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Jindal Steel & Power.jpg
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Regulatory Overhang + Single-Digit RoIC = De-rating; Sell
We assign a Sell rating to Jindal Steel & Power (JSPL) because of regulatoryoverhang, which will lead to a sharp deterioration in incremental return ratios.Inthe past five years, JSPL has grown multi-fold on the back of captive resources,
but future expansion depends on merchant raw material supply. Besides this,JSPL is apparently one of the few companies which have benefited from captivecoal mine allocation, which along with the companys large size, makes it morevulnerable to regulatory actions like ceiling on merchant power price or demandfor free power (as witnessed in Orissa). We expect RoE and RoCE to declinefrom 21.9% and 12.2% in FY12 to 15.3% and 9.1% in FY14E, respectively, whileRoIC over FY10-14E is likely to be just 3.9%. We have set a TP of Rs300 on JSPL.
Is it still Sell despite 35% underperformance in past six months? We believe Yes:
JSPL has declined 30% in the past six months versus a 5% rise in Nifty, but, westillfeel the pain is not over. The negative news flow is unlikely to stop, which coupled withdistressed earnings due to delay in key projects will continue to lead to de-rating of thestock. Considering the above weakness, we feel a major portion of the price damagehas already taken place, but theres likely to be a sizeable time correction goingahead.
Our estimates substantially below consensus projections: Our FY14EEBITDA/PAT estimates are 9%/19% below consensus projections, respectively,
as we have assumed a subdued pricing scenario for steel prices and power tariff.Our revenue estimate for FY14E is 8% above street estimate. It appears the street istaking very low output from new facilities as these would be non-integrated in nature.
Utkal B1 coal block hits regulatory hurdle: The Orissa government has stoppedapproving mining leases due to a Supreme Court directive that all natural resourcesshould be auctioned. This, coupled with the recent CAG (Comptroller and AuditorGeneral of India) recommendation that coal mines have to be allocated via the auctionroute would prolong the pain, acting as a headwind on the stock.
Jindal Powers (JPL) 2x600MW plant doesnt figure in coal linkage list: The list ofpower plants for coal linkage under fuel supply agreement (FSA) doesnt include JPLsfirst two units of 4x600MW as per the minutes of Standing Linkage Committees (SLC)meeting. Though it is not the end, it has definitely led to uncertainly in respect of coalsourcing. For the remaining 2x600MW units, JPL has to rely on imported and e-auctioned coal, which erodes the returns profile sharply.
Iron ore sourcing at Angul plant remains a concern: JSPL has indicated sourcingofiron ore either from a third-party mine or in-house pellets. We would like to hi
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Share holding (%)
Q3FY12
Q4FY12
Q1FY13
Promoter
58.6
58.9
59.0
FII
22.3
23.1
21.9
DII
7.8
6.9
7.3
Corporate
3.3
3.1
3.9
General Public
8.1
7.9
3.9
One Year Indexed Stock Performance
Price Performance (%)
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2.0
18.2
38.9
11.9
21.1
EBITDA
58,513
63,162
67,932
70,649
80,061
EBITDA (%)
52.8
48.2
37.3
34.7
32.4
Adj PAT
35,730
37,539
39,649
32,770
38,033
EPS (Rs)
38.4
40.2
42.4
35.1
40.7
YoY (%)
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17.3
4.7
5.5
(17.4)
16.1
RoE (%)
34.3
26.6
21.9
15.4
15.3
RoCE (%)
20.6
14.3
12.2
9.9
9.1
P/E (x)
10.6
10.1
9.6
11.6
10.0
EV/EBITDA (x)
7.9
8.1
8.1
8.6
8.2
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Source: Company, Nirmal Bang Institutional Equities Research
Jindal Steel & Power
405060708090100110120130Sep-11Nov-11Jan-12Mar-12May-12Jul-12Sep-12JINDAL STEEL &
PNSE S&P CNX NIFTY INDEX
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Exhibit 1: Operations summary
FY08
FY09
FY10
FY11
FY12
FY13E
FY14E
ProductionStandalone (tn)
Sponge iron
1,185,739
1,248,511
1,309,408
1,319,840
1,319,940
1,350,808
1,492,600
Pig iron
1,250,636
1,262,261
1,508,502
1,665,581
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1,667,851
1,674,367
1,636,600
Steel products
1,425,060
1,844,651
2,251,738
2,272,692
2,756,921
3,145,000
3,915,000
Pellet
-
-
226,818
2,787,284
3,736,915
4,009,830
4,016,250
Power (mu)
2,665
2,831
2,941
3,420
4,630
6,917
8,696
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Volume Standalone (tn)
Sponge iron
405,446
385,583
343,369
113,894
78,457
1,925
-
Pig iron
347,261
280,419
245,193
201,688
85,428
-
-
Steel products
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1,328,390
1,508,121
1,804,863
1,900,383
2,385,224
2,620,860
3,412,850
Pellet
-
-
11,893
564,510
2,028,330
2,032,622
1,926,610
Power (mu)
893
1,124
945
926
1,446
3,055
4,565
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21,106
13,989
17,794
EPS (Rs)
13.3
16.5
15.9
22.1
22.6
15.0
19.0
Jindal Power (Rsmn)
Power volume (mu)
468
5,804
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7,431
7,841
7,833
7,898
8,844
Net sales
1,264
32,585
39,219
33,377
29,797
28,433
32,861
EBITDA
955
27,074
33,846
27,211
23,126
21,167
23,080
PAT
194
15,819
23,188
20,016
17,650
17,442
16,661
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Valuation
JSPL trades at P/E multiples of 11.6x and 10.0x based on FY13E and FY14E earnings, while EV/EBITDAmultiples stand at 8.6x and 8.2x for the same period. The P/E and EV/EBITDA multiples are higher than the
past 10 yearsmedian of 7.0x and 6.7x, respectively. We believe the stock may witness a de-rating due todeterioration in returns ratio and regulatory overhang. As per our calculations,we expect RoICE (returnon incremental capital employed adjusted with CWIP) of 3.7% over FY12-FY14E, while RoICE overFY10-FY14E is also likely to be 3.9%. We have valued JSPL based on SOTP methodology, where powerand steel business have been valued separately. We have valued the steel business at 5.5x FY14EV/EBITDA and CWIP according to each projectsreturns profile and gestation period. Power business has
been valued at 6.0x FY14E EV/EBITDA, while international subsidiaries have beenvalued at 5.5x FY14EEV/EBITDA. Our target price of Rs300 is 26% below the CMP. Our target price is 21% lower than theexisting lowest target price as per Bloomberg database.
