 ‐1,282.1 ‐1,284.4 ‐1,284.1EBITDA (Core) 218.9 293.8 253.0 276.3Growth, % 28.7 34.2 (13.9) 9.2Margin, % 16.6 18.6 16.5 17.7Depreciation ‐59.6 ‐73.4 ‐75.6 ‐78.6EBIT 159.3 220.4 177.5 197.7Growth, % 40.5 38.4 (19.5) 11.4Margin, % 12.1 14.0 11.5 12.7Interest paid ‐55.0 ‐76.6 ‐75.1 ‐71.7Other Non‐Operating Income 9.1 14.2 12.8 13.4Pre‐tax profit 113.4 158.0 115.1 139.4Tax provided ‐34.1 ‐67.2 ‐46.1 ‐55.8Profit after tax 79.3 90.8 69.1 83.6Others (Minorities, Associates) ‐41.5 2.2 2.3 2.3Net Profit 37.8 93.1 71.4 86.0Growth, % (4.3) 146.5 (23.3) 20.4Net Profit (adjusted) 37.8 93.1 71.4 86.0Unadj. shares (m) 1.1 1.1 1.1 1.1Wtd avg shares (m) 1.1 1.1 1.1 1.1 Balance Sheet Y/E Mar, Rs bn FY18 FY19 FY20e FY21eCash & bank 228.5 58.7 43.4 34.3Debtors 124.2 118.1 115.2 116.9Inventory 283.3 316.6 308.8 299.4Loans & advances 10.7 19.9 19.4 19.7Other current assets 32.1 76.7 76.7 76.7Total current assets 678.8 589.9 563.6 547.0Investments 29.9 32.1 32.5 32.8Gross fixed assets 1,444.8 1,803.9 1,869.7 1,957.3Less: Depreciation ‐479.2 ‐552.6 ‐628.2 ‐706.8Add: Capital WIP 161.6 179.6 219.1 273.8Net fixed assets 1,127.2 1,430.8 1,460.6 1,524.4Non‐current assets 251.4 274.9 268.9 272.8Total assets 2,097.6 2,335.8 2,333.7 2,385.1Current liabilities 556.6 610.3 589.2 606.5Provisions 43.4 40.5 42.0 43.5Total current liabilities 600.0 650.8 631.2 649.9Non‐current liabilities 879.5 972.1 934.9 898.2Total liabilities 1,479.5 1,622.9 1,566.1 1,548.2Paid‐up capital 11.4 11.4 11.4 11.4Reserves & surplus 597.3 677.8 732.5 801.8Shareholders’ equity 618.1 712.9 767.6 836.9Total equity & liabilities 2,097.6 2,335.8 2,333.7 2,385.1

Source: Company, PhillipCapital India Research Estimates

Cash Flow Y/E Mar, Rs bn FY18 FY19 FY20e FY21ePre‐tax profit 113.4 158.0 115.1 139.4Depreciation 59.6 73.4 75.6 78.6Chg in working capital ‐181.6 ‐55.5 ‐0.6 23.3Total tax paid ‐30.2 ‐46.0 ‐45.1 ‐49.5Other operating activities 168.3 0.3 0.0 0.0Cash flow from operating activities 129.6 130.2 145.0 191.9Capital expenditure ‐108.9 ‐377.1 ‐105.3 ‐142.4Chg in investments 37.9 ‐2.2 ‐0.3 ‐0.3Cash flow from investing activities ‐71.0 ‐379.3 ‐105.7 ‐142.7Free cash flow 58.7 ‐249.0 39.3 49.1Equity raised/(repaid) 38.0 0.0 0.0 0.0Debt raised/(repaid) 87.7 75.5 ‐40.2 ‐44.0Dividend (incl. tax) ‐13.6 ‐17.6 ‐16.7 ‐16.7Cash flow from financing activities 63.9 74.5 ‐54.6 ‐58.3Net chg in cash 122.5 ‐174.5 ‐15.2 ‐9.2 Valuation Ratios

FY18 FY19 FY20e FY21ePer Share dataEPS (INR) 33.0 81.3 62.3 75.1Growth, % (18.9) 146.5 (23.3) 20.4Book NAV/share (INR) 531.6 602.0 649.8 710.3FDEPS (INR) 33.0 81.3 62.3 75.1CEPS (INR) 85.1 145.4 128.3 143.8CFPS (INR) 114.3 109.7 135.3 168.2DPS (INR) 10.0 13.0 13.0 13.0Return ratiosReturn on assets (%) 7.0 7.5 6.2 6.6Return on equity (%) 6.2 13.5 9.6 10.6Return on capital employed (%) 9.7 10.2 8.3 8.8Turnover ratiosAsset turnover (x) 1.2 1.2 1.0 1.0Sales/Total assets (x) 0.7 0.7 0.7 0.7Sales/Net FA (x) 1.2 1.2 1.1 1.0Working capital/Sales (x) (0.1) (0.1) (0.0) (0.1)Fixed capital/Sales (x) 0.7 0.8 0.8 0.8Receivable days 34.3 27.3 27.3 27.3Inventory days 78.2 73.3 73.3 70.0Payable days 67.6 61.8 60.2 61.1Working capital days (29.4) (18.3) (16.4) (21.9)Liquidity ratios Current ratio (x) 1.2 1.0 1.0 0.9Quick ratio (x) 0.7 0.4 0.4 0.4Interest cover (x) 2.9 2.9 2.4 2.8Total debt/Equity (%) 151.0 146.3 126.3 108.8Net debt/Equity (%) 113.4 137.8 120.4 104.6Valuation PER (x) 17.3 6.6 7.8 6.5PEG (x) ‐ y‐o‐y growth (0.8) 0.0 (0.3) 0.3Price/Book (x) 1.1 0.9 0.7 0.7Yield (%) 1.8 2.4 2.7 2.7EV/Net sales (x) 1.0 1.0 0.9 0.9EV/EBITDA (x) 6.1 5.3 5.7 5.1EV/EBIT (x) 8.4 7.1 8.2 7.1



Jindal Steel & Power (JSP IN) At an inflection point INDIA | METALS | INITIATING COVERAGE

26 June 2019

Promoted by Mr O P Jindal, Jindal Steel and Power (JSPL) was incorporated in 1979. The company currently operates in the steel, power, mining, and infrastructure sectors in Asia, Africa, Australia, and the Middle East. Its Indian capacities includes an 8.6mn tpa steel plant in Raipur (Chhattisgarh) and Angul (Odisha), 9mn tpa pellet plant in Barbil (Odisha), a 3,400 MW thermal power plant in Tamnar (Chhattisgarh), and a 258km‐long 400‐KV double‐circuit transmission line for the distribution of power in India. Apart from this, JSPL has a 2mn tpa steel plant in the Sultanate of Oman. It operates coal and iron ore mines in Australia, South Africa, and Mozambique. Additionally, the company produces cement under the Jindal Panther brand and provides structural steel fabrication and project management services for constructing steel buildings, as well as offers engineering‐based customized construction solutions. Angul to drive volume CAGR of c.17% over FY19‐21 Angul’s contribution in JSPL’s steel production has already increased to c.44% from 29% earlier, and it is expected to ramp up its contribution to 55‐60% in the next couple of years – driving volume CAGR of c.17% for the next couple of years. This will trigger economies of scale and bring down conversion cost (Rs 1,400/t over the next two years), boosting margins. Long‐product‐heavy portfolio is a positive JSPL’s product portfolio is heavily skewed towards long products and therefore its dependency on infra spends is one of the highest among large steel players. It has started receiving orders for rails from Indian railways where the margins are better. We expect long products demand to outstrip flat products based on governments infra spending, so JSPL stands to benefit the most. RoCE and RoE to improve by 220bps and 540bps by FY21 Until FY19, JSPL was making marginal losses at consolidated levels. We expect it to start reporting net profits from FY20, which would jump significantly in FY21 on improving operating performance and reducing debt. This will significantly improve the return ratio too. Debt reduction of close to Rs 85bn in the next couple of years JSPL’s net debt has already come down by c.Rs 34bn in FY19 despite its Angul capex and higher working capital requirement for the capacity ramp‐up. With improving cash flows and absence of any big‐ticket capex plans, we expect debt to reduce by additional Rs 85bn, which is a c. 22% reduction over the next couple of years. Outlook and valuation We re‐initiate coverage on the stock with a Buy rating and an SOTP target of Rs 225. We believe the company is at an inflection point. The Angul ramp up will drive standalone EBITDA (CAGR of c.11% over FY19‐21) while its Oman and power businesses will support incremental cash flows, aiding rapid de‐leveraging. With its higher exposure to the longs portfolio, JSPL will benefit from India’s focus on infrastructure spending. Key risks • Our investment thesis is largely based on the Angul ramp up and improving outlook of

the power sector; delays will have a bearing on our earnings assumptions. • Failure to hive off or turnaround its foreign mining assets remains a risk.


1MTH 3MTH 1YRABS ‐11.1 ‐11.4 ‐36.7REL TO BSE ‐11.1 ‐15.7 ‐47.8 PRICE VS. SENSEX

Source: PhillipCapital India Research KEY FINANCIALS Rs mn FY19 FY20E FY21ENet Sales 393,721 446,187 479,234EBIDTA 84,056 88,846 97,823Net Profit ‐9,331 2,007 8,304EPS, Rs (9.6) 2.1 8.6PER, x (16.6) 69.9 16.9EV/EBIDTA, x 6.5 5.5 4.6P/BV, x 0.5 0.4 0.4ROE, % (2.9) 0.6 2.5Debt/Equity (%) 121.8 109.1 94.1


0

100

200

300

400

500

Apr‐16 Apr‐17 Apr‐18 Apr‐19JSPL BSE Sensex


JINDAL STEEL & POWER INITIATING COVERAGE

Angul: Key to the turnaround story; expect volume CAGR of 17%... JSPL’s turnaround story primarily revolves around a timely ramp up of the Angul plant. After commissioning of the steel melting shop (SMS) in March 2018, the company has managed to steadily ramp up the plant (Angul’s volume contribution jumped from 29% in FY18 to 44% on FY19 and it is likely to jump to 52% in FY20. In FY19, sales volumes growth was 36% yoy. JSPL has already achieved an annualised production run rate of over 6mn tonnes. We expect it to report 24% yoy volumes growth in FY20 to 6.3mn tonnes, and 11% in FY21 to 7mn tonnes. ....which will bring cost savings At the current run rate of 80% BF utilisations, Angul’s cost of production (CoP) is already at the Raigarh plant levels. Given that Angul (a more efficient new plant) has the potential to ramp up production even further by c.2.0‐2.5mn tpa, it has the potential to reduce CoP by c.Rs 1,500 per tonne more. At optimum levels, JSPL has the potential to produce 8mn tpa, but we are building in a moderate volume target of 6.5mn tonnes in FY20 and 7.2mn tonnes in FY21. Plant‐wise production trend

Expect Angul plant’s production to overtake Raigarh in FY20. Almost all the incremental growth would come from the Angul ramp up

Cost trend

We expect overall c.Rs 1,100/t cost reduction by FY21 over FY19 on higher production, implying Angul CoP to be lower by Rs 1,500/t over Raigarh

Source: Company, PhillipCapital India Research Estimates Better long‐product demand expectations to bode well JSPL’s product portfolio is heavily skewed towards its long product portfolio and therefore its dependency on infra spends is one of the highest among large steel players. Currently, JSPL produces and sells over 80% long steel, as its plate mill is yet to ramp up to the desired level. We believe consumption of long‐steel products will grow at a faster pace compared with flat‐steel products, mainly because of the government’s focus on infrastructure. For FY19, the government’s revised capital expenditure was 20% higher at Rs 3.2tn on a yoy basis and funds of Rs 4.56tn have been budgeted for FY20. This will help long‐steel demand to outperform the flat‐steel demand, which bodes well for JSPL.

0

1

2

3

4

5

6

7

8

FY17 FY18 FY19E FY20E FY21E

Mn tonn

es

Raigarh Angul

0

2,000

4,000

6,000

8,000

10,000

12,000

14,000

16,000


Rs /ton

neEmployee Power Manuf exp



Product mix skewed towards long products

Note: Includes Oman mill as well Source: Company presentation Oman volume CAGR to be 11% JSPL’s Oman plant (2mn tpa steel plant expanding to 2.4mn tonnes) is expected to report c.11% CAGR over the next couple of years based on a continued ramp up in capacity. Product‐mix benefits should accrue from sales of value‐added products from the bar mill. We are building US$ 72/t of EBITDA for FY20 and US$ 75/t for FY21; also, although EBITDA/t was impacted due to lower spreads, operating performance will improve because of operating leverage and an increasing re‐bar share in sales volumes. Volumes to improve; EBITDA/t to remain steady

Source: Company, PhillipCapital India Research Estimates New PPAs may help the power business Its power plant remains underutilised due to poor demand and coal unavailability. Currently, JSPL is utilising 1,600‐1,700 MW out of its total capacity of 3,600 MW, as it has a PPA for c.1,070 MW and is selling 500‐600 MW through short‐term bilateral agreements and merchant markets. The current PPA has been backed by coal linkage for 1,200 MW, and for the rest it buys coal from e‐auctions and the spot market. As there was no new PPA from the government for the last two years, capacity utilisations were subdued. However, in the government’s recent 2,500MW PPA, JSPL is L1 in 510MW; receiving the final award would increase the utilisation to 47% of capacity from current 31%. We expect EBITDA/unit to remain at Rs 0.9‐1.0.

0

2

4

6

8

10

FY18

Mn tonn

es

Rebar Mill

Rail & Universal Beam

Medium & Light section

Wire rod mill

Plate mill

Nearly 70% of the productport folio is long products, which are primarily used in infrastructure and housing

0.0

0.5

1.0

1.5

2.0

2.5

30

50

70

90

110

130

150


Volumes (mn tonnes) ‐RHS EBITDA/t (US$) (LHS)



Current PPAs – 31% of capacity has been tied up MW Tamil Nadu Karnataka Chhattisgarh TotalTamnar I 200 ‐ ‐ 200Tamnar II (EUP 2) 400 350 60 810Tamnar II (EUP 3) ‐ ‐ 60 60Total 600 350 120 1,070

Source: Company, PhillipCapital India Research Power plants to continue generating cash profits Despite underutilisation of facilities and suffering from higher coal prices in the last three years, JSPL has managed to report cash profit in its power business. The company is using these cash flows to gradually trim down its debt and finance its working‐capital requirements. Though we expect EBITDA per unit to remain at c.Rs 1 for the next 2‐3 years due to higher competition in PPAs and underutilisation of plants, cash profit will improve on lower debt and higher volumes. Cash profit (Rs mn)

Source: Company, PhillipCapital India Research Estimates Overseas debt servicing is self‐reliant JSPL has managed to bring down overseas debt to US$ 1.8bn from US$ 2.0bn (equally divided between Oman and other global ventures). We understand that the total interest outgo is c.US$ 100‐110mn, but Oman alone has the potential to earn an EBITDA of close to US$ 150‐160mn; Mozambique and South Africa mines are likely to earn US$ 10‐15mn and US$ 1‐2mn per annum, while Australia could continue reporting losses. Overall, its overseas operations have enough cash flows to service their interest themselves. JSPL is looking to sell assets (entirely or partly) to reduce its overseas debt. Focus on debt reduction will continue JSPL remains committed to deleveraging its balance sheet. Current consolidated net debt stood at c.Rs 392bn (down from Rs 453bn in FY17) and we expect deleveraging intensity to improve on incremental cash flows from the steel business, considering that all its major capex is complete. We are building in Rs 85bn debt reduction in the next couple of years.

0

1,000

2,000

3,000

4,000

5,000

6,000

7,000

8,000

9,000




Expect significant debt reduction going forward

Source: Company, PhillipCapital India Research Estimates Earnings estimates Rs mn FY17 FY18 FY19 FY20E FY21EStandalone Volumes (mn tonnes) Steel 3.5 3.8 5.1 6.3 7.0 Pellets 2.7 3.0 2.9 2.3 1.3 Realisation (Rs/t) Steel 35,304 42,934 48,362 46,860 46,624 Pellets 4,200 5,460 8,190 7,400 7,000 Net Sales 138,481 170,652 277,160 314,861 336,117 EBITDA 28,582 39,731 60,170 66,492 73,962 EBITDA/t (Rs) 7,579 9,901 11,291 10,502 10,570 Jindal Power Generation (mn units) 8,761 13,955 10,396 13,070 13,547 Realisation (Rs/unit) 3.6 2.9 3.7 3.5 3.5 Net sales 31,190 40,810 38,580 46,127 48,053EBITDA 10,480 14,340 11,550 14,356 14,408EBITDA (Rs /unit) 1.2 1.0 1.1 1.1 1.1 Oman ‐ US$ mn Volumes (mn tonnes) 1.2 1.7 1.8 2.0 2.2 EBITDA 90 220 180 146 164EBITDA/t (US$) 75 131 100 73 75

Source: Company, PhillipCapital India Research Estimates SOTP target price Business FY21 EBITDA Multiple Rs mnSteel 73,962 5.5 406,791 Power 14,408 5.0 72,038 Oman & Others 9,454 5.0 47,269 Target EV 526,098 Net Debt 305,470 Available to Eq 220,628 Per share value 225

Source: PhillipCapital India Research

0

100

200

300

400

500

0

2

4

6

8

10

12


Net Debt (Rs bn) ‐RHS Debt/EBITDA (x) (rhs)



Financials

Consolidated Income Statement Y/E Mar, Rs mn FY18 FY19 FY20e FY21eNet sales 273,834 393,721 446,187 479,234Growth, % 30 44 13 7Total income 273,834 393,721 446,187 479,234Raw material expenses ‐94,607 ‐162,349 ‐200,529 ‐210,741Employee expenses ‐9,557 ‐10,719 ‐10,872 ‐11,671Other Operating expenses ‐104,979 ‐136,599 ‐145,940 ‐158,999EBITDA (Core) 64,691 84,056 88,846 97,823Growth, % 37.4 29.9 5.7 10.1Margin, % 23.6 21.3 19.9 20.4Depreciation ‐38,830 ‐54,804 ‐43,739 ‐46,414EBIT 25,861 29,252 45,107 51,410Growth, % 240.2 13.1 54.2 14.0Margin, % 9.4 7.4 10.1 10.7Interest paid ‐38,657 ‐42,642 ‐39,552 ‐37,861Other Non‐Operating Income 29 157 165 173Pre‐tax profit ‐12,767 ‐13,233 5,720 13,721Tax provided 2,398 3,902 ‐3,713 ‐5,417Profit after tax ‐10,369 ‐9,331 2,007 8,304Others (Minorities, Associates) 87 0 0 0Net Profit ‐10,281 ‐9,331 2,007 8,304Growth, % (52.5) (9.2) (121.5) 313.7Net Profit (adjusted) (10,281) (9,331) 2,007 8,304Unadj. shares (m) 968 968 968 968Wtd avg shares (m) 968 968 968 968 Balance Sheet Y/E Mar, Rs mn FY18 FY19 FY20e FY21eCash & bank 4,784 4,234 3,774 7,280Marketable securities at cost 2 50 50 50Debtors 18,261 30,292 30,561 32,824Inventory 49,596 65,095 67,234 72,213Loans & advances 62,139 34,674 39,118 42,015Other current assets 8,454 8,787 8,557 9,191Total current assets 143,235 143,132 149,293 163,573Investments 1,515 1,509 1,509 1,509Gross fixed assets 863,423 875,362 876,485 882,949Less: Depreciation ‐167,975 ‐167,975 ‐174,440 ‐220,854Add: Capital WIP 38,770 29,055 5,811 8,717Net fixed assets 734,217 736,442 707,855 670,811Non‐current assets 13,337 14,770 16,738 17,978Total assets 892,304 895,853 875,395 853,870 Current liabilities 194,550 214,300 218,332 205,493Provisions 2,782 3,147 3,214 5,554Total current liabilities 197,331 217,447 221,546 211,047Non‐current liabilities 386,724 357,141 330,925 314,192Total liabilities 584,055 574,588 552,471 525,238Paid‐up capital 968 968 968 968Reserves & surplus 302,878 323,309 325,268 331,307Shareholders’ equity 308,250 321,266 322,924 328,632Total equity & liabilities 892,304 895,853 875,395 853,870