Exhibit 2: Valuation summary
(Rsmn)
EBITDA
EV/EBITDA multiple (x)
Amount
Steel segment
48,413
5.5
266,273
Power segment
23,080
6.0
138,479
International & other segments
8,569
5.5
47,127
Total
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80,061
5.6
451,879
Cash
5,359
Debt
285,408
CWIP (discounted as per project specific)
112,686
Minority interest
4,222
Market capitalisation
280,295
No of shares (mn)
935
Target price (Rs)
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300
Downside (%)
26%
Source: Nirmal Bang Institutional Equities Research
Our estimates versus consensus projections
Our FY13E EBITDA and PAT estimates are 7% and 19% below consensus projections, respectively,largely due to lower price assumption in the steel segment. We believe that consensus is yet to factor in therecent decline in steel prices and this should result in more downgrades in coming months. We would alsolike to highlight that consensus is yet to factor in the exceptional loss on account of Bolivian investment. After1QFY13, consensus EBITDA estimate for FY13E has been downgraded by 5%, or Rs4,019mn, while PATestimate has been downgraded by 8%, or by Rs3,352mn. We would like to note that1QFY13 EBITDA andadjusted PAT were 17% and 12% below consensus estimates, which coupled with a ex
ceptional loss ofRs5,741mn would have resulted in bigger reduction in PAT estimate. Our FY14E EBITDA/PAT estimatesare 9%/19% below consensus projections, largely driven by lower steel price assumption and highercosts assumption due to delay in raw material integration. We expect steel prices at export parity due tosubstantial capacity addition. Besides this, the steel plate (major incrementalrevenue driver in comingquarters) market is more vulnerable compared to overall steel market due to hugecapacity addition in thatsegment. Surprisingly, our FY13E/FY14E revenue estimates are 2% and 8% higher than consensusprojections as it appears the street is not factoring in any material revenue from the non-integrated segment.
Exhibit 3: Our estimates versus consensus projections
(Rsmn)
NBIE estimates
Bloomberg consensus estimates
Deviation (%)
FY13E
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FY14E
FY13E
FY14E
FY13E
FY14E
Net sales
203,771
246,841
199,563
228,171
2.1
8.2
EBITDA
70,649
80,061
75,614
87,643
(6.6)
(8.7)
PAT
32,770
38,033
40,661
46,741
(19.4)
(18.6)
Source: Bloomberg, Nirmal Bang Institutional Equities Research
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0160320480640800
Apr-02May-04Jun-06Jul-08Aug-10Sep-12JSPL share price6.0x10.0x14.0x18.0x(Rs)06121824Apr-02May-04Jun-06Jul-08Aug-10Sep-12P/EMedian P/EMed +1SDMed +2SDMed -1SD(x)0160320480640800Apr-02May-04Jun-06Jul-08Aug-10Sep-12JSPL share price3.0x6.0x9.0x12.0x(Rs)04
81216Apr-02May-04Jun-06Jul-08Aug-10Sep-12EV/EBITDAMedian EV/EBITDAMed +1SDMed +2SDMed-1SDMed -2SD(x)0160320480640800Apr-02May-04Jun-06Jul-08Aug-10Sep-12JSPL share price1.0x1.5x2.0x2.5x(Rs)-
2.04.06.08.0Apr-02May-04Jun-06Jul-08Aug-10Sep-12P/BVMedian P/BVMed +1SDMed +2SDMed -1SD(x)152229364350-510152025Apr-02May-04Jun-06Jul-08Aug-10Sep-12P/EAverage RoE (RHS)(x)(%)152229364350-3691215Apr-02May-04Jun-06Jul-08Aug-10Sep-12EV/EBITDA Average RoE (RHS)(x)(%)152229364350-1.53.04.5
6.07.59.0
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Apr-02May-04Jun-06Jul-08Aug-10Sep-12P/BVAverage RoE (RHS)(x)(%)Exhibit 4: 1-year forward P/E
Exhibit 5: 1-year forward average P/E
Source: Bloomberg, Nirmal Bang Institutional Equities Research
Source: Bloomberg, Nirmal Bang Institutional Equities Research
Exhibit 6: 1-year forward EV/EBITDA
Exhibit 7: 1-year forward average EV/EBITDA
Source: Bloomberg, Nirmal Bang Institutional Equities Research
Source: Bloomberg, Nirmal Bang Institutional Equities Research
Exhibit 8: 1-year forward P/BV
Exhibit 9: 1-year forward average P/BV
Source: Bloomberg, Nirmal Bang Institutional Equities Research
Source: Bloomberg, Nirmal Bang Institutional Equities Research
Exhibit 10: Average P/E, RoE
Exhibit 11: Average EV/EBITDA, RoE
Exhibit 12: 1 Average P/BV, RoE
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Source: Bloomberg, Nirmal Bang Institutional Equities Research
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Exhibit 13: Revenue-Consensus estimate vs. our projection
Exhibit 14: EBITDA-Consensus estimate vs. our projection
Source: Bloomberg, Nirmal Bang Institutional Equities Research
Source: Bloomberg, Nirmal Bang Institutional Equities Research
Exhibit 15: PAT-Consensus estimate versus our projection