Cash Flow Y/E Mar, Rs mn FY18 FY19 FY20e FY21ePre‐tax profit ‐12,767 ‐13,233 5,720 13,721Depreciation 38,830 54,804 43,739 46,414Chg in working capital ‐26,335 15,498 ‐4,080 ‐24,328Total tax paid ‐905 7,261 ‐1,031 ‐2,601Other operating activities ‐5,613 29,761 ‐2,500 ‐2,500Cash flow from operating activities ‐6,789 94,091 41,848 30,707Capital expenditure ‐16,884 ‐57,028 ‐15,152 ‐9,370Chg in investments 2,481 6 0 0Chg in marketable securities 2 ‐48 0 0Cash flow from investing activities ‐14,402 ‐57,070 ‐15,152 ‐9,370Free cash flow ‐21,191 37,021 26,696 21,337Equity raised/(repaid) 19,235 0 2,452 2,500Debt raised/(repaid) 3,576 ‐30,157 ‐29,307 ‐20,000Cash flow from financing activities 20,834 ‐37,571 ‐27,156 ‐17,831Net chg in cash ‐357 ‐550 ‐460 3,506 Valuation Ratios

FY18 FY19 FY20e FY21ePer Share dataEPS (INR) (10.6) (9.6) 2.1 8.6Growth, % (55.1) (9.2) (121.5) 313.7Book NAV/share (INR) 313.9 335.0 337.1 343.3FDEPS (INR) (10.6) (9.6) 2.1 8.6CEPS (INR) 29.5 47.0 47.3 56.5CFPS (INR) 29.4 72.3 58.0 59.2DPS (INR) ‐ ‐ ‐ 2.0Return ratiosReturn on assets (%) 3.1 3.7 4.7 5.3Return on equity (%) (3.4) (2.9) 0.6 2.5Return on capital employed (%) 4.0 4.8 6.2 7.1Turnover ratiosAsset turnover (x) 0.3 0.5 0.6 0.7Sales/Total assets (x) 0.3 0.4 0.5 0.6Sales/Net FA (x) 0.4 0.5 0.6 0.7Working capital/Sales (x) (0.2) (0.2) (0.2) (0.1)Fixed capital/Sales (x) 2.5 1.8 1.6 1.4Receivable days 24.3 28.1 25.0 25.0Inventory days 66.1 60.3 55.0 55.0Payable days 73.2 61.8 60.7 61.1Working capital days (74.8) (69.9) (59.6) (39.2)Liquidity ratios Current ratio (x) 0.7 0.7 0.7 0.8Quick ratio (x) 0.5 0.4 0.4 0.4Interest cover (x) 0.7 0.7 1.1 1.4Total debt/Equity (%) 141.4 121.8 109.1 94.1Net debt/Equity (%) 139.8 120.5 107.9 91.9Valuation PER (x) (20.6) (16.6) 69.9 16.9PEG (x) ‐ y‐o‐y growth 0.2 1.6 (0.6) 0.1Price/Book (x) 0.7 0.5 0.4 0.4Yield (%) ‐ ‐ ‐ 1.4EV/Net sales (x) 2.3 1.4 1.1 0.9EV/EBITDA (x) 9.8 6.5 5.5 4.6EV/EBIT (x) 24.6 18.7 10.9 8.7



Steel Authority of India (SAIL IN) Timely ramp up and cost rationalisation is the key INDIA | METALS | INITIATING COVERAGE

26 June 2019

Steel Authority of India (SAIL) is the largest state‐owned steel producer in India with a 75% stake held by the Government of India (GoI). At present, SAIL owns and operates five integrated steel plants viz., Bhilai Steel Plant (BSP), Durgapur Steel Plant (DSP), Rourkela Steel Plant (RSP), Bokaro Steel Plant (BSL), and IISCO Steel Plant (ISP). In addition to this, the company also has three special steel plants – Alloy Steel Plant, Salem Steel Plant, and Visvesvaraya Iron & Steel Plant. SAIL is on the verge of completing its modernisation and capacity expansion, and once this is complete, its capacity will rise to 20mn tpa of crude steel across 5 plants. It has 100% captive iron‐ore mines and it fulfils most of its coal requirement through imports. It is the largest supplier for rails and heavy plates in India, and is currently looking to sell its 3 special‐steel alloy plants with a combined capacity of c.1.0mn tonnes. Incremental capacities are coming at an opportune time We expect demand CAGR of 6.4% over the next couple of years, when most big players are near optimum utilisation, presenting SAIL with a unique opportunity to capture a larger part of incremental demand, as it has spare capacity. With 40‐45% of its portfolio being in long products, SAIL should be at an advantage as demand in long products will be a bit better than in flat products. SAIL has already ended FY19 with sales of 14.1mn tonnes and we expect it to report an additional 1.5mn tonnes each for FY19 and FY20. Volumes and EBITDA CAGR at 10% and 11% over FY19‐21 Despite flattish yoy sales at 14.1mn tpa in FY19, JPC data suggests that SAIL is already producing saleable steel at an annualised rate of +16mn tonnes. Given that the Bhilai blast furnace is slated to commission in a couple of months, we firmly believe that SAIL’s volumes CAGR over FY19‐21 will be c.10%, which would arrest any fall in operating margins due to lower realisations. Positive FCF will help SAIL to deleverage Despite huge expansion and modernisation over the years, SAIL has managed to keep its debt‐equity ratio below 1.3x at the end of FY19. FY19 debt was c.Rs 452bn, lower than Rs 468bn at the end of 3QFY19. We expect free cash flow generation to remain healthy despite planned capex of Rs 40bn in FY20. SAIL will repay close to Rs 38bn (9%) of debt over the next couple of years. Outlook and valuation The key monitorable remains a timely ramp up of facilities. SAIL has been under‐delivering over the past 3‐4 years, as its projects have been marred by cost and time overruns and accidents in plants. Therefore, against its annual sales guidance of c.17mn tonnes sales in FY20, we are only building in 15.6mn tonnes for FY20. It has the highest fixed costs among peers, so it should derive high operating leverage benefits too. We re‐initiate coverage on SAIL with a Neutral rating and a target of Rs 58 (5.5x FY21 EV/EBITDA) considering modest upside of 18% from current levels. The target has upside potential if it posts better‐than‐expected volumes and improved economies of scale. However, historical performance parameters suggest that SAIL has been lagging behind its guidance and therefore we will continue to watch volume execution. Key Risks • Further delays in ramping up. • Possibility of increase in capex programme, derailing de‐leveraging expectations.


1MTH 3MTH 1YRABS ‐2.4 0.9 ‐38.6REL TO BSE ‐2.4 ‐3.4 ‐49.8 PRICE VS. SENSEX

Source: PhillipCapital India Research KEY FINANCIALS Rs mn FY19 FY20E FY21ENet Sales 669,673 692,661 761,395EBIDTA 97,341 98,459 119,594Net Profit 25,682 24,225 36,898EPS, Rs 6.2 5.9 8.9PER, x 9.6 8.4 5.5EV/EBIDTA, x 7.2 6.4 5.1P/BV, x 0.6 0.5 0.4ROE, % 6.5 5.7 8.0Debt/Equity (%) 113.9 100.8 89.3


0

40

80

120

160

200

240

Apr‐16 Apr‐17 Apr‐18 Apr‐19SAIL BSE Sensex


STEEL AUTHORITY OF INDIA INITIATING COVERAGE

In a sweet spot We expect Indian steel demand CAGR at c.6.4% for the next couple of years, which implies cumulative 13‐14mn tonnes of incremental steel demand. Market leaders such as Tata and JSW are nearing optimum capacity, so new expansion is 12‐15 months away, and stressed assets such as Essar and Bhushan are already running close to 85‐90% of their effective capacity. These market conditions will benefit SAIL despite its laggard behaviour, whereby it will be able to push volumes. About 40‐45% of its product portfolio is in long products – we expect demand in long products to be a bit better than flat, which will support SAIL’s portfolio. It should report sales volumes of 15.6mn tonnes for FY20 and 17mn tonnes for FY21. Increasing iron ore prices to benefit in the short to medium term Following the Vale Dam disaster and lower shipment guidance by Rio Tinto, global iron ore prices (63.5% Fe fines) increased by over 37% since February and c.8% on a wow (week on week) basis. To pass on higher costs, global steel players have to hike prices soon. Eventually, Indian players will also follow suit, as import parity becomes favourable. SAIL has 100% captive iron ore, so it stands to benefit more from this situation. Iron ore prices (US$/t)

Source: Bloomberg Volumes CAGR at 10% over FY19‐21 and EBITDA at 11% SAIL saw flat volumes in FY19 as growth was compromised by incidents in Bhilai BF and at the Bokaro hot strip mill. However, looking at JPC (Joint Plant Committee) data, SAIL is already producing saleable steel at an annualised rate of +16mn tonnes. As the Bhilai BF has also re‐commissioned and is now ramping up well, we firmly believe that SAIL’s volume CAGR would be c.10% over FY19‐21, which would improve operating margins considerably due to higher fixed costs. Planned expansion Mn tonnes Crude Steel Saleable SteelPlant FY19 Post expansion FY19 Post expansionBSP ‐Bhilai Steel Plant 4.5 7.0 3.7 6.6 DSP ‐ Durgapur Steel 2.2 2.2 2.1 2.1 RSP ‐Rourkela Steel Plant 3.7 4.2 3.3 4.0 BSL ‐Bokaro Steel Limited 3.8 4.6 3.6 4.2 ISP ‐ IISCO, Burnpur 1.9 2.5 1.9 2.4 Total 16.1 20.5 14.7 19.3

Note: We have not added data from the 3 small plants as they are up for sale.


25

35

45

55

65

75

85

95

105

115

125

Mar‐16

Apr‐16

May‐16

Jun‐16

Jul‐1

6Au

g‐16

Sep‐16

Oct‐16

Nov

‐16

Dec‐16

Jan‐17

Feb‐17

Mar‐17

Apr‐17

May‐17

Jun‐17

Jul‐1

7Au

g‐17

Sep‐17

Oct‐17

Nov

‐17

Dec‐17

Jan‐18

Feb‐18

Mar‐18

Apr‐18

May‐18

Jun‐18

Jul‐1

8Au

g‐18

Sep‐18

Oct‐18

Nov

‐18

Dec‐18

Jan‐19

Feb‐19

Mar‐19

Apr‐19

May‐19

Jun‐19

Iron ore prices moved up sharply in the last 3‐4 months on supply crunch



Economies of scales to play out SAIL is in the last leg of its expansion and modernisation plan, and except Bhilai, all its other plants are already commissioned. We expect it to execute 17mn tonnes of sales in FY21 from c.14mn tonnes in FY19. With its huge fixed costs, an increase in volume alone can have an impact of Rs 1,500‐2,000 per tonne on EBITDA as a large part of its savings come from employee‐cost reduction on a per tonne basis. Fixed cost per tonne to reduce as volumes ramp up

Source: Company, PhillipCapital India Research Estimates SAIL’s employee costs are under much better control Over the last 3‐4 years, SAIL has worked on manpower rationalisation and productivity. It has managed to reduce employee strength to 72,339 in FY19 from 93,352 in FY15 and is targeting a strength of around 65,000 by FY21. This reflects in its employee costs, which touched c.13% of sales in FY19 from c.26% in FY16. Management maintains that employee cost will remain flattish at Rs 88‐89bn for FY20, except a one‐time cash payment of Rs 12bn for gratuity. Employee cost trend

Employee cost or production per tonne has been coming down on lower employees and higher production

Labour productivity trend

Labour productivity has increased by 33% over FY15 while number of employees were down by c.21%


8

10

12

14

16

18

0

3,000

6,000

9,000

12,000

15,000

18,000


Mn tonn

e

Rs/ton

ne

Employee Power Store & SpairsConversion/handling Volumes (rhs)

0%

5%

10%

15%

20%

25%

30%

0

1,000

2,000

3,000

4,000

5,000

6,000

7,000

8,000

9,000


Rs/ton

ne

Employee % of sales (rhs)

0

100

200

300

400

500

0

20,000

40,000

60,000

80,000

100,000

FY15 FY16 FY17 FY18 FY19 FY20

No of employeesLabour productivity (rhs) ‐ Perman/yr (rhs)

EBITDA/tonne has huge potential from current levels, which is not factored into SAIL’s stock prices yet



Positive FCF will help to deleverage Despite the huge expansion and modernisation projects over the years, SAIL has managed to keep its debt‐equity ratio below 1.3x at the end of FY18. Debt stood at c.Rs 468bn in 9MFY19 and fell to Rs 451bn by the end of FY19. The company is likely to generate free cash flow near the completion of its capital expenditure and on better cash flows from operations. We expect SAIL to bring down its debt levels to Rs 410bn by FY21. Debt to peak out in FY19 on conclusion of expansion

Source: Company, PhillipCapital India Research Estimates Earnings estimates Rs mn FY18 FY19P FY20E FY21EVolumes (mn tonnes) 14.1 14.1 15.6 17.0 Realisation (Rs/t) 40,422 47,427 44,345 44,788 Net Sales 569,184 669,673 692,661 761,395 EBITDA 46,356 97,341 98,459 120,782 EBITDA/t (Rs) 3,292 6,894 6,303 7,105


0.4

0.6

0.8

1.0

1.2

1.4

200

250

300

350

400

450

500


X

Rs bn

Ner Debt Ner Debt/Equity (rhs)



Financials

Consolidated Income Statement Y/E Mar, Rs mn FY18 FY19 FY20e FY21eNet sales 569,184 669,673 692,661 761,395Growth, % 30 18 3 10Other income 6,416 0 0 0Total income 575,600 669,673 692,661 761,395Raw material expenses ‐278,767 ‐295,743 ‐307,542 ‐344,111Employee expenses ‐88,659 ‐88,303 ‐89,186 ‐90,078Other Operating expenses ‐161,283 ‐188,286 ‐197,473 ‐207,612EBITDA (Core) 46,891 97,341 98,459 119,594Growth, % 4,714.8 107.6 1.1 21.5Margin, % 8.2 14.5 14.2 15.7Depreciation ‐30,660 ‐33,847 ‐35,847 ‐37,847EBIT 16,232 63,494 62,612 81,747Growth, % (162.8) 291.2 (1.4) 30.6Margin, % 2.9 9.5 9.0 10.7Interest paid ‐28,228 ‐31,549 ‐32,049 ‐32,549Other Non‐Operating Income 4,152 5,328 5,595 5,874Pre‐tax profit ‐7,844 37,273 36,157 55,072Tax provided 2,452 ‐11,591 ‐11,932 ‐18,174Profit after tax ‐5,392 25,682 24,225 36,898Net Profit ‐5,392 25,682 24,225 36,898Growth, % (80.1) (576.3) (5.7) 52.3Net Profit (adjusted) (5,392) 25,682 24,225 36,898Unadj. shares (m) 4,131 4,131 4,131 4,131Wtd avg shares (m) 4,131 4,131 4,131 4,131 Balance Sheet Y/E Mar, Rs mn FY18 FY19 FY20e FY21eCash & bank 3,456 2,877 477 2,401Debtors 38,710 44,975 46,519 51,135Inventory 170,243 195,103 197,361 216,945Loans & advances 63,893 62,386 65,122 71,584Other current assets 21,346 18,590 19,228 21,136Total current assets 297,647 323,931 328,706 363,201Investments 26,297 29,759 30,057 30,357Gross fixed assets 955,416 613,734 661,775 707,716Less: Depreciation ‐369,170 0 ‐36,347 ‐74,694Add: Capital WIP 183,954 160,136 153,136 143,136Net fixed assets 770,200 773,870 778,564 776,157Non‐current assets 18,646 23,295 23,991 24,728Total assets 1,154,410 1,179,523 1,189,986 1,223,112Current liabilities 434,187 416,172 413,034 412,262Provisions 44,051 56,263 56,928 52,626Total current liabilities 478,238 472,435 469,962 464,889Non‐current liabilities 306,706 310,627 295,753 295,886Total liabilities 784,944 783,061 765,715 760,775Paid‐up capital 41,305 41,305 41,305 41,305Reserves & surplus 328,161 355,156 382,966 421,032Shareholders’ equity 369,466 396,462 424,271 462,337Total equity & liabilities 1,154,410 1,179,523 1,189,986 1,223,112


Cash Flow Y/E Mar, Rs mn FY18 FY19 FY20e FY21ePre‐tax profit ‐7,844 37,273 36,157 55,072Depreciation 30,660 33,847 35,847 37,847Chg in working capital ‐67,155 ‐43,649 ‐10,218 ‐38,248Total tax paid ‐680 1,361 ‐11,932 ‐18,174Other operating activities 592 1,313 584 ‐1,832Cash flow from operating activities ‐44,427 30,146 50,438 34,665Capital expenditure ‐65,112 ‐37,517 ‐40,541 ‐35,441Chg in investments ‐1,534 ‐3,462 ‐298 ‐301Cash flow from investing activities ‐66,646 ‐40,979 ‐40,838 ‐35,741Free cash flow ‐111,073 ‐10,833 9,600 ‐1,076Equity raised/(repaid) 3,843 0 3,000 3,000Debt raised/(repaid) 106,897 10,255 ‐15,000 0Cash flow from financing activities 110,740 10,255 ‐12,000 3,000Net chg in cash ‐333 ‐579 ‐2,400 1,924 Valuation Ratios

FY18 FY19 FY20e FY21ePer Share dataEPS (INR) (1.3) 6.2 5.9 8.9Growth, % (80.1) (576.3) (5.7) 52.3Book NAV/share (INR) 89.4 96.0 102.7 111.9FDEPS (INR) (1.3) 6.2 5.9 8.9CEPS (INR) 6.1 14.4 14.5 18.1CFPS (INR) 3.9 9.6 13.1 11.2Return ratiosReturn on assets (%) 2.0 4.9 4.7 5.7Return on equity (%) (1.5) 6.5 5.7 8.0Return on capital employed (%) 3.4 7.7 7.3 8.7Turnover ratiosAsset turnover (x) 0.8 0.8 0.8 0.9Sales/Total assets (x) 0.5 0.6 0.6 0.6Sales/Net FA (x) 0.8 0.9 0.9 1.0Working capital/Sales (x) (0.2) (0.1) (0.1) (0.1)Fixed capital/Sales (x) 1.0 0.9 0.9 0.8Receivable days 24.8 24.5 24.5 24.5Inventory days 109.2 106.3 104.0 104.0Payable days 52.0 46.1 46.1 46.1Working capital days (89.8) (51.8) (44.7) (24.7)Liquidity ratios Current ratio (x) 0.7 0.8 0.8 0.9Quick ratio (x) 0.3 0.3 0.3 0.4Interest cover (x) 0.6 2.0 2.0 2.5Total debt/Equity (%) 122.6 113.9 100.8 89.3Net debt/Equity (%) 121.7 113.2 100.7 88.7Valuation PER (x) (53.8) 9.6 8.4 5.5PEG (x) ‐ y‐o‐y growth 0.5 (0.0) (1.5) 0.1Price/Book (x) 0.8 0.6 0.5 0.4EV/Net sales (x) 1.3 1.0 0.9 0.8EV/EBITDA (x) 15.8 7.2 6.4 5.1EV/EBIT (x) 45.6 11.0 10.1 7.5



JSW Steel (JSTL IN) Aggressive expansion plans to weigh on balance sheet INDIA | METLAS | INITIATING COVERAGE

26 June 2019

Promoted by Mr O. P. Jindal, JSW Steel is the flagship company of the JSW group with an installed capacity of 18mn tpa spread across three plants – Karnataka (12mn tpa in Vijayanagar), Tamilnadu (1mn tpa at Salem), and Maharashtra (5mn tpa at Dolvi). The group set up its first steel plant in 1982 at Vasind near Mumbai. Soon after, it acquired Piramal Steel, which operated a mini steel mill at Tarapur in Maharashtra. JSW Steel is one of the lowest‐cost steel producers in the world and has a strong presence in the value‐added flat‐steel segment. In the last one year, it has been on an acquisition spree. In India, it acquired Bhushan Power (2.3mn tpa, scalable to 3mn) and Monnet Ispat (1.5mn tpa as a minority partner). It has flexed its muscles in the international market by acquiring manufacturing facilities in the US (Acero Junction, 1.3mn tpa) and Italy (Aferpi, c.1mn tpa). It is also aggressively looking at improving its raw‐material security (acquired captive iron ore mines in Karnataka, which can produce c.5mn tpa per annum once fully operational). Subdued domestic growth, profitability to be diluted We have built in a mere 6% volume CAGR for FY19‐21 in its Indian operations, considering that its Dolvi expansion is still a year away. If we include its newly acquired facilities in Italy and in the US, this CAGR may improve to 9%, but we are sceptical about the new facilities contributing to the bottom‐line anytime soon. JSW is among the lowest‐cost producers in the world and increasing volumes add little to its operating leverage. Overall profitability is set to take a dive as EBITDA of Indian operations (most profitable), will be diluted at the consolidated level due to the inclusion of lower‐profit overseas businesses, as their turnaround is likely to take longer than initially expected. Acquisitions may drag profitability JSW acquired many companies in the last one year – Monnet Ispat and Bhushan Power in India and mills in the US and in Italy. Though all these will contribute significantly in terms of volumes, we are not very confident about how quickly JSW can turn around these facilities towards profitability (currently incurring losses). We expect the profitability of these mills to remain lower than the Indian operations even in long run, and possibly become a drag in the short to medium term. Expansion to put pressure on the balance sheet JSW has embarked on an aggressive expansion plan to increase its domestic capacity by c.34% by FY21 at a capex of c.Rs 470bn (Rs 144bn spent already). Its net debt has already increased by c.Rs 82bn in FY19 vs. FY18, which we expect will further accelerate to c. Rs 530bn by FY21 (a 15%+ increase over FY19 and 40% over FY18). JSW will acquire Bhushan Power for Rs 197bn, putting more pressure on the balance sheet. Outlook and valuation JSW’s consolidated profitability will deteriorate for the next couple of years as standalone profitability would be under pressure on increasing raw material costs and because it could take longer to turn around acquired facilities than what was generally expected. With aggressive expansion plans, its debt would increase meaningfully by the end of FY20, which would put pressure on the balance sheet/cash flows and expose the company to financial risk in case the steel‐cycle tanks. We are valuing the company on EV/EBITDA – target multiple of 6x for the domestic business and 5.5x for subsidiaries – to arrive at a target of Rs 225, which is lower than its CMP. We initiating coverage with a Sell rating. Our target has a downside risk if its aggressive inorganic expansion continues. Key risks • Delays in Dolvi expansion. • Significant increase in debt due to planned capex and acquisition of Bhushan Power.