Source: Bloomberg, Nirmal Bang Institutional Equities Research
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0918273645FY06FY07FY08FY09FY10FY11FY12FY13EFY14ERoCE RoE(%)01020304050101520253035FY07FY08FY09FY10FY11FY12FY13EFY14ERoCE adjusted with CWIPRoIC (RHS)(%)(%)-
0.91.82.73.64.5FY08 FY09 FY10 FY11 FY12 FY13E FY14ESteel productsPellet(mt)(0.0)0.71.42.12.8
3.5FY08 FY09 FY10 FY11 FY12 FY13E FY14ESteel productsPellet(mt)Return ratios to deteriorate substantially
JSPL is going to witness a very sharp fall in return ratios in the coming yearsas new expansion is likely to bevalue dilutive. We expect RoE and RoCE to drop from 21.9% and 12.2% in FY12 to 15.3% and 9.1% inFY14E, respectively. Return on capital employed, excluding CWIP, is also expected to witness a sharpdrop from 19.4% in FY12 to 12.8% in FY14E. The key indicator, return on incremental capital employed
(RoIC) is likely to remain in low single-digits over FY12-FY14E. The huge deterioration in return ratios wouldlead to de-rating of the stock as earnings disappointment sets in.
Exhibit 16 : RoCE and RoE
Exhibit 17: RoCE adjusted with CWIP and RoIC
Source: Company, Nirmal Bang Institutional Equities Research
Source: Company, Nirmal Bang Institutional Equities Research
Volume growth to be healthy in FY12-FY14E, but not profitable due to non-integrated nature
We expect the company to report a 20% CAGR volume growth in steel during FY12-FY14E. However,most of the growth would be driven by the non-integrated segment. The company has commissioned various
downstream facilities like plate mill, wire rod mill and bar mill without commensurate increase in semi- finishedsteel capacity. The company is also marginally short on metallics capacity. It w
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ill have to source thesematerials from a third party on merchant basis, which leaves very little scope for incremental profitability. Weexpect almost 66% of the incremental volume to be based on usage of merchant semi-finished steelas a raw material during FY12-FY14E. After registering a multi-fold jump in pellet sales, we expect pellet
volume to marginally decline in FY14 due to commissioning of DRI plant at Angul.The company is alsoexpected to register strong volume growth in the power segment to the tune of 76% CAGR duringFY12-14E, but most of this growth would be driven by 6x135MW Angul power plant,which is notprofitable due to ceiling on power tariff and higher proportion of e-auctioned coal.
Exhibit 18 : Steel and pellet production
Exhibit 19: Steel and pellet volume
Source: Company, Nirmal Bang Institutional Equities Research
Source: Company, Nirmal Bang Institutional Equities Research
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0123450246810FY08 FY09 FY10 FY11 FY12 FY13E FY14EJSPL power generationJSPL power volume (RHS)(bu)(bu)0246810FY08 FY09 FY10 FY11 FY12 FY13E FY14ETamnar 1 volumeTamnar 2 volume(bu)
Exhibit 20: JSPL power generation and volume
Exhibit 21 : JPL power volume
Source: Company, Nirmal Bang Institutional Equities Research
Source: Company, Nirmal Bang Institutional Equities Research
Angul steel plant value dilutive in medium term
JSPL is investing Rs128,000mn in Angul steel plant, which includes 2.0mt of gas-based DRI, 1.6mt steelmelting shop (SMS), 1.5mt plate mill and 810MW (6x135MW) power plant. The company expects the DRIplant to get operational by the end of 1QFY14, while SMS would also be commissioned at the same time. Weare factoring in a three-month delay in commissioning of this plant and expect commercial production to start
from 3QFY14. We are also conservative on the ramp-up schedule and expect 15% capacity utilisationin 2HFY14. JSPL has started commercial production at its plate mill last month,but the company would getthe feedstock from its Raipur plant and other local suppliers in Orissa till itstarts SMS. We have estimated40% capacity utilisation in FY14E, but it would not have a material impact on profitability, as over 75%of plate mill raw material would be sourced from a third party. The company is using coal gasificationplant instead of normal conventional natural gas at the DRI plant. JSPL believesthere would not be anymaterial savings in the cost structure of sponge iron, but the grade of finishedsteel would be much better thannormal conventional sponge iron routed-steel. The company has been allocated Utkal B1 coal block for itssponge iron operations at Angul. The company has not been allocated any iron oremine and it expects to signthird-party contracts for the same.