SELL CMP RS 267 TARGET RS 225 (‐16%) COMPANY DATA O/S SHARES (MN) : 2417MARKET CAP (RSBN) : 645MARKET CAP (USDBN) : 9.352 ‐ WK HI/LO (RS) : 427 / 252LIQUIDITY 3M (USDMN) : 27.8PAR VALUE (RS) : 1 SHARE HOLDING PATTERN, % Mar 19 Dec 18 Sep 18PROMOTERS : 42.7 42.6 42.3FII / NRI : 19.1 20.1 35.3FI / MF : 2.9 2.6 1.9NON PRO : 22.5 22.6 8.2PUBLIC & OTHERS : 12.2 12.2 12.3 PRICE PERFORMANCE, %


Source: PhillipCapital India Research KEY FINANCIALS Rs mn FY19 FY20E FY21ENet Sales 824,990 817,820 907,969EBIDTA 189,520 155,192 174,986Net Profit 75,240 47,111 55,352EPS, Rs 31.4 19.6 23.1PER, x 8.5 13.6 11.5EV/EBIDTA, x 5.8 7.2 6.7P/BV, x 1.8 1.7 1.5ROE, % 21.6 12.3 13.0Debt/Equity (%) 150 139 134


0

50

100

150

200

250

300

350

Apr‐16 Apr‐17 Apr‐18 Apr‐19JSW Steel BSE Sensex


JSW STEEL INITIATING COVERAGE

Profitability to be a function of cost and realisation… JSW Steel is operating at close to optimal capacity utilisation in India and further volume growth largely depends on the timely expansion of Dolvi and Vijayanagar plants, expected to commission by 2HFY21. Though JSW has acquired the 1.5mn tpa Monnet facility and steel plant in the US and Italy with a combined capacity c.2.5mn tpa, it has only a 30% stake in Monnet whereas US and Italy plants would take time to ramp up to full potential. Therefore, we believe that for the next 12‐15 months, its profitability will largely depend on realisation and raw‐material cost swings. …therefore, we are building an Indian operation volume CAGR of c.4% JSW has given a sales‐volume guidance of 16mn tonnes for FY20, up only 2.4% yoy. As new capacities will take time to start contributing, we have built in only 4% volume CAGR for FY19‐21 for the Indian operations. In the US and in Italy, the company has the potential to add 1.5‐2.0mn tonnes of incremental sales over the next two years. However, because we are not sure how quickly JSW will be able to turn around these facilities, we are building combined sales of 0.8mn tonnes in FY20 and 1.3mn tonnes in FY21. The profitability of these mills will remain much lower than its Indian operations. Plant‐wise volume contribution

Source: Company, PhillipCapital India Research Estimates A play on cost competitiveness; margins to come under pressure JSW is among the most efficient low‐cost steel producers in the country. Majority of its cost savings come from significantly lower labour costs, which we expect will be very hard for Tata or SAIL to replicate, even in the long run. The company is in the process of upgrading its capacities to c.23mn tonnes by FY21 from 18mn tpa currently. However, given its current conversion‐cost dynamics, we do not expect incremental capacities to bring in any significant operating leverage benefits as the company is already at par with global standards. Considering the movement in steel prices and raw material (especially iron ore) we expect its margins to come under pressure as steel prices have moderated in the last three months while iron ore prices have increased. Also, as JSW is among the largest steel exporters from India. Export margins are likely to be thinner than domestic margins, so its EBITDA/tonne will see some moderation.

5

7

9

11

13

15

17

19

21

FY17 FY18 FY19 FY20E FY21E

India US Italy



Conversion cost (Rs/tonne)

JSW steel has significantly lower CoP vs. its peers. Majority of savings come from lower employee costs

Number of employees per mn tonnes of capacity in FY18

Tata Steel and SAIL have as many as 4x and 6x higher employees per mn tonnes of capacity. We expect this gap to continue

Source: Company, PhillipCapital India Research Estimates Aggressive expansion to put pressure on the balance sheet JSW embarked on an aggressive domestic expansion (c.34% higher capacity by FY21), buoyed by a robust domestic steel market in FY18 and improving utilisations. Majority of the expansion will come from its Dolvi plant (+5mn tpa) followed by the Vijayanagar plant (+1.5mn tpa). Apart from this, JSW is expanding its downstream capacity to improve value addition. It is likely to spend Rs 300bn over next two years on capex – this is in addition to the Rs 144bn spent till date. Its net debt has increased yoy by c.Rs 83bn in FY19, which we believe will accelerate to c.Rs 530bn by FY21 (up 15% over FY19). JSW is even acquiring Bhushan Power for Rs 197bn – which it would like to de‐consolidate so as to reduce the stress on its balance sheet. Considering cash flows, it would only be able to part‐fund the acquisition from its own cash, which may put more pressure on its balance sheet in the form of higher debt. Planned c. Rs 570bn capex in India over FY19‐21

Out of the total planned capex of Rs 444bn, JSW has already spent Rs 144bn (Rs 47bn in FY18 and Rs 100bn in FY19).


0

3,000

6,000

9,000

12,000

15,000

18,000

JSW Tata SAIL JSW Tata SAIL JSW Tata SAIL JSW Tata SAIL

FY15 FY16 FY17 FY18

Employee Power Store & Spairs Conversion/handling

646

2,621

4,046

0

1,000

2,000

3,000

4,000

5,000

0

20000

40000

60000

80000

100000

JSW Tata SAIL

No of employees ‐ LHS Employee/per mn tonne

217

444

641

53

121 7 46

197

0

100

200

300

400

500

600 Pellet, coke ovens, CPP,coveyer etc

Value added capacity to increase by 3.2 mn tpa

Increasing crude steel capacity by 6.7 mn tonne

Mining capex

Annual capex guidance

Majority of the cash outflow will start from FY20

47

100

150 147

0

20

40

60

80

100

120

140

160

FY18 FY19 FY20E FY21E



Overseas capex to add to the debt Apart from the huge capex in India, JSW has big plans for its overseas subsidiaries. It has announced investments worth c.US$ 1bn in the US, equally divided between Acero Junction and its US plate/pipe mill. Its Acero capex will be divided into two phases of US$ 250mn each. In Phase 1, JSW will revamp and restart the electric‐arc furnace (EAF) and slab‐caster along with modernisation of the hot‐strip mill. Then, depending on the economic scenario, it will add another EAF to make its Ohio facility a fully integrated unit with 3mn tpa capacity. The plate and pipe mill will entail a capex of US$ 500mn to increase the capacity to 2mn tonnes. Bhushan’s acquisition is expensive; turnaround may take longer JSW is set to acquire Bhushan Power for Rs 197bn, implying an acquisition cost of c.US$ 1,100‐1,150/t (on the effective capacity base), which we believe is a bit expensive compared to most recent deals. While Bhushan’s nameplate capacity is close to 3mn tpa, its effective capacity is c.2.3‐2.5mn tonnes only because some upstream re‐balancing capacities would be required; this indicates more investments will be needed in order to utilise the true potential of the plant. We firmly believe that Bhushan’s turnaround may follow the ISPAT way, and could take anywhere between 2‐3 years. Until then, Bhushan may become a drag on overall performance. Overseas operations may weigh down profitability After losing out on the opportunity to acquire big‐ticket stressed assets in India during the initial period, JSW went abroad and acquired Acero Junction (1.5MTPA electric arc furnace and a 3MTPA hot‐strip mill) and Aferpi (2.5mn tpa facility comprising a 320KT rail mill, a 400KT bar mill, and a 600KT wire‐rod mill). Since then, steel prices in the US and in Europe have been falling. At present, both plants are operating at suboptimal levels, which are dragging profitability. Both Aferpi and Acero are incurring losses at EBITDA levels. Given the trimmed global growth forecasts, modernisation plan in Acero, and usage of Indian billets in Aferpi, we believe that it would take longer than expected to turn around the mills at the PBT level. We expect both mills to be a drag on profitability. Overall leverage dynamics to deteriorate for the next couple of years JSW Steel’s pending capex is c.Rs 300bn in India and overseas (excluding Bhushan acquisition). We believe that its cash flows will lag behind, considering that new facilities will take both time and additional investments to turn around, forcing JSW to finance the capex through debt. We expect net debt to increase to c.Rs 530bn in the next two years, with net debt/EBITDA deteriorating to 3x. Any deterioration in the steel sector’s outlook would expose the company to financial risk. For example, a Rs 1,000/t fall in domestic EBITDA would increase the net debt/EBITDA by 30‐40bps. Therefore, we remain cautious for the next couple of years. Leverage increasing


2.0

2.2

2.4

2.6

2.8

3.0

3.2

3.4

3.6

200

250

300

350

400

450

500

550

FY17 FY18 FY19 FY20 FY21

Net Debt (Rs bn) ‐ LHS Debt/EBITDA (x)



Earnings estimates (standalone) Rs mn FY17 FY18 FY19 FY20E FY21EVolumes (mn tonnes) 14.8 15.6 15.6 16.0 17.5Realisation (Rs/t) 34,940 40,831 47,970 44,765 44,765Net Sales 516,208 637,870 747,690 717,330 782,357EBITDA 115,432 137,410 184,030 151,428 169,352EBITDA/t (Rs) 7,813 8,796 11,807 9,450 9,690

Source: Company, PhillipCapital India Research Estimates SOTP valuation EBITDA Multiple EVStandalone 169,352 6.0 1,016,113Subsidiaries 5,633 5.5 30,984Total EV 1,047,097Net debt 529,334Equity Holders share 517,764No Of Shares 2,400 Target Price 225

Source: PhillipCapital India Research Estimates



Financials

Consolidated Income Statement Y/E Mar, Rs mn FY18 FY19 FY20e FY21eNet sales 688,130 824,990 817,820 907,969Growth, % 26 20 ‐1 11Other Operating income 14,120 22,580 20,682 21,624Total income 702,250 847,570 838,502 929,593Raw material expenses ‐390,250 ‐432,060 ‐451,761 ‐496,075Employee expenses ‐18,430 ‐24,890 ‐29,770 ‐34,550Other Operating expenses ‐145,630 ‐201,100 ‐201,780 ‐223,982EBITDA (Core) 147,940 189,520 155,192 174,986Growth, % 21.5 28.1 (18.1) 12.8Margin, % 21.5 23.0 19.0 19.3Depreciation ‐33,870 ‐40,410 ‐43,936 ‐49,672EBIT 114,070 149,110 111,256 125,313Growth, % 30.5 30.7 (25.4) 12.6Margin, % 16.6 18.1 13.6 13.8Interest paid ‐37,010 ‐39,170 ‐43,066 ‐44,998Other Non‐Operating Income 1,670 2,040 2,244 2,468Pre‐tax profit 78,730 111,980 70,434 82,784Tax provided ‐15,380 ‐36,440 ‐23,243 ‐27,319Profit after tax 63,350 75,540 47,191 55,465Others (Minorities, Associates) 420 ‐300 ‐80 ‐113Net Profit 63,770 75,240 47,111 55,352Growth, % 83.0 18.0 (37.4) 17.5Net Profit (adjusted) 63,770 75,240 47,111 55,352Unadj. shares (m) 2,410 2,400 2,400 2,400Wtd avg shares (m) 2,410 2,400 2,400 2,400 Balance Sheet Y/E Mar, Rs mn FY18 FY19 FY20e FY21eCash & bank 10,630 61,870 48,968 40,894Marketable securities at cost 3,120 820 820 820Debtors 47,040 71,600 70,978 78,802Inventory 125,940 145,480 144,216 160,113Loans & advances 9,110 30,990 30,721 34,107Other current assets 3,250 3,340 3,340 3,340Total current assets 199,090 314,100 299,042 318,076Investments 11,570 18,120 19,026 19,977Gross fixed assets 691,380 739,620 837,710 954,890Less: Depreciation ‐109,690 ‐109,690 ‐153,626 ‐203,298Add: Capital WIP 56,290 115,400 167,400 197,400Net fixed assets 637,980 745,330 851,484 948,992Non‐current assets 71,060 70,420 69,808 77,503Total assets 920,180 1,149,140 1,240,530 1,365,718Current liabilities 289,640 420,080 432,690 471,163Provisions 1,380 2,580 2,709 2,844Total current liabilities 291,020 422,660 435,399 474,008Non‐current liabilities 353,820 383,030 426,623 469,914Total liabilities 644,840 805,690 862,022 943,922Paid‐up capital 2,410 2,400 2,400 2,400Reserves & surplus 277,570 345,550 380,833 424,357Shareholders’ equity 275,340 343,450 378,508 421,796Total equity & liabilities 920,180 1,149,140 1,240,530 1,365,718


Cash Flow Y/E Mar, Rs mn FY18 FY19 FY20e FY21ePre‐tax profit 78,730 111,980 70,434 82,784Depreciation 33,870 40,410 43,936 49,672Chg in working capital ‐36,200 103,190 17,883 6,303Total tax paid ‐19,720 ‐24,230 ‐22,464 ‐26,524Other operating activities 3,259 2,692 ‐454 ‐454Cash flow from operating activities 59,939 234,042 109,335 111,781Capital expenditure ‐40,920 ‐147,760 ‐150,090 ‐147,180Chg in investments ‐910 ‐6,550 ‐906 ‐951Chg in marketable securities ‐120 2,300 0 0Cash flow from investing activities ‐41,950 ‐152,010 ‐150,996 ‐148,131Free cash flow 17,989 82,032 ‐41,661 ‐36,350Equity raised/(repaid) ‐4,420 ‐10 0 0Debt raised/(repaid) ‐6,930 ‐20,670 40,438 40,000Dividend (incl. tax) ‐9,099 ‐11,513 ‐11,328 ‐11,328Cash flow from financing activities ‐22,209 ‐32,353 28,805 28,323Net chg in cash ‐4,220 49,679 ‐12,856 ‐8,027 Valuation Ratios

FY18 FY19 FY20e FY21ePer Share dataEPS (INR) 26.5 31.4 19.6 23.1Growth, % 82.2 18.5 (37.4) 17.5Book NAV/share (INR) 116.2 145.0 159.7 177.8FDEPS (INR) 26.5 31.4 19.6 23.1CEPS (INR) 40.5 48.2 37.9 43.8CFPS (INR) 45.2 31.8 58.2 48.9DPS (INR) 3.2 4.1 4.0 4.0Return ratiosReturn on assets (%) 11.1 11.1 7.5 7.7Return on equity (%) 22.8 21.6 12.3 13.0Return on capital employed (%) 16.5 16.9 11.7 11.8Turnover ratiosAsset turnover (x) 1.1 1.2 1.0 1.1Sales/Total assets (x) 0.8 0.8 0.7 0.7Sales/Net FA (x) 1.1 1.2 1.0 1.0Working capital/Sales (x) (0.2) (0.2) (0.2) (0.2)Fixed capital/Sales (x) 0.8 0.8 0.8 0.8Receivable days 25.0 31.7 31.7 31.7Inventory days 66.8 64.4 64.4 64.4Payable days 105.0 89.6 89.6 89.6Working capital days (55.3) (74.6) (81.9) (78.3)Liquidity ratios Current ratio (x) 0.7 0.7 0.7 0.7Quick ratio (x) 0.3 0.4 0.4 0.3Interest cover (x) 3.1 3.8 2.6 2.8Total debt/Equity (%) 139.9 150.4 138.6 133.8Net debt/Equity (%) 136.1 132.6 125.8 124.2Valuation PER (x) 10.1 8.5 13.6 11.5PEG (x) ‐ y‐o‐y growth 0.1 0.5 (0.4) 0.7Price/Book (x) 2.3 1.8 1.7 1.5EV/Net sales (x) 1.5 1.3 1.4 1.3EV/EBITDA (x) 6.9 5.8 7.2 6.7EV/EBIT (x) 8.9 7.4 10.1 9.3



NMDC Ltd. (NMDC IN)

Will benefit from supply tightness INDIA | METALS | INITIATING COVERAGE

26 June 2019

Incorporated in 1958 and owned by GoI, NMDC has high‐grade iron‐ore reserves to the tune of 1.5bn tonnes in Chhattisgarh and Karnataka. Since its inception, it is involved in the exploration of a wide range of minerals, including iron ore, copper, rock phosphate, limestone, dolomite, gypsum, bentonite, magnesite, diamond, tin, tungsten, graphite, and beach sands. NMDC is India's single largest iron‐ore producer, presently producing about 32mn tonnes of iron‐ore from three fully mechanised mines – Bailadila Deposit‐14/11C, Bailadila Deposit‐5, 10/11A (Chhattisgarh State), and Donimalai Iron Ore Mines (Karnataka State). NMDC is also developing a 3mn tpa steel plant in Nagarnar, Chhattisgarh. Iron ore market to report deficit; ‘higher for longer’ prices to stay Iron ore prices, at US$ 119/t, have risen +40% from January 2019 following the Vale Dam’s collapse. Additionally, BHP and Rio Tinto announced shipment curtailments to the tune of 20‐21mn tpa due to cyclone‐related damage. We believe that 60‐70mn tonnes of shipments are hit, leading to a supply crunch in 2019. We now expect a seaborne market deficit of c. 30mn tonnes in 2019 and an almost balanced market in 2020. This means iron‐ore prices will stay higher for longer than previously anticipated (expect domestic prices to follow with a lag). Volumes depressed by Donimalai shutdown, expect 2% CAGR with upside potential In FY19, closure of the Donimalai Mines in 2H affected overall performance. As we do not have clarity on when they will restart, we are building in a subdued volume CAGR of 2%, assuming that NMDC will be able to use the Chhattisgarh capacity to optimum levels and Karnataka volumes at 7mn tonnes. Our estimates would have an upside potential of 5‐6mn tonnes, if the Donimalai Mines restart. Improving evacuation capability is a key to volume growth NMDC’s current mining capacity stands at 43mn tonnes (includes 7mn tonnes in Donimalai). However, its sales have remained range‐bound at 30‐35mn tonnes in the last 4‐5 years due to lack of evacuation facilities in Chhattisgarh. Though NMDC has big plans to increase its mining capacities by over 50%, the actual deliverable largely depends on timely completion of the doubling of the Jagdalpur railway line (to enhance capacity by 9mn tonnes) and a plan to commission a 15mn tpa slurry pipeline. Valuation Global supply shocks following the dam disaster in Vale and the cyclone in Australia sent iron ore prices skyrocketing. Since the domestic vs. imported iron‐ore price difference is +40%, we expect iron‐ore exports from Odisha to pick up, and domestic prices to eventually follow international prices, albeit at lower rate – which should benefit NMDC, as it is the largest merchant miner in India. Donimalai Mines restarting would remain a trigger. Re‐initiate with a Buy rating and a target of Rs 131, based on SOTP value. SOTP valuation (Rs mn) FY20 FY21EBITDA 61,706 60,781Multiple 5.0 5.0 Target EV 308,528 303,905Net Debt / (Cash) (32,796) (26,717)Eq holders 341,324 330,621No of shares 3,062 3,062 Fair Value 111 108 CWIP @ 50% discount 68,962 68,962 Vale per share 23 23 Target price 134 131