Exhibit 22: Angul project details
Project costs
Capacity
Capex (Rsmn)
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DRI (mt)
2.00
31,410
Plate mill (mt)
1.50
26,000
SMS (mt)
1.60
35,770
Power (MW)
810
34,820
Total project costs
128,000
Source: Company
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6x135MW power plant - losing proposition in the absence of linkage/captive coal
JSPL has commissioned two units of 135MW each and both are operating at 70-75% of their capacity. Out ofthe remaining four, the company expects the first unit to start operations by the end of 2QFY13, while the
other three units would get commissioned in every two-three months subsequently.However, the company islikely to commission all units before FY13 in order to get Section 80IA tax benefit. We would like to highlightthat in 3QFY12, JSPL had given guidance to commission all the units prior to FY12 as the Section 80IAtax benefit was scheduled to expire in March 2012. Currently the company has coal linkage for four unitsfrom Mahanadi Coalfield (MCL), but it is receiving only around 35-40% of linkagecoal with the rest beingsourced through e-auction. JSPL is incurring losses on these units as power tariff for captive power plant is
fixed in Orissa and the company is currently selling power at Rs3.2/unit, whilethe costs remain high - inthe range of Rs3.0-3.5/unit - due to large component of e-auctioned coal. Therefore, we believe, it is notcommercially viable to start these units as profitability would remain under severe pressure. We dont expectthe company to operate these units at optimum capacity until there is some clarity on coal sourcing.
Utkal B1 coal block is a major value driver, but uncertainty lurks
JSPL has been allocated Utkal B1 coal block for its sponge iron operations at Angul, Orissa, which has
reserves of 228mt. Despite securing all the clearances (environmental and forestI and II) over sixmonths ago, the company has not been able to sign its mining lease agreement. Earlier, the dispute wasregarding free power supply to Orissa government, where the government finally agreed to 13% freeelectricity off-take of surplus power. However, after the CAG audit of coal mineallocation and the SupremeCourts directive that all natural resources should be auctioned, the Orissa government stopped approvingmining leases for all mining assets. We do not expect resolution of this issue in the near term as coal mineallocation has become a fierce political issue. A revamp of the coal mine allocation policy would takemore than a couple of quarters and we fear the sector may get trapped in policyparalysis, just like thetelecommunications sector.
This coal mine remains significant as it is the most critical asset which will determine the profitabilityof Angul steel and power plant. JSPL would have peak production capacity of 6mtrun of mine (ROM) fromthis mine. The grade of coal is between E and F and hence the company has set upa coal washery. JSPLwould get around 2.1mt of washed coal, which would be used in coal gasification
projects for DRI. Themiddlings production of around 3.6mt would be used in 810MW power plant. We believe that until JSPL starts
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coal mines, its power plants are not likely to turn profitable. We expect aroundRs3,000/tn of saving in steelcosts and Rs1.5/unit of saving in power costs.
Iron ore sourcing a major concern
JSPL has not been allocated any iron ore mine for its Angul steel plant. The com
pany is contemplating variousoptions, which include increasing the output at its existing mine, i.e. Tensa mine from 3mt to 5-6mt, signingthird-party contracts with local vendors in Orissa and using pellets from Barbilunit. However, we believe thatincreasing iron ore output from its current mine requires all necessary approvals and logistics infrastructure,as the company has not applied for the same and it would be a long-drawn affair.We rule out this possibility inthe medium term of two-three years. After the recent controversy regarding the existing third-party contract,with Sarada mines, we feel there is least possibility of the company getting thi
rd-party vendors at lucrativerates. Usage of pellets from Barbil unit is a fair possibility, but we would like to highlight that thecompany is not adding any new pellet unit in Barbil in the next two years; therefore the existingmerchant pellet volume would only be diverted for captive purpose. This would only shift the profitabilityfrom one unit to another, rather than adding any incremental profits.
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-5001,0001,5002,0002,500
FY08FY09FY10FY11FY12(Rs/tn)Exhibit 23: Iron ore costs rose by almost three times in past four years
Source: Company
Returns profile of Angul steel plant
As per our calculations, JSPL needs EBITDA/tn of around Rs11,800 in order to achieve 14% RoE.Although JSPL has achieved this kind of EBITDA in the past at Raigarh steel plan
t, it was achieved with thehelp of captive resources i.e. iron ore and thermal coal. As stated earlier, thecompany is facing tough time ingetting iron ore projects on stream for Angul steel plant, which will result inlower profitability of the unit. Asper our calculations, the company is likely to generate EBITDA/tn of around Rs8,600. This will lead toRoE and RoCE of a mere 2.5% and 5.8%, respectively. Just to give a proper perspective, the companyposted standalone RoCE (CWIP adjusted) of 16.4% for FY12, while average RoCE (CWIP adjusted) for pastfive years stood at 18.5%. In order to generate RoCE similar to FY12, the company needs to achieve
EBITDA/tn of Rs18,150/tn, which seems to be a herculean task in the current situation. As per ourcalculations, EBITDA/tn would improve to around Rs18,000/tn in case of captive raw material sourcing.
Exhibit 24: Return ratios at different EBITDA/tn levels
(Rsmn)
Desired
Actual likely
Various scenario
EBITDA (Rs/tn)
11,836
8,600
9,000
10,000
11,000
12,000
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14,000
16,000
18,000
EBITDA
17,755
12,900
13,500
15,000
16,500
18,000
21,000
24,000
27,000
Depreciation
4,659
4,659
4,659
4,659
4,659
4,659
4,659
4,659
4,659
Interest costs
7,175
7,175
7,175
7,175
7,175
7,175
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7,175
7,175
7,175
PBT
5,921
1,066
1,666
3,166
4,666
6,166
9,166
12,166
15,166
PAT
3,914
705
1,101
2,093
3,084
4,076
6,059
8,042
10,025
RoE (%)
14.0
2.5
3.9
7.5
11.0
14.6
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21.7
28.8
35.9
RoCE (%)
9.3
5.8
6.3
7.3
8.4
9.5
11.6
13.7
15.8
Source: Nirmal Bang Institutional Equities Research
Pellet expansion Not so remunerative
JSPL has 4.5mt pellet plant at Barbil, Orissa, and it is currently operating atcapacity utilisation of around90%. It is currently sourcing fines from own inventory as well as own generation. The company expectsinventories to last for another two-three years. Pellet product was in strong profit cycle in the past 24-36months due to iron ore shortage, but this situation is likely to change going forward. The company isexpanding its pellet production capacity from 4.5mt to 9.0mt, because of the rising requirement of Angul steelplant, which is likely to be commissioned in the next 18-24 months. However, bythe time the companycommissions its next pellet unit, the pellet market would witness pressure on profitability from twosides. Firstly, overcapacity in pellet market with several players setting up pellet units and secondly,the availability of iron ore fines is a cause for concern. As a large number ofpellet units are gettingcommissioned, the current inventory is likely to get exhausted in next 24 monthsat various mines, whilecurrent fines production would not be able to match demand. This will result inhigher prices for iron ore finesand lower prices for pellets.
4x135MW power plant stable operations
JSPL has built captive power units in anticipation of steel capacity rising at i
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ts Raigarh unit. The company isusing middlings as a feed to these units and therefore the variable costs are around Rs1/unit. These units arecurrently making strong profits on the back of lower costs and stable merchant price realisation. However, thecompany is operating three units at optimum capacity (operating at 65-70% due tousage of middlings as
feed) and the fourth unit is likely to stabilise in the next two months.
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2.02.83.64.45.26.00246810FY08 FY09 FY10 FY11 FY12 FY13E FY14ETamnar 1 generation Realisation(bu)(Rs/unit)-142842
5670FY09FY10FY11FY12FY13EFY14ERoERoCE(%)JPLs 1,000MW plant operating at full capacity - the golden phase is over
The company posted strong profits from JPLs 1,000MW power plant with average RoEbeing 49% overFY09-11 on the back of strong merchant power tariff and lower costs due to captive coal mines. Althoughcaptive coal mining would continue to keep costs low for JPL, merchant power tariff has dropped considerablyin the past 12 months. The company is operating at a PLF (plant load factor) of
98% for the past three yearsand there are no levers available to improve the profits except merchant tariff.We believe merchant powertariff will remain in the range of Rs3.5-4.0/unit in the coming quarters. We also believe that stateelections in coming quarters will not have a material impact on merchant power tariff as subdued economicenvironment has hurt demand. Besides this, in case merchant power tariff moves up, there is significantrisk of regulatory action as JSPL has been looked at as a profiteering company due to highermerchant power tariff and lower generation costs on account of captive coal mines.
Exhibit 25 : JPLs Tamnar-1 power generation, realisation
Exhibit 26 : JPLs RoE, RoCE
Source: Company, Nirmal Bang Institutional Equities Research
Source: Company, Nirmal Bang Institutional Equities Research
4x600MW Tanmar - 2 power plant value dilutive
JPL is setting up a 2,400MW (4x600MW) power plant at the same location as Tamnar1 with a capitalexpenditure of Rs134,100mn. The company started work on the plant around 2009, but it had to stop the workas it was lacking environmental clearance. It got all clearances by the end of FY11 and started work on theproject, which is likely to be commissioned by June 2013. Although JPL indicatedthat it is trying hard to
commission its first unit before March 2013 in order to avail the tax benefit under Section 80IA of Income TaxAct, we remain circumspect about commissioning of this unit before March 2013. T
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he remaining three unitswould be commissioned every three months subsequently and the company expects full commissioning bythe end of FY14. We expect the first unit to start commercial power generation by the end of 3QFY14 orthe beginning of 4QFY14. A large portion of volume growth from these projects would be visible in
FY15E and FY16E.