Source: PhillipCapital India Research Estimates


1MTH 3MTH 1YRABS 13.3 5.9 2.4REL TO BSE 13.3 1.6 ‐8.7 PRICE VS. SENSEX



60

80

100

120

140

160

180

Apr‐16 Apr‐17 Apr‐18 Apr‐19NMDC BSE Sensex


NMDC INITIATING COVERAGE

‘Higher for longer’ iron‐ore prices to continue due to supply disruption The Vale Dam Disaster in Brazil in late January sparked a string of restrictions at its Brazil mining operations, prompting the company to reduce its annual guidance of iron‐ore production by c.50‐70mn tonnes. At the same time, Rio Tinto and BHP announced a cumulative curtailment of 20mn tonnes of shipments due to a cyclone. At least 60mn tones of supply are likely to have been hit due to these events, which, coupled with a continuous fall in Chinese iron ore inventories, pushed iron ore prices to US$ 120/t from US$ 72/t in early January. Our previous calculations had indicated softening prices, following a surplus supply of c.25mn tonnes in the global seaborne market. However, with the top‐3 miners already lowering 2019 forecasts, we believe higher iron ore prices are here to stay and for longer than anticipated. We now expect a seaborne market deficit of c. 30mn tonnes in 2019 and an almost balanced market in 2020. Therefore, iron‐ore prices are likely to stay higher in 2019 at an average of c.US$ 95/t and will drop to US$ 85 for 2020. Seaborne demand and supply trend (mn tonnes)

Global seaborne trade continues to depend on China. We expect Chinese appetite for imported ore to come down in 2020, denting iron ore prices

Iron‐ore market balance

Vale, Rio Tinto, and BHP combined indicated c.60mn tonnes of shipments losses

Source: Company, PhillipCapital India Research Estimates Domestic prices also improved NMDC saw lump prices erosion of 26% and fine erosion of 21% between November 2018 and mid‐May 2019 because of record output from Orissa. However, as expected, the company has actually increased lump and fine prices by Rs 250/t each at the end of May to take advantage of rising international prices. Domestic iron‐ore trades at a significant discount to international prices since the former attracts 30% export duty. Currently, domestic iron ore is c.43% cheaper than exported iron ore. With companies shifting to domestic iron ore from imported, we anticipate another marginal price hike in the near future. Domestic and international price trend

NMDC domestic prices started moving in tandem with international prices

Iron‐ore import parity

NMDC prices are at a c.43% discount to imported landed prices

71%

72%

72%

73%

73%

74%

74%

75%

‐

200

400

600

800

1,000

1,200

1,400

1,600

2016 2017 2018 2019E 2020E

Seaborne demand China imports China share (rhs)

(40)

(30)

(20)

(10)

‐

10

20

30

2019E 2020E

Pre Vale accident Post Vale accident

20

40

60

80

100

120

1,000

1,500

2,000

2,500

3,000

3,500

4,000

4,500

May‐17

Jun‐17

Jul‐1

7Au

g‐17

Sep‐17

Oct‐17

Nov‐17

Dec‐17

Jan‐18

Feb‐18

Mar‐18

Apr‐18

May‐18

Jun‐18

Jul‐1

8Au

g‐18

Sep‐18

Oct‐18

Nov‐18

Dec‐18

Jan‐19

Feb‐19

Mar‐19

Apr‐19

May‐19

Jun‐19

US$/ton

ne

Rs/ton

ne

NMDC ‐ LumpNMDC ‐ FinesChine 63.55% Fe Fines CIF (RHS)

‐2,000

‐1,000

‐

1,000

2,000

3,000

4,000

5,000

Aug‐16

Oct‐16

Dec‐16

Feb‐17

Apr‐17

Jun‐17

Aug‐17

Oct‐17

Dec‐17

Feb‐18

Apr‐18

Jun‐18

Aug‐18

Oct‐18

Dec‐18

Feb‐19

Apr‐19

Jun‐19

Lump Fines

We believe higher iron ore prices are here to stay and for longer than anticipated

Currently, imported iron ore is c.43% cheaper/more expensive than domestic iron ore



Targeting 56% increase in mining capacity by FY22 NMDC’s current mining capacity is 43mn tonnes (including 7mn tonnes in Donimalai). It is improving its evacuation capabilities in Chhattisgarh by doubling of the Jagdalpur line – to enhance its capacity by 9mn tonnes in existing operations. It is also planning to develop 15mn tpa of greenfield mines (JV with CMDC) by FY22. An increase in its mining capacity will depend largely on NMDC’s ability to evacuate material, which has prompted the company to also undertake a 15‐mn tpa slurry pipeline at an estimated cost of c.Rs 30bn. Mining capacity enhancement plan Project ML validity (year) FY19 FY22Existing operating mines Kirandul 2037 14 21

Bacheli 2020 15 17Donimalai 2038 7 7Kumarswamy 2022 7 7Sub total 43 52

Greenfield Mines (JV with CMDC)

Deposit 13 2067 0 10Deposit 4 NA 0 5Sub total 0 15

Grand total 43 67

Source: Company, PhillipCapital India Research Estimates More misses than hits in volume growth, but we expect things to improve In the last five years, NMDC has managed to live up to its volume guidance only once. In FY19, the closure of the Donimalai mines in 2H depressed overall performance. It has cut its production guidance for 2022 to 67mn tpa from 100mn tpa. However, we expect volumes to improve with its steps to improve evacuation – which is a bottleneck for achieving higher volumes; healthy steel production growth (6‐7% CAGR for the next three years) bodes well for the company. Target vs. actual sales: History of overpromising and under delivering

Source: Company, PhillipCapital India Research Estimates We are building a volume CAGR of 2% over FY19‐21 Out of NMDC’s existing mining capacity of 43mn tpa, its Chhattisgarh capacity is 28‐29mn tpa (c.66%). Given that we do not have clarity on when the Donimalai Mine will start, we are building in a subdued volume CAGR of 2%; this assumes that NMDC will mine the Chhattisgarh capacity for c.24mn tonnes and Karnataka volumes will be 7mn tonnes in FY20. If the Donimalai Mines re‐start, our estimates would increase by 5‐6mn tonnes.

20

25

30

35

40


Target Actual



Volumes trend

NMDC volumes CAGR will be 10% over FY19‐21

Volumes expectations

Chhattisgarh’s contribution will continue to increase since we have not built in Donimalai restarting

Source: Company, PhillipCapital India Research Estimates Steel plant to see cost and time overruns NMDC is going solo in completing its steel plant for now, after failing to find a buyer due to high valuations. It expects the 3mn‐tonne mill to commission by 2HFY20 (we expect delays). Since it is already delayed, its cost has inflated from Rs 155bn to touch Rs 180bn of which NMDC has spent Rs 130‐40bn so far. Further cost escalations cannot be ruled out considering past delays. NMDC will spend Rs 55‐60bn on steel plants over the next couple of years; its management expects its new steel mills to be profitable because of iron‐ore backing (its own), new efficient technology, and low manpower costs (to employ only 4,000‐4,500 people to run the plant). We have not factored in revenues from the steel mill yet into our estimates. Merchant mining license expires in 2020 – is this a boon for NMDC? As per the MMDR Act, merchant mining licences are likely to be auctioned in 2020. This puts 60‐70mn tonnes of output at risk in Orissa itself. As we have seen in the past, any disruption in mining activities are beneficial for NMDC, as it creates a short‐term supply crunch, sending prices higher. However, our recent experience on auctions suggests that a good part may be earmarked for captive users in the region as captive usage is preferred. This could erode some of NMDC’s client base. JSW Steel, Essar Steel, JSPL, and Bhushan are among major companies that may opt for captive mining, reducing their reliance on NMDC. While short‐term disruptions cannot be ruled out, we expect the Orissa government to be proactive about mine auctions, as iron ore mining is a major revenue source. Dividend yield to remain high NMDC’s dividend payout ratio has always been c. 50% or more. In FY19, the company has declared an interim dividend of Rs 5.5, which is already 28% higher than its FY18 dividend. Given our estimate of ‘higher for longer’ iron‐ore prices, we expect FY20 dividend to be between Rs 5.5‐6.0/share, considering that NMDC would maintain its pay‐out ratio at a little over 50% till FY21. At CMP, we expect dividend yield at c.5%.

25

27

29

31

33

35

37


65% 66% 72% 77% 79%

35% 34% 28% 23% 21%

0%

20%

40%

60%

80%

100%


Chhattisgarh Karnataka



Dividend history

Source: Company, PhillipCapital India Research Estimates Major assumptions Rs mn FY17 FY18 FY19 FY20E FY21EVolumes (mn tonnes) 35.6 36.1 32.4 30.9 33.5Realisation (Rs/t) 2,445 3,185 3,710 3,610 3,360 Net Sales 88,281 116,145 121,527 112,900 114,052 EBITDA 36,018 58,084 69,244 61,706 60,781 EBITDA/t (Rs) 1,011 1,610 2,140 1,999 1,814


1.0

2.0

3.0

4.0

5.0

6.0

7.0


Dividned per share Yield



Financials

Consolidated Income Statement Y/E Mar, Rs mn FY18 FY19 FY20e FY21eNet sales 116,145 121,527 112,900 114,052Growth, % 31.6 4.6 ‐7.1 1.0Total income 116,145 121,527 112,900 114,052Raw material expenses 212 272 ‐824 ‐949Employee expenses ‐10,464 ‐10,394 ‐10,914 ‐12,005Other Operating expenses ‐47,809 ‐42,161 ‐39,457 ‐40,317EBITDA (Core) 58,084 69,244 61,706 60,781Growth, % 61.3 19.2 (10.9) (1.5)Margin, % 50.0 57.0 54.7 53.3Depreciation ‐2,560 ‐2,790 ‐3,069 ‐3,376EBIT 55,523 66,454 58,636 57,405Growth, % 63.0 19.7 (11.8) (2.1)Margin, % 47.8 54.7 51.9 50.3Interest paid ‐371 ‐403 ‐202 0Other Non‐Operating Income 5,197 5,890 4,538 3,674Pre‐tax profit 60,350 71,940 62,973 61,078Tax provided ‐23,733 ‐25,565 ‐22,670 ‐21,988Profit after tax 36,616 46,375 40,303 39,090Net Profit 36,616 46,375 40,303 39,090Growth, % 41.4 26.7 (13.1) (3.0)Net Profit (adjusted) 36,616 46,375 40,303 39,090Unadj. shares (m) 3,164 3,062 3,062 3,062Wtd avg shares (m) 3,164 3,062 3,062 3,062 Balance Sheet Y/E Mar, Rs mn FY18 FY19 FY20e FY21eCash & bank 54,382 46,077 36,437 30,358Debtors 14,727 14,245 13,234 13,369Inventory 5,717 6,662 6,189 6,252Loans & advances 4 5 6 7Other current assets 13,564 12,651 11,753 11,873Total current assets 88,395 79,640 67,619 61,859Investments 7,865 9,393 9,393 9,393Gross fixed assets 33,685 34,175 47,968 55,689Less: Depreciation ‐6,968 ‐6,968 ‐10,038 ‐13,414Add: Capital WIP 125,199 137,925 154,425 171,925Net fixed assets 151,916 165,131 192,354 214,199Non‐current assets 34,059 37,828 39,720 41,705Total assets 286,091 297,820 314,913 332,984 Current liabilities 35,412 30,621 28,705 28,961Total current liabilities 35,412 30,621 28,705 28,961Non‐current liabilities 7,141 7,684 8,068 8,471Total liabilities 42,553 38,305 36,774 37,433Paid‐up capital 3,164 3,062 3,062 3,062Reserves & surplus 240,374 256,453 275,078 292,490Shareholders’ equity 243,538 259,515 278,140 295,552Total equity & liabilities 286,091 297,820 314,913 332,984


Cash Flow Y/E Mar, Rs mn FY18 FY19 FY20e FY21ePre‐tax profit 60,350 71,940 62,973 61,078Depreciation 2,560 2,790 3,069 3,376Chg in working capital ‐2,867 ‐7,568 ‐1,041 ‐1,646Total tax paid ‐23,057 ‐27,536 ‐22,670 ‐21,988Other operating activities ‐2,214 ‐8,038 0 0Cash flow from operating activities 34,772 31,589 42,331 40,820Capital expenditure ‐16,635 ‐16,006 ‐30,292 ‐25,221Chg in investments ‐595 ‐1,529 0 0Cash flow from investing activities ‐17,229 ‐17,535 ‐30,292 ‐25,221Free cash flow 17,543 14,055 12,038 15,599Dividend (incl. tax) ‐16,054 ‐19,775 ‐21,678 ‐21,678Cash flow from financing activities ‐16,054 ‐19,877 ‐21,678 ‐21,678Net chg in cash 1,489 ‐5,822 ‐9,640 ‐6,079 Valuation Ratios

FY18 FY19 FY20e FY21ePer Share dataEPS (INR) 11.6 15.1 13.2 12.8Growth, % 41.4 30.9 (13.1) (3.0)Book NAV/share (INR) 77.0 84.8 90.8 96.5FDEPS (INR) 11.6 15.1 13.2 12.8CEPS (INR) 12.4 16.1 14.2 13.9CFPS (INR) 12.4 12.7 13.0 12.8DPS (INR) 4.3 5.5 6.0 6.0Return ratiosReturn on assets (%) 13.6 16.0 13.2 12.1Return on equity (%) 15.0 17.9 14.5 13.2Return on capital employed (%) 15.3 18.1 14.6 13.2Turnover ratiosAsset turnover (x) 0.8 0.8 0.6 0.6Sales/Total assets (x) 0.4 0.4 0.4 0.4Sales/Net FA (x) 0.8 0.8 0.6 0.6Working capital/Sales (x) (0.0) 0.0 0.0 0.0Fixed capital/Sales (x) 0.2 0.2 0.3 0.4Receivable days 46.3 42.8 42.8 42.8Inventory days 18.0 20.0 20.0 20.0Payable days 10.0 14.2 13.4 13.0Working capital days (4.4) 8.8 8.0 8.1Liquidity ratios Current ratio (x) 2.5 2.6 2.4 2.1Quick ratio (x) 2.3 2.4 2.1 1.9Interest cover (x) 149.7 164.8 290.9Dividend cover (x) 2.7 2.7 2.2 2.1Total debt/Equity (%) 2.1 1.4 1.3 1.2Net debt/Equity (%) (20.3) (16.4) (11.8) (9.0)Valuation PER (x) 9.5 7.3 8.4 8.6PEG (x) ‐ y‐o‐y growth 0.2 0.2 (0.6) (2.9)Price/Book (x) 1.4 1.3 1.2 1.1Yield (%) 3.9 5.0 5.5 5.5EV/Net sales (x) 2.6 2.4 2.7 2.7EV/EBITDA (x) 5.1 4.3 4.9 5.1EV/EBIT (x) 5.4 4.4 5.2 5.4



Hindalco (HNDL IN) Creating stability in a volatile environment INDIA | METALS | INITIATING COVERAGE

26 June 2019

Established in 1958, Hindalco Industries is an Aditya Birla Group flagship, engaged in the production of aluminium and copper. Hindalco’s aluminium smelting operations are located at Renukoot in Uttar Pradesh, Aditya Aluminium in Odisha, Mahan Aluminium in Madhya Pradesh, and Hirakud in Odisha. Together, these facilities produce around 1.3mn tpa of primary aluminium. HNDL’s aluminium smelters are backed by its captive bauxite mines. Its 500KT copper facility at Dahej includes copper smelters backed by a captive power plant, oxygen plants, by‐products plants, utilities, and a captive jetty. In 2007, the company acquired Novelis Inc., a world leader in aluminium rolling (c.3.3mn tpa) and recycling with a global footprint in 10 countries outside India. This buy made Hindalco one of the largest aluminium rolled‐product producers in the world. In 2018, Novelis announced that it would acquire Aleris’ 1mn tpa complementary rolling and recycling facilities at an EV of US$ 2.58bn). Stable business model Hindalco’s business model is largely insulated from price fluctuations as Novelis and Hindalco’s copper business currently contribute to c.64% of its total EBITDA in FY19. With the inclusion of Aleris, its total ‘conversion business’ EBITDA will rise to 72‐73%. In its domestic business, Hindalco is focusing on value addition to partially cushion the impact of fluctuating LME on realisations. All this ensures that HNDL has steady cash flows to meet its capex and debt‐repayment obligations. Aleris – a strategic long‐term bet Aleris’ acquisition will fast‐forward the company’s capability to service more segments and consolidate its market position in the high‐value automotive and aerospace segments. Aleris has already touched an EBITDA of US$ 382/t in Q1CY20 and US$ 316/t in CY19, and has legroom to improve once synergy benefits come in. We expect Aleris to add US$ 340‐350mn to Hindalco’s overall EBITDA in FY21, an additional 12‐13%. Focus on value addition in the domestic business Hindalco has begun a US$ 1bn investment to increase its domestic aluminium VA (value added) portfolio to 70% from 35% currently, and copper to 80‐90% from 68% in the next 4‐5 years. Value addition currently gives US$ 50‐100/t higher EBITDA, depending on the product and has the potential to increase standalone EBITDA by 15‐16% even assuming minimum benefits. De‐leveraging to continue after acquiring Aleris Aleris’ acquisition would result in HNDL’s debt increasing by US$ 2.58bn, derailing Hindalco’s de‐leveraging plan in the short term. However, considering stable cash flow, we expect the company to generate enough cash to pay‐off c.Rs 100bn of other debts, meaning only a Rs 75bn increase in net debt by FY21, with additional EBITDA of US$ 340mn. Outlook and valuation HNDL’s fully integrated domestic operations, paired with highly stable overseas operations, provide comfort about its ability to generate enough cash flow to reduce debt and continue its growth momentum. Though increase in debt due to the Aleris acquisition and uncertainty because of the trade war remains a near‐term overhang, we do not expect this problem to spiral to unmanageable levels. We are valuing the company on an SOTP basis to arrive at a fair value of Rs 260. We re‐initiate coverage with a Buy rating. Key risks • Escalation of trade war may pull down LME and weigh on Novelis’ volumes. • Brexit impact on Novelis; rising aluminium import in India.