Coal allocation first 2x600MW not figuring in CIL coal linkage list creates uncertainty
JSPL has indicated that it has been allocated coal linkage for first two units of 1,200MW by MahanadiCoalfields (MCL). These mines are part of the Talcher coal block. The company isnot clear about thedefinition of long-term power purchase agreement (PPA), a mandatory requirementfor getting coal linkagefrom Coal India, and the counterparty to PPA. The company has made its presentat
ion to the government thatlong-term PPAs have been out of the market since quite some time. However, we are surprised to see thatthe list of power plants meant for coal linkage under FSA doesnt include first two units of 1,200MWas per the minutes of Standing Linkage Committees (SLC) meeting. Although it doesnt mean that theseunits would never feature in the list again, it has surely added uncertainly tocoal sourcing. For the remainingunits (2x600MW), JPL may have to rely on imported and e-auctioned coal, which would diminish the returnsprofile substantially. The company is also contemplating coal import from overseas subsidiaries. JPL plans to
increase the production at its current coal mines, i.e. Gare Palma IV/2 and IV/3, which supply coal to Tanmar1,000MW unit. This mine has total reserves of 246mt and its peak production capacity is 6.25mt. We seelower possibility of getting coal linkage or increased production at the existing mines, while coal frominternational arms would only shift profitability from one unit to another.
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As per our calculations, the first two units of the project is likely to generate net present value (NPV)of Rs28,574mn based on 65% linkage coal and 35% e-auctioned coal. The company needs to provide 5%power to state grid at a variable cost in case of getting coal linkage. Therefore, we have assumed 3.25% of
power sales at variable cost. Besides this, Chhattisgarh government has first right of refusal for 30% of grosscapacity at a rate to be approved by the appropriate electricity regulatory commission for a period of 20 years.We have assumed long-term merchant rate of Rs3.8/unit for our calculations. However, the remaining twounits are likely to generate negative NPV of Rs11,551mn based on 50% coal sourcing through e-auction and the rest via imports. The entire project is likely to generate NPV of Rs17,022mn,significantly lower than the equity investment of Rs33,525mn.
Largest coal allocation to JSPL makes it vulnerable to regulatory action
JSPL and JPL have been allocated nine coal blocks for captive usage and three coal blocks are operationalfrom these. JSPL has been allocated five coal blocks since 2006 and these blocksare listed in the CAG reporton coal scam. We expect a long wait before the coal scam issue is put to rest and it would impact thecompanys performance. Though Utkal B1 coal block was allocated in September 2003,the recent directivefrom the apex court that all natural resources should be auctioned made the Orissa government to stopsigning mining lease agreements for all mines. The companys sheer size with the f
act that JSPL hasbeen allocated maximum coal reserves, to the tune of 2,587mt, makes it vulnerable to potentialregulatory action. Although, we believe that CAG reporting gains made by privateminers are overstated.Just to cite an example, the CAG has calculated a loss of Rs163,953mn from Ramchandi promotional block. Itmay be noted that foreign currency savings on account of indigenous crude oil, time value of money, indirectand direct tax income, employment generation and overall economic growth enabledwith the help of theseprojects have not been considered by CAG. Nonetheless, JSPL topping the list ofcoal mine allocation has ledto potential fear of regulatory action.
Exhibit 27: Coal blocks allocated to JSPL group
Company
Date of Allotment
Block allocated
Coal fields
State
End-use
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Reserves (mt)
JSPL
20.06.1996
Gare-Palma-IV/1
Hasdoe-Arand
Chhattisgarh
Sponge Iron
124.00
JPL
01.07.1998
Gare-Palma-IV/2
Mand Raigarh
Chhattisgarh
Power
123.00
JPL
01.07.1998
Gare-Palma-IV/3
Mand Raigarh
Chhattisgarh
Power
123.00
JSPL
29.09.2003
Utkal B 1
Talcher
Orissa
Sponge Iron
228.40
JSPL
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13.01.2006
Gare Palma IV/6@
Mand Raigarh
Chhattisgarh
Sponge Iron
156.00
JSPL
20.02.2007
Jitpur
Chupperbita
Jharkhand
Power
81.09
JSPL
17.01.2008
Amarkonda Murgadangal#
Birbhum
Jharkhand
Power
205.00
JSPL
27.02.2009
Ramchandi Promotion Block
Talcher
Orissa
CTL
1,500.00
JSPL
12.10.2009
Urtan North*
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Sohagpur
Madhya Pradesh
Sponge Iron
46.55
Note: @ This block is through a JV with Nalwa Sponge Iron, # This block is via aJV with Gagan Sponge Iron, * This block is via a JVwith Monnet Ispat,
Source: Coal ministry
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Power project costs of JPL highest among peers
The Tamnar-2 power projects total capital cost stands at Rs134,100mn i.e. Rs55.9mn/MW. The costs ofGodda and Dumka power projects are also in a similar range - Rs54.7mn/MW and Rs55.6mn/MW. The costs
remained high compared to peers, which ranges between Rs33.0-52.2mn/MW. This canpartially be attributedto the BTG contract given to BHEL as compared to Chinese players by peers.