1MTH 3MTH 1YRABS 3.4 ‐1.2 ‐7.5REL TO BSE 3.4 ‐5.5 ‐18.7 PRICE VS. SENSEX

Source: PhillipCapital India Research KEY FINANCIALS Rs bn FY19 FY20E FY21ENet Sales 1,305 1,226 1,250EBIDTA 155 141 148Net Profit 55 46 51EPS, Rs 24.7 20.6 23.0PER, x 9.2 9.2 8.3EV/EBIDTA, x 5.8 5.7 5.1P/BV, x 0.9 0.7 0.6ROE, % 9.6 7.4 7.7Debt/Equity (%) 91.3 78.4 66.9


0

50

100

150

200

250

300

350


Hindlaco BSE Sensex


HINDALCO INITIATING COVERAGE

Moving away from cyclicality through value addition and focus on conversion biz Over the years, Hindalco has created a business model that is less dependent on LME prices and more on product mix and volumes. Currently, Novelis and its copper business (the conversion businesses) – contribute to c.64% of Hindalco’s total EBITDA, which is largely insulated from LME fluctuations. Hindalco continues to invest in businesses that will insulate it even more from market fluctuations – such as Aleris and the ones that provides value addition. If we include Aleris, its total conversion business’ EBITDA will rise to 75‐76%. In its domestic business, Hindalco is focusing on value addition to partially cushion the impact of realisations, which would also ensure that the company has steady cash flows to meet capex and debt repayment obligations. Aleris’ contribution will insulate Hindalco from LME dependence even more

Source: Company, PhillipCapital India Research Acquired Aleris – a strategic fit that will facilitate the next leg of growth On July 2018, Hindalco announced that it is acquiring a 100% stake in Aleris through Novelis at an EV of US$ 2.58bn (taking over US$ 1.8bn debt and c.US$ 775mn equity); it is expected to be complete in the next 6‐9 months. Novelis is also likely to pay an additional US$ 50mn, contingent on Aleris’ North America unit achieving business‐plan milestones, and US$ 150mn as ‘break fee’ if the deal doesn’t go through. Aleris’ acquisition is a strategic fit for Hindalco and would straight away increase its overall rolling capacity by c.30% whereas a greenfield project would have taken more than three years. HNDL will be able to increase its market share to over 50% in the high‐yielding automotive segment with further enhancement of product mix due to the addition of aerospace and building and construction (high‐margin businesses). Expected change in product mix after Aleris’ acquisition


0%

20%

40%

60%

80%

100%

FY17 FY18 FY19 FY20 FY20 Post Aleris

63%

20%

17%

47%

22%

19%

4%8%

Can

Auto

Specialities

Aero

B&C



Prima facie valuation looks expensive…but is it really? At an EV of US$ 2.58bn, the CY18 EV/EBITDA for Aleris stands at 9.4x. Management indicated that the company has the potential to increase its EBITDA to US$ 360mn, primarily on incremental volumes (its North America automotive body sheet facility was commissioned in 2018) which pegged the value at 7.2x potential EV/EBITDA. However, this does not include Aleris’ potential growth in aerospace and synergy benefits with Novelis. The combined entity (Novelis + Aleris) would be buying c.4.2mn tonnes of aluminium annually, representing 6‐7% of global primarily aluminium production, providing it with good bargaining power. Moreover, it would hold over 50% of the global automotive market share in terms of aluminium supply, giving it some pricing power. If we peg US$ 50mn on synergy benefits, this would reduce the EV to a reasonable level of 6.5x to potential FY21 EBITDA. EBITDA/tonne for Aleris to improve at a better rate

Source: Company, PhillipCapital India Research Novelis to maintain steady EBITDA of US$ 400/t Novelis has already achieved an adjusted EBITDA of over US$ 1.3bn and is operating at close to optimum utilization levels. We see a 2% fall in volumes in FY20 because of weak demand, which we believe will bounce back in FY21. The company has announced a c.300KT automotive capacity addition (200KT in Kentucky and 100KT in China; both to commission by FY21). As Novelis is a pass‐through business model, its profitability is now a function of volumes and product mix. Weaker demand for the automotive segment, and the possibility of stagnant volumes because of the global trade war, may have a bearing on Novelis’ financials, partially negated by higher use of scrap (55‐57%). The company has maximum exposure in North America (c.40% of EBITDA) where market conditions for aluminium remain favourable. All said, we believe that it will report stable performance ahead. Volumes and automotive sales trend

Expect automotive sales to be lower in FY20 and recover in FY21

Regional sales mix

North America continues to dominate, followed by Latin America Source: Company, PhillipCapital India Research

150

200

250

300

350

400

450


US$/ton

ne

Novelis Aleris

10%

12%

14%

16%

18%

20%

22%

320

340

360

380

400

420


EBITDA/tonne ‐ US$ Automotive Share ‐ RHS

0%

20%

40%

60%

80%

100%

120%


North America Europe Asia South America



Aluminium hedges to partially cushion LME fall As a policy, Hindalco continues to hedge some part of its aluminium sales volumes to normalise price fluctuations. The current INR rate of hedging stands at Rs 152,400/tonne (c.US$ 2,180 vs. market price of US$ 1,800/t) for roughly 11% of total volumes; c.4% is hedged at US$ 2,421/t for FY20. Therefore, Hindalco stands to gain partially due to the recent sharp fall in LME due to the US‐China trade war. Expect CoP (ex‐alumina) to come down 10% yoy Cost of production jumped significantly in FY19 due to higher alumina and coal costs (coal shortage in India led to higher prices at e‐auctions and lower linkage delivery). Current cost of linkage coal is around Rs 850‐900/mn Kcal while e‐auction coal costs around Rs 1,300‐1,400/mn Kcal. Captive coal cost is c.Rs 1,300‐1,400/mn Kcal. At the same time, anode and caustic soda costs have also come off meaningfully (current prices are 10‐11% lower than the FY19 average). During FY19, Hindalco added more coal linkage, which means more cost savings. Currently, out of a total requirement of 16mn tpa requirement, Hindalco has linkage for 12mn tpa (73‐75% receiving), c.4mn is captive (3mn tpa operational now), and the remaining 3.5‐4.0mn it buys from e‐auctions. We expect overall CoP (ex‐alumina) to come down by c.10% in FY20, thus cushioning the fall in realisations to a certain extent. Input costs are coming down (USD/t)

Coal linkages are likely to improve

Considering improving linkage‐coal percentage, we expect blended coal cost per tonne to fall c.5% yoy for FY20

Source: Company, PhillipCapital India Research Value addition is a focus area Hindalco is likely to spend Rs 60‐70bn in the next four years to increase its value‐addition sales in aluminium to 75‐80% from current 35%. It has land available in Mahan and Aditya to add 360KT capacity. Its existing capacities are running at optimum utilisations and for now, Hindalco is only willing to add downstream VAP (extrusion and rolled products) due to coal availability issues. Management has indicated that unless they have enough coal‐supply security, Hindalco has no plans to expand the upstream capacities capex, as this requires huge investments. Copper business to remain stable Shutdown of Sterlite Copper had some positive impact on domestic premiums. Copper volumes are expected to peak at 400KT in FY20. However, Hindalco has recently commissioned a 235KT copper rod value‐addition plant, which is likely to reach its optimum utilisation levels by FY20 end. This would help to increase value‐added products, which command c.US$ 200/tonne better premiums than copper cathodes. However, 2018 TC/RC contracts have been settled at c.10% lower yoy, improving value‐addition and higher by‐products credits to offset them. Overall, we see the copper division reporting a stable performance.

40

50

60

70

80

90

100

110

120

200

300

400

500

600

700

800

May‐17

Jul‐1

7

Sep‐17

Nov

‐17

Jan‐18

Mar‐18

May‐18

Jul‐1

8

Sep‐18

Nov

‐18

Jan‐19

Mar‐19

May‐19

Anode Caustic Soda Coal ‐ RHS

0%

20%

40%

60%

80%

100%

FY18 FY19 FY20E FY21E

Linkage Captive mine E‐Auction / imports



De‐leveraging plan to hit a speed‐breaker, but not for too long Current consolidated net debt stands at c.Rs 384bn (including US$ 3.4bn net debt in Novelis). Inclusion of Aleris would increase gross debt by c.Rs 180bn by the end of FY20, deteriorating the D/E ratio. We expect Hindalco to re‐pay existing debt at a run rate of c.Rs 20bn each year, despite its FY20 capex plan of Rs 26bn in its Indian business (value addition and increasing capacity of Utkal Alumina by 500Kt) and US$ 700‐750mn in Novelis (US$ 200‐250mn on sustenance capex and rest on capacity addition in the US). As inclusion of Aleris will strengthen its cash flows, we expect de‐leveraging to continue after this small setback. Capex update Hindalco has lined up c.US$ 2.5bn capex over the next three years, which we believe it will manage from internal cash, considering good cash inflows. Details: • US$ 655mn on expanding Novelis’ rolling capacity to 3.7mn tpa from 3.3mn tpa

over the next three years. • Maintenance capex of US$ 200‐250mn per annum. • In India, US$ 1bn on expanding value‐add capacity in aluminium and copper • US$ 185‐190mn for a 500KT expansion project at Utkal Alumina (India). Planned capex by Novelis Novelis Capacity (KT) Capex (US$) COD Product Changzhou, China 100 180 CY20 Auto Gutherie, Kentucky, USA 200 300 CY21 Auto Pindamonhangaba, Brazil 100KT rolling; 60KT recycling 175 CY21 Can Utkal Alumina plant 500 185 FY22 Alumina

Source: Company, PhillipCapital India Research Major assumptions FY17 FY18 FY19P FY20E FY21ESTANDALONE Tonnes Aluminium 1,233,000 1,253,000 1,274,000 1,274,000 1,276,000 Copper 376,000 394,800 355,320 394,349 394,731 Realisation LME Aluminium 1,690 2,050 2,045 1,800 1,800Copper 5,170 6,400 6,347 6,300 6,400EBITDA/tonne ‐ US$ Aluminium 409 459 326 296 321Copper 578 535 572 590 594Utkal Alumina Volumes (tonnes) 1,500,000 1,500,000 1,500,000 1,500,000 1,500,000 Realisation ‐ US$/t 214 290 430 360 340EBITDA/tonne ‐ US$ 66 120 222 149 129Novelis Volumes (KT) 3,067 3,188 3,274 3,209 3,241Auto Mix 17% 20% 20% 20% 22%Adj EBITDA US$ mn 851 1,146 1,254 1,218 1,313EBITDA/tonne ‐ US$ 354 380 383 380 405ALERIS Volumes (KT) 830 800 873 855 900EBITDA/tonne ‐ US$ 247 251 316 340 370 *We have not consolidated Aleris in our numbers yet Source: Company, PhillipCapital India Research Estimates



SOTP target price Rs mn EBITDA MultipleStandalone 43,698 6.0 262,187Novelis 90,598 6.5 588,887Utkal 13,364 5.0 66,821Total EV 917,895Net Debt/ (cash) 329,956Equity holders 587,939

Target Price 264




Financials Consolidated Income Statement Y/E Mar, Rs bn FY18 FY19 FY20e FY21eNet sales 1,145.5 1,305.4 1,226.5 1,250.4Growth, % 15.0 14.0 ‐6.0 2.0Other income 6.2 0.0 0.0 0.0Total income 1,151.7 1,305.4 1,226.5 1,250.4Raw material expenses ‐688.8 ‐786.9 ‐902.4 ‐913.7Employee expenses ‐86.4 ‐90.4 ‐21.2 ‐23.4Other Operating expenses ‐1,011.7 ‐1,149.5 ‐1,084.7 ‐1,101.8EBITDA (Core) 139.2 155.0 140.8 147.7Growth, % 11.8 11.3 ‐9.1 4.8Margin, % 12.2 11.9 11.5 11.8Depreciation ‐46.1 ‐47.7 ‐48.6 ‐49.6EBIT 93.1 107.3 92.2 98.1Growth, % 16.7 15.2 ‐14.1 6.3Margin, % 8.1 8.2 7.5 7.8Interest paid ‐39.1 ‐37.8 ‐35.9 ‐34.1Other Non‐Operating Income 11.0 11.3 11.0 11.2Non‐recurring Items 0.0 0.0 0.0 0.0Pre‐tax profit 65.1 80.8 67.4 75.1Tax provided ‐20.7 ‐25.9 ‐21.6 ‐24.0Profit after tax 44.3 54.9 45.8 51.1Others (Minorities, Associates) 0.1 0.0 0.0 0.0Net Profit 44.4 55.0 45.8 51.1Growth, % 129.9 23.7 ‐16.6 11.5Net Profit (adjusted) 44.4 55.0 45.8 51.1Unadj. shares (m) 2.2 2.2 2.2 2.2Wtd avg shares (m) 2.2 2.2 2.2 2.2 Balance Sheet Y/E Mar, Rs bn FY18 FY19 FY20e FY21eCash & bank 80.6 97.9 60.1 74.0Marketable securities at cost 39.0 38.6 38.6 38.6Debtors 99.6 114.6 87.4 92.5Inventory 216.3 221.9 208.5 212.6Loans & advances 34.8 36.2 34.0 34.7Other current assets 29.3 30.8 60.5 65.1Total current assets 499.6 539.9 489.0 517.4Investments 69.0 51.8 51.8 51.8Gross fixed assets 1,251.4 1,259.5 1,298.3 1,370.3Less: Depreciation ‐400.0 ‐400.0 ‐448.6 ‐498.2Add: Capital WIP 19.8 39.7 74.7 44.7Net fixed assets 871.3 899.3 924.5 916.9Non‐current assets 30.2 27.2 25.6 26.1Total assets 1,476.6 1,526.3 1,498.9 1,520.2Current liabilities 323.2 337.4 320.4 325.1Provisions 74.5 74.4 65.3 74.4Total current liabilities 397.6 411.8 385.6 399.5Non‐current liabilities 530.3 539.4 497.6 459.4Total liabilities 928.0 951.2 883.3 858.9Paid‐up capital 2.2 2.2 2.2 2.2Reserves & surplus 546.3 572.8 613.3 659.0Shareholders’ equity 548.6 575.1 615.6 661.4Total equity & liabilities 1,476.6 1,526.3 1,498.9 1,520.2 Source: Company, PhillipCapital India Research Estimates

Cash Flow Y/E Mar, Rs bn FY18 FY19 FY20e FY21ePre‐tax profit 65.1 80.8 67.4 75.1Depreciation 46.1 47.7 48.6 49.6Chg in working capital ‐98.6 ‐5.6 ‐13.2 0.6Total tax paid ‐9.6 ‐20.7 ‐21.6 ‐24.0Cash flow from operating activities 3.0 102.2 81.3 101.3Capital expenditure ‐52.6 ‐75.7 ‐73.8 ‐42.0Chg in investments ‐6.7 17.2 0.0 0.0Chg in marketable securities 50.5 0.5 0.0 0.0Cash flow from investing activities ‐8.8 ‐58.0 ‐73.8 ‐42.0Free cash flow ‐5.8 44.2 7.5 59.3Equity raised/(repaid) 21.8 0.0 14.0 14.0Debt raised/(repaid) ‐39.8 1.6 ‐40.0 ‐40.0Dividend (incl. tax) ‐3.2 ‐3.1 ‐5.3 ‐5.3Cash flow from financing activities ‐21.1 ‐1.6 ‐31.3 ‐31.3Net chg in cash ‐26.9 42.6 ‐23.8 28.0 Valuation Ratios

FY18 FY19 FY20e FY21ePer Share data EPS (INR) 19.9 24.7 20.6 23.0Growth, % 129.8 24.0 (16.6) 11.5Book NAV/share (INR) 246.1 258.6 276.8 297.3FDEPS (INR) 19.9 24.7 20.6 23.0CEPS (INR) 40.6 46.1 42.5 45.3CFPS (INR) 36.8 38.0 32.0 40.8DPS (INR) 1.2 1.2 2.0 2.0Return ratios Return on assets (%) 5.7 6.2 5.4 5.6Return on equity (%) 8.1 9.6 7.4 7.7Return on capital employed (%) 7.4 7.9 6.9 7.2Turnover ratios Asset turnover (x) 1.2 1.3 1.2 1.2Sales/Total assets (x) 0.8 0.9 0.8 0.8Sales/Net FA (x) 1.3 1.5 1.3 1.4Working capital/Sales (x) 0.0 0.1 0.1 0.1Fixed capital/Sales (x) 0.7 0.7 0.7 0.7Receivable days 31.7 32.0 26.0 27.0Inventory days 68.9 62.1 62.1 62.1Payable days 73.6 65.7 65.7 65.7Working capital days 18.1 18.5 20.8 23.3Liquidity ratios Current ratio (x) 1.5 1.6 1.5 1.6Quick ratio (x) 0.9 0.9 0.9 0.9Interest cover (x) 2.4 2.8 2.6 2.9Total debt/Equity (%) 94.8 91.3 78.4 66.9Net debt/Equity (%) 80.1 74.3 68.6 55.7Valuation PER (x) 10.8 9.2 9.2 8.3PEG (x) ‐ y‐o‐y growth 0.1 0.3 (0.6) 0.8Price/Book (x) 0.9 0.9 0.7 0.6Yield (%) 0.6 0.5 1.1 1.1EV/Net sales (x) 0.8 0.7 0.7 0.6EV/EBITDA (x) 6.3 5.8 5.7 5.1EV/EBIT (x) 9.4 8.3 8.7 7.7



Hindustan Zinc (HZ IN) Surplus zinc market to take shine away from volume growth INDIA | METALS | INITIATING COVERAGE

26 June 2019

Hindustan Zinc (HZ) was incorporated from the erstwhile Metal Corporation of India on January 10, 1966, as a Public Sector Undertaking. In April 2002, Sterlite Opportunities and Ventures Limited (SOVL) acquired a majority stake in it. Currently, Vedanta holds 64.9% of HZ, the Indian government holds 29.5%, and the public holds the rest. HZ is India’s largest and only integrated Indian player in zinc and the world’s second‐largest zinc‐lead miner with an annual capacity of 1‐mn tonnes (capacity 834KT, lead capacity 201KT). It is expanding to increase its annual capacity to 1.2mn tpa in Phase 1 by FY20 and up to 1.35mn tpa in Phase 2. HZ has a reserve base of c. 106mn tonnes with an average zinc‐lead grade of 10.5% and mineral resources of 306mn tonne. Overall mine life is >25 years. Zinc deficit may erode on increasing mine supply Global zinc supply is expected to outstrip demand on increasing production with new projects (Dugald River Mine, Gamsberg, New Century Resource, and Hellyer Tailings Project). IZLSD expects 2019 zinc deficit to come down to c.121KT (384KT in 2018) and move to a surplus in 2022. China – after it relaxes its environment norms, Australia, and India will contribute to a majority of the increase in refined metal production. A recent sharp jump in spot TC also indicates an easing concentrate market. We expect zinc prices to remain range‐bound with a bias towards a US$ 50‐100/t correction in 2020 as Gamsberg and Duglad river ramp up later in the year. Expect volume CAGR of 10% over FY19‐21 HZ is on track to increase its current mining capacity to 17.7mn tpa by FY20, from 12.1mn tpa currently, entirely from underground mines. It FY19 volumes were disappointing, as integrated metal production fell 7% yoy to 894KT. However, as shaft sinking in its RK and SK mines is almost complete and we see an integrated metal volumes CAGR of 10% over FY19‐21, backed by higher production in Sindesar Khurd (SK) and Rampura Agucha (RA) mines. Silver to boost profitability Silver production capacities will double from current levels on higher recovery from fumers. It has already produced 679 tonnes of silver in FY19, which we expect will see a higher CAGR of 13% over FY19‐20 to 870 tonnes by FY21. The cost of silver production is negligible (by‐product) and every additional tonne adds to EBITDA. We expect silver to contribute c.27‐28% of HZ’s total EBITDA by FY21, up from c.18% in FY18. Dividend yield to remain high at 6‐8% Barring FY18, HZ has been a good dividend‐paying story since FY16. Improving zinc LME prices after 2016 aided significant improvement in cash flows. As the parent company needed incremental cash to pursue the acquisition of Anglo and meet its debt obligations, we firmly believe that dividend pay‐out will remain at elevated levels of at least Rs 15‐20 per share for the next couple of years, implying yields of 6‐8% per annum. Outlook and valuation Zinc markets are gradually moving towards surplus, which, coupled with trade‐war concerns, would put pressure on prices. We expect benefits of higher mined metal volumes and improving silver recovery to counterbalance the impact of falling realisations and strengthening INR. However, current prices seem to factor this in. We initiate coverage on this stock with a Neutral rating and a target of Rs 225 (7.0x FY21, EV/EBITDA), implying 3% downside to current prices.

NEUTRAL CMP RS 231 TARGET RS 225 (‐3%) COMPANY DATA O/S SHARES (MN) : 4225MARKET CAP (RSBN) : 974MARKET CAP (USDBN) : 14.052 ‐ WK HI/LO (RS) : 292 / 226LIQUIDITY 3M (USDMN) : 2.6PAR VALUE (RS) : 2 SHARE HOLDING PATTERN, % Mar 19 Dec 18 Sep 18PROMOTERS : 64.9 64.9 64.9FII / NRI : 31.1 31.1 31.4FI / MF : 2.4 2.4 2.4NON PRO : 0.6 0.6 0.4PUBLIC & OTHERS : 1.0 1.0 0.9 PRICE PERFORMANCE, %


Source: PhillipCapital India Research KEY FINANCIALS Rs mn FY19 FY20E FY21ENet Sales 211,180 217,413 232,435EBIDTA 106,712 105,105 112,656Net Profit 79,572 70,822 75,378EPS, Rs 18.8 16.8 17.8PER, x 12.1 13.7 12.9EV/EBIDTA, x 7.4 7.7 7.2P/BV, x 2.9 2.9 2.9ROE, % 23.7 21.2 22.5Debt/Equity (%) 7.6 ‐ ‐


50

70

90

110

130

150

170

190

Apr‐16 Apr‐17 Apr‐18 Apr‐19Hind. Zinc BSE Sensex


HINDUSTAN ZINC INITIATING COVERAGE

Expansion plans to increase metal capacity by 35% in next 3‐4 years HZ is increasing its mining and smelting capacities by c.48% and 35% in two phases. Under phase 1, HZ will increase its current mining capacity to 17.7mn tpa by FY20 from underground mines from c.13mn tpa presently and smelting capacity to +1 mn. It is also doubling its silver production. Overall capex is expected to be US$ 350‐400mn for each of the next two years. HZ also announced Phase 2, which will run concurrently with Phase 1. Under this, it plans to increase its ore capacity to 20.4mn tonnes. Rampura Agucha, Sindesar Khurd, and Rajpura Dariba mines capacities would increase by 0.5mn tpa each; Zawar mine by 1.2mn tpa in the next three years. It will also be increasing its smelting capacity to 1.35mn tonnes. Mine expansion (mn tonnes)

SK Mine is likely to become the most important, with maximum volumes and high percentage of silver production

Smelter expansion (000 tonnes)

Smelting capacity to increase to c.1.2mn tonnes

Source: Company, PhillipCapital India Research Estimates Major volume growth to be visible from FY20 HZ disappointed us in terms of volumes in FY19, as integrated metal production fell 7% yoy to 894KT. However, shaft‐sinking in RK and SK mines is almost complete and we expect it to report integrated metals volume CAGR of 10% over FY19‐21 backed by higher production in these mines. Incremental smelting capacity is likely to come in Dariba (Rajasthan) where the company is increasing its capacity to 450KT from 340KT. Volumes growth


0

5

10

15

20

25

FY18 FY20E FY21E

Kayad

Rajpur Dariba

Zawar

SK

RA 620 648 648

320 334450

88 9292

0

200

400

600

800

1000

1200

1400

Current Phase I Phase II

Chanderiya Dariba Debari

1,0281,190

1,074

0

200

400

600

800

1,000

0

200

400

600

800

1,000

1,200


Tonn

es

000 tonn

es

Zinc Lead Silver ‐ RHS



Silver to boost profitability Silver production capacity will double from current levels. In the first leg (on‐going 17.4mn tpa plan) capabilities would be enhanced to 1,000 tonnes where more than half will come from higher SK output (Sindesar Khurd Mine in Rajasthan) and enhanced recovery, as the company is installing 3 fumers with a potential for recovering 100+ tonnes of silver each. In the next leg (20.4mn tpa mining), silver capacities would increase to 1,500 tonnes. HZ’s 679 tonnes of silver production in FY19 will see 13% CAGR over FY19‐20 to 870 tonnes by FY21. The cost of silver production is negligible (by product) and every additional tonne adds to EBITDA. We expect silver to contribute to c.28% of total EBITDA from FY21, up from around 18% in FY18. Silver contribution is increasing steadily

Source: Company, PhillipCapital India Research Estimates As production rises, cost of production will fall FY19 CoP (ex‐royalty) came in higher than management expectations at US$ 1,008/t (management expected US$ 950‐975/t at the beginning of FY19), primarily because of lower yoy production and higher costs such as increasing coal and diesel cost and higher overburden in underground mining (complete transition to underground mining). SK and RA (Rampura Agucha in Rajasthan) mines shafts will start commercial production in the next 3‐4 months, aiding volume growth. The management has guided CoP of less than US$ 1,000/t for FY20. We expect US$ 40/t lower CoP in FY20 aided by higher production and lower energy prices. Production and CoP trend


10%

12%

14%

16%

18%

20%

22%

24%

26%

28%

30%

50

60

70

80

90

100

110

120

130


EBITDA ‐ Rs bn Silver contribution (%) ‐ RHS

733 670 638 544 426

223

137 210 249 345 481 724

936 1,100

‐

200

400

600

800

1,000

1,200

(150)

50

250

450

650

850

1,050

1,250

FY13 FY14 FY15 FY16 FY17 FY18 FY19 FY21E

US$/t

In 000

tonn

es

Open cast Underground CoP (RHS)



Dividend yield to remain high Barring FY18, HZ has been a good dividend‐paying story since FY16. Improving zinc LME prices after 2016 aided significant improvement in cash flows. Given that the parent company Vedanta Resources needed incremental cash to pursue the acquisition of Anglo and meet its debt obligations and still needs cash to meet its obligation, we firmly believe that dividend pay‐out will remain at elevated levels. HZ has already paid dividend of Rs 20/share in FY19. For FY20‐21, we expect payout at a healthy Rs 15‐20/share, implying 6% yields at the lower end. Dividend pay‐out and yield to remain high

Source: Company, PhillipCapital India Research Estimates Capex and cash position HZ has been spending US$ 300‐350 for each year on expansions (including capex for the newly announced expansion). We expect FY20 capex to increase to c.US$ 400mn levels, as HZ would spend a majority of its 1.35mn tpa expansion capex in FY20‐21. Its net‐cash position as of FY19 end was c.Rs 170bn. This is likely to see a marginal fall (4%) considering Rs 15 per share dividend in FY20. Major assumptions FY18 FY19 FY20E FY21EVolumes ‐ tonnes Zinc 791,461 694,000 763,400 839,740 Lead 168,246 198,000 219,780 246,154Silver 594 676 770 870 LME ‐ US$ Zinc 3,040 2,720 2,550 2,450 Lead 2,385 2,136 1,900 1,800 INR 65.0 70.0 69.0 69.0

Source: Company, PhillipCapital India Research Estimates The target price’s sensitivity to change in LME prices FY18 FY19 FY20E FY21EZinc (US$/t) 2,550 2,400 2,300 2,200 Lead (US$/t) 1,900 1,800 1,700 1,600 EBITDA (Rs mn) 112,656 107,654 100,830 94,006 Target Price (Rs) 225 218 204 191


0%

2%

4%

6%

8%

10%

12%

‐

5

10

15

20

25

30

35


Dividend/share (Rs) Yeild (%) ‐RHS



Financials

Consolidated Income Statement Y/E Mar, Rs mn FY18 FY19 FY20e FY21eNet sales 220,840 211,180 217,413 232,435Growth, % 28 ‐4 3 7Total income 220,840 211,180 217,413 232,435Raw material expenses ‐4,980 640 0 0Employee expenses ‐7,760 ‐9,050 ‐9,955 ‐10,951Other Operating expenses ‐85,383 ‐96,058 ‐102,353 ‐108,828EBITDA (Core) 122,717 106,712 105,105 112,656Growth, % 26.0 (13.0) (1.5) 7.2Margin, % 55.6 50.5 48.3 48.5Depreciation ‐14,830 ‐18,830 ‐22,779 ‐21,332EBIT 107,887 87,882 82,326 91,324Growth, % 36.1 (18.5) (6.3) 10.9Margin, % 48.9 41.6 37.9 39.3Interest paid ‐2,830 ‐1,130 0 0Other Income 17,510 17,820 16,038 16,359Pre‐tax profit 122,567 104,572 98,364 107,683Tax provided ‐32,210 ‐25,000 ‐27,542 ‐32,305Profit after tax 90,357 79,572 70,822 75,378Net Profit 90,357 79,572 70,822 75,378Growth, % 8.7 (11.9) (11.0) 6.4Net Profit (adjusted) 90,357 79,572 70,822 75,378Unadj. shares (m) 4,225 4,225 4,225 4,225Wtd avg shares (m) 4,225 4,225 4,225 4,225 Balance Sheet Y/E Mar, Rs mn FY18 FY19 FY20e FY21eCash & bank 19,640 230 ‐2,100 ‐2,112Marketable securities at cost 202,220 194,880 164,880 164,880Debtors 1,840 1,960 2,018 2,157Inventory 13,790 15,440 15,896 16,994Loans & advances 120 70 72 77Other current assets 3,820 3,140 3,297 3,462Total current assets 241,430 215,720 184,063 185,458Gross fixed assets 206,570 260,170 273,694 290,964Less: Depreciation ‐93,550 ‐112,380 ‐134,559 ‐155,891Add: Capital WIP 32,200 22,540 34,540 42,540Net fixed assets 145,220 170,330 173,675 177,613Non‐current assets 20,590 19,270 19,511 20,091Total assets 429,320 424,580 394,583 398,763

Current liabilities 28,250 62,690 34,160 36,432Provisions 2,200 2,190 2,234 2,278Total current liabilities 30,450 64,880 36,393 38,710Non‐current liabilities 39,550 23,650 24,833 24,833Total liabilities 70,000 88,530 61,226 63,543Paid‐up capital 8,450 8,450 8,450 8,450Reserves & surplus 350,870 327,600 324,907 326,770Shareholders’ equity 359,320 336,050 333,357 335,220Total equity & liabilities 429,320 424,580 394,583 398,763


Cash Flow Y/E Mar, Rs mn FY18 FY19 FY20e FY21ePre‐tax profit 122,567 104,572 98,364 107,683Depreciation 14,830 18,830 22,779 21,332Chg in working capital ‐141,860 18,810 ‐28,218 329Total tax paid ‐26,810 ‐22,180 ‐25,616 ‐30,572Other operating activities 1,617 ‐3,977 ‐5,469 ‐6,969Cash flow from operating activities ‐29,656 116,055 61,840 91,803Capital expenditure ‐29,410 ‐43,940 ‐26,124 ‐25,270Chg in marketable securities 35,610 7,340 30,000 0Cash flow from investing activities 6,200 ‐36,600 3,876 ‐25,270Free cash flow ‐23,456 79,455 65,716 66,533Equity raised/(repaid) ‐820 0 5,469 6,969Dividend (incl. tax) ‐39,884 ‐98,865 ‐73,515 ‐73,515Cash flow from financing activities ‐40,704 ‐98,865 ‐68,046 ‐66,546Net chg in cash ‐64,160 ‐19,410 ‐2,330 ‐13 Valuation Ratios

FY18 FY19 FY20e FY21ePer Share dataEPS (INR) 21.4 18.8 16.8 17.8Growth, % 8.7 (11.9) (11.0) 6.4Book NAV/share (INR) 85.0 79.5 78.9 79.3FDEPS (INR) 21.4 18.8 16.8 17.8CEPS (INR) 24.9 23.3 22.2 22.9CFPS (INR) 8.9 17.9 18.2 19.6DPS (INR) 8.0 20.0 15.0 15.0Return ratiosReturn on assets (%) 19.7 18.9 17.3 19.0Return on equity (%) 25.1 23.7 21.2 22.5Return on capital employed (%) 23.2 21.2 19.6 20.9Turnover ratiosAsset turnover (x) 3.6 1.9 1.6 1.7Sales/Total assets (x) 0.5 0.5 0.5 0.6Sales/Net FA (x) 1.6 1.3 1.3 1.3Working capital/Sales (x) (0.0) (0.2) (0.1) (0.1)Fixed capital/Sales (x) 0.5 0.7 0.6 0.6Receivable days 3.0 3.4 3.4 3.4Inventory days 22.8 26.7 26.7 26.7Payable days 35.2 41.0 41.0 41.0Working capital days (Ex‐Cash) (14.3) (72.7) (21.6) (21.6)Liquidity ratios Current ratio (x) 8.5 3.4 5.4 5.1Quick ratio (x) 8.1 3.2 4.9 4.6Interest cover (x) 38.1 77.8Total debt/Equity (%) ‐ 7.6 ‐ ‐Net debt/Equity (%) (61.7) (50.5) (48.8) (48.6)Valuation PER (x) 14.1 12.1 13.7 12.9PEG (x) ‐ y‐o‐y growth 1.2 (1.0) (1.3) 2.0Price/Book (x) 3.5 2.9 2.9 2.9Yield (%) 2.7 8.8 6.6 6.5EV/Net sales (x) 4.7 3.8 3.7 3.5EV/EBITDA (x) 8.5 7.4 7.7 7.2EV/EBIT (x) 9.7 9.0 9.8 8.9



Vedanta Ltd (VEDL IN) Caught in a trade war INDIA | METALS | INITIATING COVERAGE

26 June 2019

Vedanta, earlier known as Sesa Sterlite/Sesa Goa, was established in 1954. It is a diversified natural resources company with business interests in oil & gas, zinc, lead, silver, copper, iron ore, aluminium, and commercial power. It is the Indian subsidiary of Vedanta Resources Plc (50.14%), a UK‐based company controlled by the Anil Agarwal family. From humble beginnings of a small aluminium and conductor business in Patna, VEDL incorporated Sesa Goa and started iron‐ore mining as its core business. The big leap came when it purchased a majority stake in Hindustan Zinc and Balco under the government’s disinvestment plan in 2001. In 2011, its parent acquired a majority stake in Cairn India (making inroads into oil & gas), which was later merged into VEDL. Currently, VEDL’s zinc business contributes 48% EBITDA, oil & gas 32%, and aluminium 8%. In 2018, it forayed into steel manufacturing by acquiring Electrosteel Steels under the IBC process (bankruptcy). Zinc to remain a crown jewel; contributes half of the group’s EBITDA VEDL’s zinc business will continue to contribute a majority of its profits, despite weak pricing outlook, as it is set to report a combined volume growth (domestic and international) of 22% in FY20, aided by a 10% increase in the India business and c.90% increase in the international one, fuelled by the Gamsberg project (zinc mine in South Africa). We see its zinc business EBITDA contributing to c.51% of the group’s EBITDA for the next couple of years. Oil and gas business is stable; expect some upside potential Vedanta began investing aggressively in the oil and gas sector (gross capex plan of US$ 2bn in the next couple of years on 7‐8 key developments and exploration projects) to enhance its production by over 50%. Though the management’s production guidance is 270‐300KT by FY21, we are building in a more conservative estimate of 220KT, considering the tricky nature of this business. However, this means our EBITDA estimate has upside potential. Pure commodity play; 10% fall in realisation can impact 20% EBITDA Vedanta is a primary producer of zinc, oil and gas, aluminium, and steel, and derives c.95% of its EBITDA from these businesses. Therefore, its earnings are highly dependent on commodity market swings. Current prices of crude is 11% lower than its FY19 average, zinc 6%, lead 11%, and aluminium is 14% lower. However, its fall in realizations will largely be compensated by higher volumes, as zinc volumes rise significantly after Gemsberg starts, and on lower CoP. Dividend yield at 9% Considering its parent company Volcan’s cash requirement of US$ 350‐400mn annually, we expect Vedanta to recommend at least Rs 15 per share dividend for the next couple of years, translating into 9% yield at CMP. Outlook and valuation We expect EBITDA to remain flattish as fall in realisations will be compensated by lower CoP and higher volumes. The parent company’s cash obligations will force Vedanta to continue its high dividend payout for the next couple of years, while net debt will increase marginally. We are valuing the company on an SOTP basis to arrive at a target of Rs 205. Initiate coverage with a Buy rating. Key risks • Further escalation of the trade war may pull down volumes. • Delays in volume ramp up of zinc and oil and gas business.


1MTH 3MTH 1YRABS 4.0 1.2 ‐26.0REL TO BSE 4.0 ‐3.1 ‐37.2 PRICE VS. SENSEX



050

100150200250300350400450


Vedanta BSE Sensex


VEDANTA INITIATING COVERAGE

Most impacted due to trade war as Vedanta is a pure commodity play Vedanta is a primary producer of zinc, oil and gas, aluminium, and steel, and derives c.95% of EBITDA from these businesses; so its earnings are highly dependent on the swing in commodity prices. Most of these base‐metal prices are in a downtrend due to global growth‐related concerns amid an escalating US‐China trade war. As of 24th July, zinc, lead, aluminium and crude prices are down about 18‐21% yoy. Given the ongoing uncertainty, the market remains a bit jittery. We do not expect any significant revival in commodity prices in the near term unless the US and China come to some trade‐practice agreement. For now, the zinc market is likely to be in surplus and oil prices are at risk due to a subdued global growth forecast. What does a 10% swing in commodity prices do to Vedanta’s EBITDA Commodity FY19 Avg. Price (US$ mn) % of Consol EBITDAZinc (US$/t) 2,743 196 6%Lead (US$/t) 2,121 42 1%Silver (US$/oz) 15.4 35 1%Oil (US$/bbl) 70 119 4%Aluminium (US$/t) 2,035 291 9%

Source: Company, PhillipCapital India Research Zinc remains the crown jewel We expect the zinc business to continue contributing to a bulk of VEDL’s profits, despite weak pricing outlook, because the company is set to report a 10% increase in India and c.90% increase in International volumes – fuelled by the Gamsberg project – which translates to a volume growth of 22% in FY20. As mentioned in the Hindustan Zinc section, the India business will increase its mined metal capacity to 1.2mn tonnes by the end of FY20, while the international business has also started to ramp up (Phase 1 of the Gamsberg project) from which VEDL expects 350KT in FY20. Our assumptions are lower than the company’s – at 280KT in FY20 and 350KT in FY21. VEDL has already chalked out a three‐phase plan for the international segment where it sees total capacity increasing to 650KT in the next 5 years with 90% contribution from Gamsberg. We believe that the zinc business EBITDA will remain close to 51% of group EBITDA for the next couple of years. Businesswise EBITDA contribution

We expect the group’s dependence on zinc and oil and gas businesses to continue

Zinc business volumes

Zinc India to continue contributing majority of volumes (76% in FY21)


48% 53% 47% 51% 51%

21%22% 32% 29% 30%

10%11% 9% 8% 8%7%7% 6% 5% 5%6% 2% 6% 8% 7%8% 5%

‐1% ‐1% ‐1%

‐20%

0%

20%

40%

60%

80%

100%


Zinc Oil & gas Aluminium Power Iron + steel Copper

‐

200

400

600

800

1,000

1,200

1,400

1,600


In `0

00 to

nnes

Zinc India Zinc International



Aggressive capex in oil and gas; plans to hike capacity by 50% After a dull 2‐3 years, Vedanta has begun investing aggressively in oil and gas from FY19 at US$ 500, 45% of the group’s capex. It has a gross capex plan of US$ 2bn for the next couple of years on 7‐8 key development and exploration projects, to enhance its production by over 50%. VEDL has already awarded contracts to the tune of US$ 1bn on growth projects. Most of these capex decisions were taken after estimating an IRR of 20% at US$ 40 brent crude. Considering current crude prices of US$ 61, Vedanta has a huge cushion/upside? available. The management expects to take the total oil and gas capacity to 270KT‐300Kt boepd by FY21. But given past delays, and the tricky nature of the basin, we are not building in any major jump in volumes for the next couple of years. We have assumed FY20/21 production at 201/221KT/ (considering FY19 exit rate was 200KT) and so our oil & gas business EBITDA has upside potential vs. our estimates. Oil and gas projects Key Projects mmboe Capex (US$ mn) Status RGD 86 440 Phase I of 45 mmscfd completed Mangala Infil 4 40 Drilling of 15 infill wells completed Liquid Handling 12 120 Bhagyam EoR 25 100 Aishwariya EoR 15 60 Aishwariya Barmer Hill 32 195

Source: Company, PhillipCapital India Research Oil and gas production target

Vedanta is targeting 40‐50% growth in oil and gas production over the next couple of years

Target oil and gas mix

Source: Company, PhillipCapital India Research Estimates Aluminium performance to remain lacklustre Vedanta’s aluminium production CAGR of 27% over FY16‐19 was aided by Jharsuguda‐2’s ramp up. However, all lines except one have now been ramped up and it has already achieved capacity utilization of c.85%. Its ability to increase production from here onwards – to 100% – is restricted by availability of raw material, even though the situation has been improving. Therefore, management has given flat guidance for FY20. Despite perceived deficit in 2019, aluminium prices continue to fall because of the ongoing trade war and are currently hovering at c.US$ 1,750/t, which is c.14% lower than the FY19 average. We believe that prices have bottomed out and should improve a bit ahead, so we are building FY20 average prices of US$ 1,800/t.

‐

50

100

150

200

250

300

FY18 FY19 FY20E Target

Rajasthan Ravva Camby

189

270‐300

201

Oil, 84%

Gas, 16%



CoP should fall c.9% yoy on improving local bauxite availability. We expect VEDL to source 33% of its requirement from Odisha Mining Corporation Ltd (OMCL). It currently gets c.3mn tonnes, which we believe will increase by 1mn tonnes. This will lead to saving of US$ 300/t of aluminium production. For coal, VEDL has secured 72% of its requirement and is looking to increase this to 90% by the end of FY20 through more linkage auctions. Alumina and energy costs have also been falling continuously. Production trend (in 000 tonnes)

Expect stagnation in production

EBITDA and CoP trend

CoP to fall c.9% on yoy basis

Source: Company, PhillipCapital India Research Estimates Looking to expand its ferrous business The iron‐ore mining business suffered a series of regulatory problems, which led to a significant fall in shipments and earnings over the last 4‐5 years. However, last year Vedanta acquired a steel business under the IBC process (1.5mn tpa expandable to 2.5mn tpa) and managed to ramp it to optimum levels within 6 months. It will now increase the balance 1mn tpa capacity by FY21 end, at a capex of US$ 300mn, to take the total capacity to 2.5mn tonnes. VEDL is also looking at developing its Jharkhand iron‐ore mine to improve the backward integration of its steel plant there, for which it has big plans. It is looking at feasible studies to expand this plant to 5‐7mn tonnes eventually. The ferrous business (steel + iron ore) contributed to 7‐8% of VEDL’s consolidated EBITDA in FY19 from just 2% in FY18. Copper to remain shut; power to be stable We continue to build an annual EBITDA‐level loss for the copper business at Rs 2.5bn. Regulatory hurdles would not allow VEDL to re‐start production easily, despite some favourable developments in court cases. We see its power business remaining stable with almost the entire contribution coming from Talwandi Sabo (expect the last 600MW SEL unit to get transferred to VAL as CPP). Copper and power are expected to contribute ‐1% and 5% of total EBITDA. INR appreciation hurt earnings; expect things to stabilise Commodity prices are pegged to international prices, which are always in USD per tonne. On the other hand, given its integrated operations, Vedanta has many costs that are pegged to INR. Therefore, USDINR fluctuations have a direct impact on its earnings. As per the management’s guidance, for every 1 US dollar change, EBITDA can move by Rs 6bn (roughly 2.5% of FY19 EBITDA). Given that the USDINR has appreciated from 73‐74 to currently close to 69‐70, it has led to an implied EBITDA loss of US$ 30‐32mn. We have built in USDINR at 69 for FY20 and FY21.