Exhibit 28: Power project capital expenditure of various players
Power projects
Capacity (MW)
Total costs (Rsmn)
Costs/MW (Rsmn)
Adani Power Mundra I and II
1,320
43,500
33.0
Sterlite Energy Jharsuguda
2,400
82,000
34.2
Reliance Power Shahapur
1,200
48,000
40.0
Reliance Power Sasan
3,960
160,950
40.6
Reliance Power Rosa II
600
24,600
41.0
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Adani Power Mundra III
1,320
57,960
43.9
Reliance Power Rosa I
600
27,020
45.0
Adani Power Mundra IV
1,980
89,600
45.3
Indiabulls Power Nashik
1,335
60,480
45.3
Adani Power Tiroda I and II
1,980
92,630
46.8
Reliance Power Butibori
300
14,050
46.8
Sterlite Energy Talwandi Sabo
1,980
93,200
47.1
Reliance Power Urthing Sobla
400
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20,800
52.0
Indiabulls Power Amravati
1,320
68,880
52.2
Jindal Power Dumka
1,320
72,240
54.7
Jindal Power Godda
660
36,660
55.5
Jindal Power Tamnar 2
2,400
134,100
55.9
Source: RHP of respective companies
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Too early to start factoring in future projects
The company has announced various projects to increase iron and power capacity multi-fold in the nextcouple of years. However, these projects are just at the early stage of implementation and would take a
couple of years before these projects commence commercial production.
Godda (1x660MW), Jharkhand
JPL is setting up a 660MW power plant in Jharkhand, which was earlier envisagedby JSPL as a captivepower plant (CPP) for supply of power to JSPLs steel plant expansion project in Jharkhand. JSPL has beenallocated Jitpur coal block for this project, which has reserves of 81mt. JSPL has entered into long-term coalsupply agreement with JPL to supply coal for 25 years at a price which would bea sum of mining costs,
transportation charges, loading charges, statutory charges, levies and other charges. In return, JSPL would beentitled to buy 350MW of power for a period of 25 years at a fixed of Rs2.8/unituntil FY19 and Rs2.5thereafter. We are valuing investment in these assets at a discount of 50% considering high gestationperiod and uncertainty regarding coal allocation.
Dumka (2x660MW), Jharkhand
JPL is setting up a 1,320MW power plant (2x660MW) in Jharkhand, which was earlier envisaged by JSPL asa CPP for supply of power to JSPLs steel plant expansion project in Jharkhand. JS
PL, in a joint venture withGagan Infraenergy i.e. Shrestha Mining and Metals Pvt Ltd (SMMPL) has been allocated Amarakonda Murgadangal coal block for this project, which has reserves of 205mt. SMMPL hasentered into a long-termcoal supply agreement with JSPL to supply coal for 25 years at a price which would be a sum of mining costs,transportation charges, loading charges, statutory charges, levies and other charges. In return, JSPL would beentitled to buy 675MW of power for a period of 25 years at a fixed rate of Rs2.8/unit until FY19 and Rs2.5/unitthereafter. We are valuing investment in these assets at a discount of 50% considering high gestationperiod and uncertainty regarding coal mine allocation.
Patratu steel plant, Jharkhand
The company has started work on 3mt steel plant, which would produce long products with an investment ofRs128,000mn. However, the work is expected to expedite post commissioning of Angul steel plant. Thecompany has recently deferred the commissioning date to March 2016 as compared to earlier guidance ofMarch 2015. We believe there can be further delay as sof Angul plant is likely to take more time than
anticipated by the company. We are factoring in a modest capex during FY13-FY14and we are valuing thiscapex at a discount of 50% considering the high gestation period and uncertainty
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regarding resourceallocation.
Coal to Liquid (CTL) project, Orissa
In order to reduce the dependence on imported crude oil and capitalising vast coal sources in India, the
government is planning to set up a first of its kind coal to liquid (crude) project in India. JSPL is one of the twoparticipants, which has been selected for setting up this unit. This project would produce 80,000 barrels perday of crude oil at peak capacity. The project involves a capex of around Rs400,000mn. However, thecompany has made very little progress on this project, while after the CAG report, matters have more or lessstagnated. We dont expect any significant outlay on this project going forward and hence we are notfactoring in any value from this project.
Hydro-power plant
The company plans to set up three hydro power plants with an aggregate capacityof 6,100MW at anestimated capex of nearly Rs400,000mn. The company has started work on these projects, but as hydro-power projects usually have a very high gestation period, JPL expects the firstunit of 1,600MW to becommissioned in FY18, while the rest of 4,500MW power projects would be commissioned by FY20. Thecompany has invested around Rs3,950mn on these projects until now and we expectfurther investment ofRs5,500mn over FY13-FY14. However, we are valuing capital expenditure at a disco
unt of 50%considering the high gestation period.
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International operations
The company has started various projects overseas, of which a couple of them have started yielding results,while a few others are at advance stage of commissioning.
Shadeed steel plant
The company has 1.5mt of gas-based hot briquetted iron (HBI) plant and currentlyit is operating at 90% of itscapacity. Shadeed steel plant sources pellets from merchant market, while the company has signed a long-term gas supply agreement for a period of 10 years at US$1/mmBtu. The company iscurrently havingEBITDA margin of around 20% at current prices and we expect it to sustain in thecoming quarters too. Weare estimating EBITDA of Rs6,306mn and Rs6,107mn for FY13E and FY14E, respectively. The company
is also looking to add a steel melting shop (SMS) with an investment of US$260mn, but it would take around18-24 months to start the project and hence we have not factored this in our earnings estimates. We havevalued SMS capital work in progress at a 20% discount. Although the company hasstated that it is notplanning to add downstream operations, we believe, it would eventually do so.