‐

500

1,000

1,500

2,000

2,500

‐

500

1,000

1,500

2,000

2,500


VAL Balco Alumina ‐ RHS

0

500

1000

1500

2000

2500

‐

50

100

150

200

250

300


EBITDA (US$/t) CoP (US$/t) ‐RHS



Segmental contribution for every 1 dollar change to EBITDA

Note: Every one dollar change leads to the EBITDA increasing or decreasing by Rs 6bn. This is a segmental breakup

of that amount.

Source: Company, PhillipCapital India Research Dividend yield to remain high (c.9%) Volcan, the trust controlled by Anil Agarwal and family, controls VEDL’s parent company. In the last 2‐3 years, Volcan has acquired c.19% stake in Anglo America and also taken Vedanta Resources (a London‐listed parent company) private for a cash outgo of US$ 1bn, leading to a huge debt pile and subsequent requirement of cash to service the interest outgo. We reckon Volcan needs US$ 350‐400mn each year to service debt, which was partially funded in the form of rich dividends from Vedanta. Minority shareholders sharply objected to its last attempt at taking out US$ 500mn as investment from Cairn and the company subsequent clarified that it has no plans for a similar transaction in the future. So we expect Vedanta to continue paying good dividends – to the tune of Rs 15 at least – which translates into to US$ 400mn cash to Volcan considering 50.1% stake, aided by HZ dividend, which fulfils 60‐70% of the dividend requirements. Dividend yield expected to be 9% at CMP


Zinc , 36%

Oil, 19%

Aluminium, 44%

Others, 1%

0%

2%

4%

6%

8%

10%

10

12

14

16

18

20

22


Dividend Yeild ‐RHS



Deleveraging derailed; debt/EBITDA to remain stable Vedanta has lined up a capex programme of US$ 1.2bn in FY20, with an optional capex of another US$ 200mn. We also understand that the parent company will need US$ 400mn in cash annually. So the overall net debt will rise by Rs 20‐24bn in FY20 before falling by Rs 10bn in FY21. We do not expect Vedanta to significantly de‐leverage from current levels in the next couple of years. As a result, its net‐debt to EBITDA would erode by 10‐20bps but still remain at comfortable levels. Net debt (Rs bn)

Net debt to remain at elevated levels

Capex (Rs bn)

Expect next 2 years to be capex heavy led by oil/gas segmentSource: Company, PhillipCapital India Research Estimates SOTP target price Rs mn FY21 EBITDA Multiple EV Stake (%) Attributable EV Per shareHindustan Zinc 112,656 7.0 788,593 64.9 511,797 110*Zinc International 16,905 6.0 101,430 100 101,430 27Copper business (2,484) 5.0 (12,422) 100 (12,422) (3)Cairn India 75,114 5.5 375,568 100 375,568 110Aluminium 20,200 5.0 100,999 51 51,509 14Iron ore 6,517 5.0 32,587 100 32,587 9Steel 12,000 5.0 60,000 100 60,000 16Power 11,846 5.0 59,229 100 59,229 15Gross value 298Net Debt (FY18) ‐ Attributable 345,139 (93)SOTP Target Price 205

Source: PhillipCapital India Research Estimates *After 20% holding discount

0.5

1.0

1.2 1.3

1.2

‐

0.2

0.4

0.6

0.8

1.0

1.2

1.4

0

50

100

150

200

250

300

350


Net Debt (Rs bn) Debt/EBITDA (x)‐ RHS

‐

0.2

0.4

0.6

0.8

1.0

1.2

1.4

1.6


Oil & gas Zinc Al & Power Others Optional



Financials Consolidated Income Statement Y/E Mar, Rs mn FY18 FY19 FY20e FY21eNet sales 918,660 920,480 891,333 928,408Growth, % 27.2 0.2 ‐3.2 4.2Total income 918,660 920,480 891,333 928,408Raw material expenses ‐322,520 ‐261,500 ‐271,879 ‐267,254Employee expenses ‐24,960 ‐30,230 ‐22,121 ‐23,998Other Operating expenses ‐319,540 ‐397,720 ‐368,246 ‐391,008EBITDA (Core) 251,640 231,030 229,088 246,148Growth, % 18.0 (8.2) (0.8) 7.4Margin, % 27.4 25.1 25.7 26.5Depreciation ‐62,830 ‐81,920 ‐84,396 ‐86,621EBIT 188,810 149,110 144,692 159,528Growth, % 25.5 (21.0) (3.0) 10.3Margin, % 20.6 16.2 16.2 17.2Other Non‐Operating Income 35,740 40,180 31,231 29,346Pre‐tax profit 166,720 132,400 122,439 136,382Tax provided ‐58,770 ‐38,620 ‐36,732 ‐40,914Profit after tax 107,950 93,780 85,707 95,467Others (Minorities, Associates) ‐33,500 ‐26,330 ‐24,673 ‐26,459Net Profit 74,450 67,450 61,034 69,008Growth, % 5.3 (9.4) (9.5) 13.1Net Profit (adjusted) 74,450 67,450 61,034 69,008Unadj. shares (m) 3,720 3,720 3,720 3,720Wtd avg shares (m) 3,720 3,720 3,720 3,720 Balance Sheet Y/E Mar, Rs mn FY18 FY19 FY20e FY21eCash & bank 52,160 83,690 103,194 98,157Marketable securities at cost 285,360 281,740 225,392 225,392Debtors 39,690 39,820 36,630 38,154Inventory 119,670 131,980 122,100 127,179Loans & advances 14,390 26,420 14,652 15,261Other current assets 39,870 34,630 33,533 34,928Total current assets 551,140 598,280 535,502 764,462Investments 1,640 48,910 48,910 48,910Gross fixed assets 1,809,670 1,920,850 1,999,769 2,081,988Less: Depreciation ‐847,730 ‐929,650 ‐1,014,046 ‐1,100,666Add: Capital WIP 161,400 222,360 237,360 252,360Net fixed assets 1,123,340 1,213,560 1,223,084 1,233,682Non‐current assets 120,390 124,930 155,784 160,789Total assets 1,845,850 2,020,430 1,999,767 2,020,763Current liabilities 672,470 766,410 745,856 758,076Provisions 23,610 25,960 27,258 28,621Total current liabilities 696,080 792,370 773,114 786,697Non‐current liabilities 357,040 452,820 451,097 450,082Total liabilities 1,053,120 1,245,190 1,224,211 1,236,779Paid‐up capital 3,720 3,720 3,720 3,720Reserves & surplus 629,400 619,250 614,998 618,721Shareholders’ equity 792,730 775,240 775,556 783,984Total equity & liabilities 1,845,850 2,020,430 1,999,767 2,020,763 Source: Company, PhillipCapital India Research Estimates

Cash Flow Y/E Mar, Rs mn FY18 FY19 FY20e FY21ePre‐tax profit 166,720 132,400 122,439 136,382Depreciation 62,830 81,920 84,396 86,621Chg in working capital ‐252,176 86,320 ‐18,140 6,603Total tax paid ‐11,847 ‐21,370 ‐36,227 ‐40,385Cash flow from operating activities ‐4,544 310,480 195,991 232,745Capital expenditure ‐143,054 ‐172,140 ‐93,919 ‐97,219Chg in investments ‐911 ‐47,270 0 0Chg in marketable securities 183,532 3,620 56,348 0Cash flow from investing activities 39,567 ‐215,790 ‐37,571 ‐97,219Free cash flow 35,022 94,690 158,420 135,526Equity raised/(repaid) 16,406 0 0 0Debt raised/(repaid) ‐34,661 79,320 ‐10,000 ‐10,000Dividend (incl. tax) ‐92,665 ‐108,810 ‐108,810 ‐108,810Cash flow from financing activities ‐124,090 ‐63,160 ‐138,915 ‐140,564Net chg in cash ‐89,068 31,530 19,505 ‐5,038 Valuation Ratios

FY18 FY19 FY20e FY21ePer Share dataEPS (INR) 20.0 18.1 16.4 18.6Growth, % 5.2 (9.4) (9.5) 13.1Book NAV/share (INR) 170.2 167.5 166.3 167.3FDEPS (INR) 20.0 18.1 16.4 18.6CEPS (INR) 36.9 40.2 39.1 41.8CFPS (INR) 13.3 62.7 40.9 44.3DPS (INR) 21.2 25.0 25.0 25.0Return ratiosReturn on assets (%) 5.6 4.9 4.3 4.5Return on equity (%) 11.8 10.8 9.9 11.1Return on capital employed (%) 9.2 7.7 6.8 7.6Turnover ratiosAsset turnover (x) 1.3 1.1 1.1 1.1Sales/Total assets (x) 0.5 0.5 0.4 0.4Sales/Net FA (x) 0.8 0.8 0.7 0.8Working capital/Sales (x) (0.5) (0.6) (0.6) (0.6)Fixed capital/Sales (x) 1.0 1.1 1.1 1.1Receivable days 15.8 15.8 15.0 15.0Inventory days 47.5 52.3 50.0 50.0Payable days 149.2 122.6 122.9 121.1Working capital days (182.3) (211.6) (220.7) (213.3)Liquidity ratios Current ratio (x) 0.8 0.8 0.7 1.0Quick ratio (x) 0.6 0.6 0.6 0.8Interest cover (x) 3.3 2.6 2.7 3.0Total debt/Equity (%) 77.0 92.6 91.6 89.5Net debt/Equity (%) 68.7 79.2 75.0 37.5Valuation PER (x) 8.4 9.3 10.3 9.1PEG (x) ‐ y‐o‐y growth 1.6 (1.0) (1.1) 0.7Price/Book (x) 1.0 1.0 1.0 1.0EV/Net sales (x) 0.8 0.9 1.0 0.7EV/EBITDA (x) 3.1 3.6 3.8 2.6EV/EBIT (x) 4.1 5.6 6.0 4.0



National Aluminium (NACL IN) Profitability dented by volume inertia, lower alumina prices INDIA | METALS | INITIATING COVERAGE

26 June 2019

Incorporated in 1981 under the Ministry of Mines, National Aluminium Company Limited (Nalco) is a fully‐integrated Navratna company engaged in the production of primary aluminium. It has a 6.8mn tpa bauxite mine, 2.1mn tpa (normative capacity) alumina refinery located at Damanjodi in Koraput district of Odisha, and a 460 KT aluminium smelter and 1,200 MW CPP plant at Angul, Odisha. NALCO has bulk shipment facilities at Vizag Port for exporting alumina and aluminium, and importing caustic soda; it also utilises facilities at Kolkata and Paradeep Ports. It has registered sales offices in Delhi, Kolkata, Mumbai, Chennai, and Bangalore, and 10 operating stockyards at various locations in India to facilitate domestic marketing. Surplus alumina market to play spoilsport FY19 was a very good year for alumina as prices jumped significantly to peak at US$ 650/t, due to a short‐term market deficit created by supply disruptions such as hydro production embargo and Rusal sanctions. With most of these problems resolved and Chinese demand slowing, participants are forecasting an alumina market surplus of 200‐1,000KT, which spells trouble for alumina prices that have already corrected c.30% yoy. These prices should normalise in the short term and remain range bound at 18‐19% (US$ 350‐360/t) of aluminium prices, which will be a 24‐25% fall from the FY19 average. Stagnant volumes + lower realisation = Falling profitability Nalco is among the lowest cost alumina producers in the world, because of its access to captive bauxite mines. As it runs its alumina refinery at optimum utilisations, profitability is now largely a function of costs and realisations. We expect average alumina/aluminium realisations for FY20 to fall c.US$ 120/245 per tonne – a c.45% fall in FY20 EBITDA for Nalco. Cash per share to deplete, but dividend yield to remain high After a buyback and dividend of Rs 5.75 per share, Nalco’s cash reserves have depleted to c.Rs 35bn. With falling operating margins and planned capex of over Rs 70bn in the next 3‐5 years, we expect cash per share to deplete further to Rs 23bn in FY20 and Rs 13mn in FY21, partially contributed by continuation of good dividend and incremental capex on alumina refinery. We expect FY20 dividend to remain at c.Rs 5 per share, implying dividend yield of 10% at CMP. Outlook and valuation Surplus alumina and slowing demand growth will weigh on alumina prices in the medium term. As Nalco’s capacities are already running at optimum utilisations, profitability will remain a function of realisations and costs until new capacities come in. Coal availability from Utkal alumina refinery could aid improvement in earnings; as we expect the project to be delayed, we haven’t factored it into our estimates. We are initiating coverage on the stock with a Neutral rating and a target of Rs 56 (5.5x FY21 EV/EBITDA). One can hold the stock only for its dividend‐yield prospects. Key risks • Escalation of trade war may pull the price down further. • Nalco continues to depend on linkage coal for smelting operations, which is prone to

distortions (low quality coal, unavailability).

NEUTRAL CMP RS 50 TARGET RS 56 (+13%) COMPANY DATA O/S SHARES (MN) : 1866MARKET CAP (RSBN) : 92MARKET CAP (USDBN) : 1.352 ‐ WK HI/LO (RS) : 79 / 46LIQUIDITY 3M (USDMN) : 6.1PAR VALUE (RS) : 5 SHARE HOLDING PATTERN, % Mar 19 Dec 18 Sep 18PROMOTERS : 52.0 56.8 56.6FII / NRI : 11.9 11.1 9.0FI / MF : 19.7 18.7 21.1NON PRO : 9.6 1.8 1.8PUBLIC & OTHERS : 6.7 11.7 11.5 PRICE PERFORMANCE, %


Source: PhillipCapital India Research KEY FINANCIALS Rs mn FY19 FY20E FY21ENet Sales 114,993 95,056 94,945EBIDTA 28,925 15,696 16,822Net Profit 17,324 9,178 9,702EPS, Rs 9.3 4.9 5.2PER, x 7.2 10.0 9.4EV/EBIDTA, x 3.1 4.4 4.7P/BV, x 1.2 0.9 0.9ROE, % 16.5 8.9 9.6Debt/Equity (%) 0.6 ‐ ‐


20

60

100

140

180

220

260

Apr‐16 Apr‐17 Apr‐18 Apr‐19Nalco BSE Sensex


NATIONAL ALUMINIUM INITIATING COVERAGE

Surplus alumina market to weigh on prices…. Nalco is among the lowest‐cost alumina producers in the word due to access to captive bauxite mines. Historically, alumina prices were always pegged to aluminium prices and ranged at 17‐19% of aluminium prices. But in 2018, this trend broke, as alumina prices jumped to multi‐year highs (25‐26% of aluminium) on supply disruptions (partial shutdown in Alunorte refinery, strike in Alcoa Australian refinery, and Rusal sanctions). In the last 4‐5 months, most issues are resolved and the market is likely to have a surplus of 200KT‐1,000KT in 2019 from a deficit in 2018. This has begun to reflect in alumina prices, which have corrected to US$ 340‐350/t (down c.25% yoy to c. 19% of aluminium prices) after peaking at US$ 640‐650/t in May 2018. Alumina price trend (US$/t)

Source: Company, PhillipCapital India Research Estimates …which will depress profitability FY19 has been a very rewarding year for the company due to multi‐year higher alumina prices on supply disruptions. However, both alumina and aluminium prices have fallen c.25% and 19% yoy. We expect FY20 average alumina prices at US$ 350/t (19‐20% of aluminium prices), which is c.26% lower than the FY19 average, based on improving supplies and easing demand concerns. We expect FY21 realisations to fall further to US$ 330/t (18% of aluminium prices). We are also building in aluminium LME at US$ 1,800/t for both years, 12% lower than the FY19 average. We believe EBITDA is set to fall c.45% in FY20 due to a significant fall in realisations and moderate fall in power cost. Volumes to remain stagnant Nalco is already running alumina capacity at 100% and aluminium at around 90‐95% utilisation levels. The next growth project – a 1mn tpa alumina refinery – is still 3‐4 years away. Until then, alumina and aluminium volumes are likely to remain more or less flattish and profits would be more a function of realisations and cost management. We expect Nalco to sell around 445‐450KT of aluminium and 1.2‐1.3mn tonnes of alumina each year until the expansion of the refinery is complete. Delays in Utkal D coal block to dampen cost rationalisation GoI allotted Utkal D and E coal blocks to Nalco in FY16. The initial plan was to start production in Utkal D first by 2018‐19. However, the commissioning was delayed due to constraints faced in obtaining MoEF clearance, non‐transfer of railway siding land from Odisha IDCO, and few other statutory approvals. Now, as per revised mining plan submitted by Nalco, production from the Utkal‐D coal mine is likely to start from March 2021. In the first year of operation, coal output is envisaged at 1mn tpa, which will be ramped up to 1.5mn tpa and 2mn tpa in the second and third years. Meanwhile, Nalco is expected to get 0.9mn tpa of coal linkage for three years to

10%

15%

20%

25%

30%

35%

100

200

300

400

500

600

700

Mar‐17

Jun‐17

Sep‐17

Dec‐17

Mar‐18

Jun‐18

Sep‐18

Dec‐18

Mar‐19

Jun‐19

Alumina FoB Australia % of aluminium (RHS)



bridge the gap. Management indicated that once fully operational, captive mines have the potential to save up to US$ 500/t in aluminium cost of production. Expansion and JV projects Nalco has formulated a long‐term corporate plan in which it envisages increasing its alumina and aluminium capacity to 3.3mn tonnes and 1.1mn tonnes respectively by 2024; it plans to add a 1mn tpa alumina refinery and a 600KT aluminium smelter. It also wants to improve its backward integration to CT pitch and caustic soda and forward integration to value‐added products such as wire rods and rolled products like foils. Out of all its projects, Nalco is likely to prioritise the 1mn tpa alumina refinery, backed by Pottangi bauxite mines with a reserve of 70mn tonnes and expected production of 3.2mn tpa of bauxite ore, the Utkal D block, and the caustic soda JV. It is likely to spend Rs 11‐12bn in FY20, majorly on a 1mn‐tpa brownfield alumina plant at Damnajodi (total project capex of Rs 55‐56bn over the next four years). We expect capex to remain at similar levels in FY21 as well. Roadmap of planned projects Projects Capacity Capex Status Utkal D & E c.2 mn tpa each Rs 5.5bn Utkal D would commission first (lease deed executed, R&R plan submitted). Expected to

commission by FY21. Alumina refinery 1mn tpa Rs 55‐56 bn All statutory clearance received and EPCM consultant finalised. Expected to complete by April

2022/23. Pottangi Mine 3.2 mn tpa ‐ MoEF pending. Expected to start by April 2022. Aluminium smelter 600 KT Rs 96bn At nascent stage; subjected to assured coal availability. Caustic Soda JV 270 KT Rs 20bn Nalco to invest Rs 2.4bn for 40% stake (project financed by 70% debt and 30% equity). Had assured

take off agreement of 50KT. Land transferred, equipment ordered. Expected to complete by 2021. Coal tar pitch 20 KT ‐ Signed MoU with MINL; project is at nascent stage.

Source: Company, PhillipCapital India Research Estimates Major assumptions FY17 FY18 FY19P FY20E FY21EVolumes ‐KT

Alumina 1,295 1,337 1,298 1,330 1,391 Aluminium 386 426 441 444 446 Realisation (US$/t) ‐LME Realisation (US$/t) 296 377 475 350 330 Alumina 1,694 2,057 2,045 1,800 1,800 EBITDA (US$/t) Alumina 132 182 319 178 162 Aluminium (17) (63) (11) (22) 40

Source: Company, PhillipCapital India Research Estimates Valuations (Rs mn) FY20E FY21EEBITDA 15,696 16,822 Multiple 5.5 5.5 EV 86,330 92,518 Debt/(Cash) (22,887) (12,720)Eq Holders 109,217 105,239 No of Shares 1,866 1,866 Target price 59 56




Financials

Consolidated Income Statement Y/E Mar, Rs mn FY18 FY19 FY20e FY21eNet sales 95,095 114,993 95,056 94,945Growth, % 26 21 ‐17 0Total income 95,095 114,993 95,056 94,945Raw material expenses ‐15,127 ‐19,146 ‐18,209 ‐17,787Employee expenses ‐22,612 ‐20,723 ‐21,344 ‐21,558Other Operating expenses ‐43,381 ‐46,199 ‐39,807 ‐38,778EBITDA (Core) 13,975 28,925 15,696 16,822Growth, % 29.4 107.0 (45.7) 7.2Margin, % 14.7 25.2 16.5 17.7Depreciation ‐4,804 ‐4,761 ‐4,809 ‐4,857EBIT 9,170 24,164 10,888 11,965Growth, % 53.0 163.5 (54.9) 9.9Margin, % 9.6 21.0 11.5 12.6Interest paid ‐20 ‐24 ‐19 ‐15Other Non‐Operating Income 2,997 3,259 2,933 2,640Pre‐tax profit 12,148 27,399 13,802 14,589Tax provided ‐6,964 ‐10,075 ‐4,624 ‐4,887Profit after tax 5,183 17,324 9,178 9,702Net Profit 5,183 17,324 9,178 9,702Growth, % (26.9) 234.2 (47.0) 5.7Net Profit (adjusted) 5,183 17,324 9,178 9,702Unadj. shares (m) 1,933 1,866 1,866 1,866Wtd avg shares (m) 1,933 1,866 1,866 1,866 Balance Sheet Y/E Mar, Rs mn FY18 FY19 FY20e FY21eCash & bank 27,690 34,964 22,079 11,912Marketable securities at cost 5,930 808 808 808Debtors 2,581 2,405 1,988 1,986Inventory 11,941 12,100 10,002 9,991Loans & advances 2,140 782 647 646Other current assets 5,858 4,948 4,090 4,085Total current assets 56,139 56,007 39,614 29,428Investments 1,308 1,866 1,866 1,866Gross fixed assets 85,916 73,246 79,997 90,748Less: Depreciation ‐13,627 0 ‐4,409 ‐8,865Add: Capital WIP 8,258 8,439 13,439 16,439Net fixed assets 80,547 81,685 89,028 98,322Non‐current assets 8,145 11,916 13,070 14,338Total assets 146,138 151,474 143,578 143,954 Current liabilities 24,409 29,051 22,222 23,098Provisions 4,981 5,988 6,254 6,532Total current liabilities 29,391 35,039 28,476 29,630Non‐current liabilities 11,699 11,585 12,175 12,795Total liabilities 41,090 46,625 40,651 42,426Paid‐up capital 9,665 9,328 9,328 9,328Reserves & surplus 95,384 95,521 93,599 92,200Shareholders’ equity 105,048 104,849 102,927 101,528Total equity & liabilities 146,138 151,474 143,578 143,954


Cash Flow Y/E Mar, Rs mn FY18 FY19 FY20e FY21ePre‐tax profit 12,148 27,399 13,802 14,589Depreciation 4,804 4,761 4,809 4,857Chg in working capital 733 4,255 ‐4,185 ‐67Total tax paid ‐7,906 ‐10,283 ‐4,058 ‐4,294Other operating activities 10,814 ‐17,186 0 0Cash flow from operating activities 20,593 8,946 10,367 15,085Capital expenditure ‐8,246 ‐5,899 ‐12,151 ‐14,151Chg in investments ‐811 ‐558 0 0Chg in marketable securities 6,282 5,122 0 0Cash flow from investing activities ‐2,775 ‐1,336 ‐12,151 ‐14,151Free cash flow 17,818 7,611 ‐1,784 934Equity raised/(repaid) 0 ‐337 0 0Dividend (incl. tax) ‐13,001 ‐12,658 ‐11,100 ‐11,100Cash flow from financing activities ‐13,001 ‐12,995 ‐11,100 ‐11,100Net chg in cash 4,817 ‐5,384 ‐12,885 ‐10,167 Valuation Ratios

FY18 FY19 FY20e FY21ePer Share dataEPS (INR) 2.7 9.3 4.9 5.2Growth, % (26.9) 246.3 (47.0) 5.7Book NAV/share (INR) 54.3 56.2 55.2 54.4FDEPS (INR) 2.7 9.3 4.9 5.2CEPS (INR) 5.2 11.8 7.5 7.8CFPS (INR) 2.1 14.2 5.0 7.4DPS (INR) 5.7 5.8 5.0 5.0Return ratiosReturn on assets (%) 3.6 11.7 6.2 6.8Return on equity (%) 4.9 16.5 8.9 9.6Return on capital employed (%) 4.3 14.2 7.5 8.0Turnover ratiosAsset turnover (x) 1.3 1.5 1.2 1.1Sales/Total assets (x) 0.7 0.8 0.6 0.7Sales/Net FA (x) 1.2 1.4 1.1 1.0Working capital/Sales (x) (0.0) (0.1) (0.1) (0.1)Fixed capital/Sales (x) 0.8 0.6 0.8 0.9Receivable days 9.9 7.6 7.6 7.6Inventory days 45.8 38.4 38.4 38.4Payable days 43.3 54.5 35.9 37.7Working capital days (7.3) (28.0) (21.1) (24.6)Liquidity ratios Current ratio (x) 2.3 1.9 1.8 1.3Quick ratio (x) 1.8 1.5 1.3 0.8Interest cover (x) 470.3 1,015.3 571.8 785.5Total debt/Equity (%) 0.4 0.6 ‐ ‐Net debt/Equity (%) (25.9) (32.7) (21.5) (11.7)Valuation PER (x) 28.5 7.2 10.0 9.4PEG (x) ‐ y‐o‐y growth (0.7) 0.0 (0.2) 1.7Price/Book (x) 1.4 1.2 0.9 0.9Yield (%) 7.5 8.6 10.2 10.2EV/Net sales (x) 1.2 0.8 0.7 0.8EV/EBITDA (x) 8.2 3.1 4.4 4.7EV/EBIT (x) 12.5 3.7 6.3 6.6


METALS SECTOR UPDATE

Stock Price, Price Target and Rating History – Tata Steel

Stock Price, Price Target and Rating History – Jindal Steel & Power

Stock Price, Price Target and Rating History – Steel Authority of India

100

200

300

400

500

600

700

800

M‐16 J‐16 S‐16 N‐16 J‐17 M‐17 M‐17 J‐17 S‐17 O‐17 D‐17 F‐18 A‐18 J‐18 A‐18 O‐18 D‐18 F‐19 A‐19

0

100

200

300

400

J‐16 A‐16 O‐16 D‐16 F‐17 A‐17 J‐17 J‐17 S‐17 N‐17 J‐18 M‐18 M‐18 J‐18 S‐18 N‐18 J‐19 M‐19 M‐19

0

25

50

75

100

125




Stock Price, Price Target and Rating History – JSW Steel

Stock Price, Price Target and Rating History – NMDC

Stock Price, Price Target and Rating History – Hindustan Zinc

50

100

150

200

250

300

350

400

450


0

20

40

60

80

100

120

140

160

180

J‐16 A‐16 O‐16 D‐16 F‐17 A‐17 J‐17 A‐17 O‐17 D‐17 F‐18 A‐18 J‐18 A‐18 O‐18 D‐18 F‐19 A‐19

80100120140160180200220240260280300320340360

M‐16 J‐16 S‐16 N‐16 J‐17 M‐17 M‐17 J‐17 S‐17 N‐17 J‐18 M‐18 M‐18 J‐18 S‐18 N‐18 J‐19 M‐19 M‐19



Stock Price, Price Target and Rating History – National Aluminium

Stock Price, Price Target and Rating History – Vedanta

Stock Price, Price Target and Rating History – Hindalco

0

20

40

60

80

100

120

J‐16 A‐16 O‐16 D‐16 F‐17 A‐17 J‐17 A‐17 S‐17 N‐17 J‐18 M‐18 M‐18 J‐18 S‐18 N‐18 J‐19 M‐19 M‐19

0

50

100

150

200

250

300

350

400

J‐16 S‐16 N‐16 J‐17 M‐17 M‐17 J‐17 S‐17 N‐17 J‐18 M‐18 M‐18 J‐18 S‐18 N‐18 D‐18 M‐19 A‐19

0

50

100

150

200

250

300




Rating Methodology We rate stock on absolute return basis. Our target price for the stocks has an investment horizon of one year. Rating Criteria Definition

BUY >= +15% Target price is equal to or more than 15% of current market price

NEUTRAL ‐15% > to < +15% Target price is less than +15% but more than ‐15%

SELL <= ‐15% Target price is less than or equal to ‐15%.

Disclosures and Disclaimers PhillipCapital (India) Pvt. Ltd. has three independent equity research groups: Institutional Equities, Institutional Equity Derivatives, and Private Client Group. This report has been prepared by Institutional Equities Group. The views and opinions expressed in this document may, may not match, or may be contrary at times with the views, estimates, rating, and target price of the other equity research groups of PhillipCapital (India) Pvt. Ltd.

This report is issued by PhillipCapital (India) Pvt. Ltd., which is regulated by the SEBI. PhillipCapital (India) Pvt. Ltd. is a subsidiary of Phillip (Mauritius) Pvt. Ltd. References to "PCIPL" in this report shall mean PhillipCapital (India) Pvt. Ltd unless otherwise stated. This report is prepared and distributed by PCIPL for information purposes only, and neither the information contained herein, nor any opinion expressed should be construed or deemed to be construed as solicitation or as offering advice for the purposes of the purchase or sale of any security, investment, or derivatives. The information and opinions contained in the report were considered by PCIPL to be valid when published. The report also contains information provided to PCIPL by third parties. The source of such information will usually be disclosed in the report. Whilst PCIPL has taken all reasonable steps to ensure that this information is correct, PCIPL does not offer any warranty as to the accuracy or completeness of such information. Any person placing reliance on the report to undertake trading does so entirely at his or her own risk and PCIPL does not accept any liability as a result. Securities and Derivatives markets may be subject to rapid and unexpected price movements and past performance is not necessarily an indication of future performance.

This report does not regard the specific investment objectives, financial situation, and the particular needs of any specific person who may receive this report. Investors must undertake independent analysis with their own legal, tax, and financial advisors and reach their own conclusions regarding the appropriateness of investing in any securities or investment strategies discussed or recommended in this report and should understand that statements regarding future prospects may not be realised. Under no circumstances can it be used or considered as an offer to sell or as a solicitation of any offer to buy or sell the securities mentioned within it. The information contained in the research reports may have been taken from trade and statistical services and other sources, which PCIL believe is reliable. PhillipCapital (India) Pvt. Ltd. or any of its group/associate/affiliate companies do not guarantee that such information is accurate or complete and it should not be relied upon as such. Any opinions expressed reflect judgments at this date and are subject to change without notice.

Important: These disclosures and disclaimers must be read in conjunction with the research report of which it forms part. Receipt and use of the research report is subject to all aspects of these disclosures and disclaimers. Additional information about the issuers and securities discussed in this research report is available on request.

Certifications: The research analyst(s) who prepared this research report hereby certifies that the views expressed in this research report accurately reflect the research analyst’s personal views about all of the subject issuers and/or securities, that the analyst(s) have no known conflict of interest and no part of the research analyst’s compensation was, is, or will be, directly or indirectly, related to the specific views or recommendations contained in this research report.

Additional Disclosures of Interest: Unless specifically mentioned in Point No. 9 below: 1. The Research Analyst(s), PCIL, or its associates or relatives of the Research Analyst does not have any financial interest in the company(ies) covered in

this report. 2. The Research Analyst, PCIL or its associates or relatives of the Research Analyst affiliates collectively do not hold more than 1% of the securities of the

company (ies)covered in this report as of the end of the month immediately preceding the distribution of the research report. 3. The Research Analyst, his/her associate, his/her relative, and PCIL, do not have any other material conflict of interest at the time of publication of this

research report. 4. The Research Analyst, PCIL, and its associates have not received compensation for investment banking or merchant banking or brokerage services or for

any other products or services from the company(ies) covered in this report, in the past twelve months. 5. The Research Analyst, PCIL or its associates have not managed or co‐managed in the previous twelve months, a private or public offering of securities for

the company (ies) covered in this report. 6. PCIL or its associates have not received compensation or other benefits from the company(ies) covered in this report or from any third party, in

connection with the research report. 7. The Research Analyst has not served as an Officer, Director, or employee of the company (ies) covered in the Research report. 8. The Research Analyst and PCIL has not been engaged in market making activity for the company(ies) covered in the Research report. 9. Details of PCIL, Research Analyst and its associates pertaining to the companies covered in the Research report: Sr. no. Particulars Yes/No

1 Whether compensation has been received from the company(ies) covered in the Research report in the past 12 months for investment banking transaction by PCIL

No

2 Whether Research Analyst, PCIL or its associates or relatives of the Research Analyst affiliates collectively hold more than 1% of the company(ies) covered in the Research report

No

3 Whether compensation has been received by PCIL or its associates from the company(ies) covered in the Research report No4 PCIL or its affiliates have managed or co‐managed in the previous twelve months a private or public offering of securities for the

company(ies) covered in the Research report No

5 Research Analyst, his associate, PCIL or its associates have received compensation for investment banking or merchant banking or brokerage services or for any other products or services from the company(ies) covered in the Research report, in the last twelve months

No



Independence: PhillipCapital (India) Pvt. Ltd. has not had an investment banking relationship with, and has not received any compensation for investment banking services from, the subject issuers in the past twelve (12) months, and PhillipCapital (India) Pvt. Ltd does not anticipate receiving or intend to seek compensation for investment banking services from the subject issuers in the next three (3) months. PhillipCapital (India) Pvt. Ltd is not a market maker in the securities mentioned in this research report, although it, or its affiliates/employees, may have positions in, purchase or sell, or be materially interested in any of the securities covered in the report.

Suitability and Risks: This research report is for informational purposes only and is not tailored to the specific investment objectives, financial situation or particular requirements of any individual recipient hereof. Certain securities may give rise to substantial risks and may not be suitable for certain investors. Each investor must make its own determination as to the appropriateness of any securities referred to in this research report based upon the legal, tax and accounting considerations applicable to such investor and its own investment objectives or strategy, its financial situation and its investing experience. The value of any security may be positively or adversely affected by changes in foreign exchange or interest rates, as well as by other financial, economic, or political factors. Past performance is not necessarily indicative of future performance or results.

Sources, Completeness and Accuracy: The material herein is based upon information obtained from sources that PCIPL and the research analyst believe to be reliable, but neither PCIPL nor the research analyst represents or guarantees that the information contained herein is accurate or complete and it should not be relied upon as such. Opinions expressed herein are current opinions as of the date appearing on this material, and are subject to change without notice. Furthermore, PCIPL is under no obligation to update or keep the information current. Without limiting any of the foregoing, in no event shall PCIL, any of its affiliates/employees or any third party involved in, or related to computing or compiling the information have any liability for any damages of any kind including but not limited to any direct or consequential loss or damage, however arising, from the use of this document.

Copyright: The copyright in this research report belongs exclusively to PCIPL. All rights are reserved. Any unauthorised use or disclosure is prohibited. No reprinting or reproduction, in whole or in part, is permitted without the PCIPL’s prior consent, except that a recipient may reprint it for internal circulation only and only if it is reprinted in its entirety.

Caution: Risk of loss in trading/investment can be substantial and even more than the amount / margin given by you. Investment in securities market are subject to market risks, you are requested to read all the related documents carefully before investing. You should carefully consider whether trading/investment is appropriate for you in light of your experience, objectives, financial resources and other relevant circumstances. PhillipCapital and any of its employees, directors, associates, group entities, or affiliates shall not be liable for losses, if any, incurred by you. You are further cautioned that trading/investments in financial markets are subject to market risks and are advised to seek independent third party trading/investment advice outside PhillipCapital/group/associates/affiliates/directors/employees before and during your trading/investment. There is no guarantee/assurance as to returns or profits or capital protection or appreciation. PhillipCapital and any of its employees, directors, associates, and/or employees, directors, associates of PhillipCapital’s group entities or affiliates is not inducing you for trading/investing in the financial market(s). Trading/Investment decision is your sole responsibility. You must also read the Risk Disclosure Document and Do’s and Don’ts before investing.

Kindly note that past performance is not necessarily a guide to future performance.

For Detailed Disclaimer: Please visit our website www.phillipcapital.in IMPORTANT DISCLOSURES FOR U.S. PERSONS This research report is a product of PhillipCapital (India) Pvt. Ltd. which is the employer of the research analyst(s) who has prepared the research report. PhillipCapital (India) Pvt Ltd. is authorized to engage in securities activities in India. PHILLIPCAP is not a registered broker‐dealer in the United States and, therefore, is not subject to U.S. rules regarding the preparation of research reports and the independence of research analysts. This research report is provided for distribution to “major U.S. institutional investors” in reliance on the exemption from registration provided by Rule 15a‐6 of the U.S. Securities Exchange Act of 1934, as amended (the “Exchange Act”). If the recipient of this report is not a Major Institutional Investor as specified above, then it should not act upon this report and return the same to the sender. Further, this report may not be copied, duplicated and/or transmitted onward to any U.S. person, which is not a Major Institutional Investor.

Any U.S. recipient of this research report wishing to effect any transaction to buy or sell securities or related financial instruments based on the information provided in this research report should do so only through Rosenblatt Securities Inc, 40 Wall Street 59th Floor, New York NY 10005, a registered broker dealer in the United States. Under no circumstances should any recipient of this research report effect any transaction to buy or sell securities or related financial instruments through PHILLIPCAP. Rosenblatt Securities Inc. accepts responsibility for the contents of this research report, subject to the terms set out below, to the extent that it is delivered to a U.S. person other than a major U.S. institutional investor.

The analyst whose name appears in this research report is not registered or qualified as a research analyst with the Financial Industry Regulatory Authority (“FINRA”) and may not be an associated person of Rosenblatt Securities Inc. and, therefore, may not be subject to applicable restrictions under FINRA Rules on communications with a subject company, public appearances and trading securities held by a research analyst account. Ownership and Material Conflicts of Interest Rosenblatt Securities Inc. or its affiliates does not ‘beneficially own,’ as determined in accordance with Section 13(d) of the Exchange Act, 1% or more of any of the equity securities mentioned in the report. Rosenblatt Securities Inc, its affiliates and/or their respective officers, directors or employees may have interests, or long or short positions, and may at any time make purchases or sales as a principal or agent of the securities referred to herein. Rosenblatt Securities Inc. is not aware of any material conflict of interest as of the date of this publication Compensation and Investment Banking Activities Rosenblatt Securities Inc. or any affiliate has not managed or co‐managed a public offering of securities for the subject company in the past 12 months, nor received compensation for investment banking services from the subject company in the past 12 months, neither does it or any affiliate expect to receive, or intends to seek compensation for investment banking services from the subject company in the next 3 months. Additional Disclosures This research report is for distribution only under such circumstances as may be permitted by applicable law. This research report has no regard to the specific investment objectives, financial situation or particular needs of any specific recipient, even if sent only to a single recipient. This research report is not guaranteed to be a complete statement or summary of any securities, markets, reports or developments referred to in this research report. Neither PHILLIPCAP nor any of its directors, officers, employees or agents shall have any liability, however arising, for any error, inaccuracy or incompleteness of fact or opinion in this research report or lack of care in this research report’s preparation or publication, or any losses or damages which may arise from the use of this research report.



PHILLIPCAP may rely on information barriers, such as “Chinese Walls” to control the flow of information within the areas, units, divisions, groups, or affiliates of PHILLIPCAP.

Investing in any non‐U.S. securities or related financial instruments (including ADRs) discussed in this research report may present certain risks. The securities of non‐U.S. issuers may not be registered with, or be subject to the regulations of, the U.S. Securities and Exchange Commission. Information on such non‐U.S. securities or related financial instruments may be limited. Foreign companies may not be subject to audit and reporting standards and regulatory requirements comparable to those in effect within the United States.

The value of any investment or income from any securities or related financial instruments discussed in this research report denominated in a currency other than U.S. dollars is subject to exchange rate fluctuations that may have a positive or adverse effect on the value of or income from such securities or related financial instruments.

Past performance is not necessarily a guide to future performance and no representation or warranty, express or implied, is made by PHILLIPCAP with respect to future performance. Income from investments may fluctuate. The price or value of the investments to which this research report relates, either directly or indirectly, may fall or rise against the interest of investors. Any recommendation or opinion contained in this research report may become outdated as a consequence of changes in the environment in which the issuer of the securities under analysis operates, in addition to changes in the estimates and forecasts, assumptions and valuation methodology used herein.

No part of the content of this research report may be copied, forwarded or duplicated in any form or by any means without the prior written consent of PHILLIPCAP and PHILLIPCAP accepts no liability whatsoever for the actions of third parties in this respect.

PhillipCapital (India) Pvt. Ltd. Registered office: 18th floor, Urmi Estate, Ganpatrao Kadam Marg, Lower Parel (West), Mumbai – 400013, India.

INSTITUTIONAL EQUITY RESEARCH Metalsbackoffice.phillipcapital.in/Backoffice/Researchfiles/PC_-_Metals_Sector_Report...INSTITUTIONAL EQUITY RESEARCH Metals

Documents