South Africa coal mine
This coal mine is located at Piet Retief, Mpumalanga, South Africa, with total high grade (anthracite and leanbituminous) mineable reserves of 50mt. The company is targeting production of 1m
t in FY13E and we areassuming 1mt of production for FY13E and FY14E each. Due to the high grade coal,the company is ableto garner US$30-35/tn premium over the benchmark thermal coal prices in international markets, while pricesremain similar to benchmark prices in the domestic market due to export parity.The distance between themine and the nearest port is 320km, where in a large part - to the tune of 90% -is covered by rail. The minehas a stripping ratio of 1:2 and the mining costs are around US$50-60/tn while freight charges are aroundUS$40/tn. We are estimating EBITDA of Rs1,485mn and Rs1,250mn for this mine forFY13E and FY14E,respectively.
Mozambique coal mine
The mine has total reserves of 1.2bn of mineable coal (thermal as well as coking), spread across 25,000hectares, with a grade of 6,000 GCV (gross caloric value). Total distance from mine to the port is 700km,which is covered by road and rail network of 120km and 580km, respectively. Thecompany is guiding to startcoal production in October 2012 and we believe it would be able to start the mine by the end of 4QFY13. The
mine has a stripping ratio of 1:2 and the mining costs are around US$35-40/tn, while the freight charges arearound US$40-45/tn. The company has guided around 1mt of coal production for FY1
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500570640710780850Apr-10Sep-10Mar-11Sep-11Mar-12Sep-12China steel priceGlobal steel price(US$/tn)28032036040044080110140170200Apr-10Sep-10Mar-11Sep-11Mar-12Sep-12Iron OreCoke (RHS)(US$/tn)(US$/tn)4075110145180-
3.57.010.514.0FY07FY08FY09FY10FY11FY12FY13EFY14EFY15EFY16ECapacityDemandDemand/Capacity (RHS)(mt)(%)Industry dynamics painful for integrated producers
Steel prices have corrected significantly in the past six months globally. Chinese domestic as well as exportprices have corrected by 19% each during the same period while European prices have declined 8%. Steel
price drop is lower to a certain extent in American market, to the tune of 4%. An important point to note isthat the decline is not going to materially hurt non-integrated producers as spot iron ore and cokingcoal prices have corrected 37% and 28% in the past six months, respectively, while scrap prices havecorrected 29% in the same period. However, it will surely impact players like JSPL, which is 100%integrated in iron ore and 100% integrated in thermal coal used for sponge iron.
Exhibit 29: Steel price
Exhibit 30: Iron ore and coke prices
Source: Bloomberg
Source: Bloomberg
Plate Industry in India Vulnerable due to capacity addition
The Indian plate industry is going to witness a tough time due to significant capacity addition in the comingquarters. The market was in deficit situation during FY06-09, which was met through imports (this includedhigher grade imports from power players for boiler requirement as well). However, capacity addition by Essarand Welspun resulted in higher capacity than demand, although imports also continued during this period ofhigh grade material that was not available in India. Plate consumption in Indiais 4.5mt versus capacity of 7mtduring FY12. Industry is likely to add around 3mt of capacity during FY13 by pla
yers like Steel Authority ofIndia (SAIL) and JSPL, which would take demand to capacity ratio at 51%. Thoughwe accept the ramp-
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up to be slow, the demand to capacity ratio is expected to remain at 55% in FY14as well. This is likelyto put significant pressure on plate prices. Though we remain negative on the flat steel segment, plate industryremains more vulnerable considering significant capacity addition and low demandto capacity ratio.
Exhibit 31: Plate industry demand and capacity
Source: Crisil Research
Pellet Industry in India Another victim of overcapacity
Pellet industry is also facing enormous capacity addition in Indian market, which would outpace demand by asignificant margin. As per CRISIL research estimate, pellet capacity is likely to rise from 42mt in FY12 to
85mt by FY16. The pellet industry is likely to face a double whammy due to significant capacity addition. Onthe one side, pellet prices are likely to drop significantly due to higher supply, while higher capacity additionwould increase iron ore fines requirement massively, resulting in higher fines prices going forward.
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Risks
Steel prices remain high compared to our estimates
We have assumed around 9% correction in steel prices from 1QFY13 to 4QFY14, largely driven by
higher supply and lower demand due to subdued economic environment. We stand byour assumption thatsteel prices would move towards export parity from import/trade parity. However,in case producers are ableto fine-tune their production and take coordinative action, steel prices may notdecline to the same extent.
Reforms in mining and environmental space
In case the company is able to start Utkal B1 coal block soon, it would give significant boost to share price.Besides this, higher coal production by Coal India would also help in lowering c
oal costs for the company.
Merchant prices surge due to low hydro availability and election
We are assuming merchant power tariff of Rs3.8/unit for FY13E and FY14E, but considering the droughtsituation currently, which would result in lower hydro-power generation, coupledwith election in some statescan result in higher power tariff.
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Financials (consolidated)
Exhibit 32: Income statement
Y/E March (Rsmn)
FY10
FY11
FY12
FY13E
FY14E
Revenue
110,915
131,122
182,086
203,771
246,841
YoY growth (%)
2.0
18.2
38.9
11.9
21.1
Raw material costs
29,976
36,193
68,024
90,172
120,817
% of sales
27.0
27.6
37.4
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55/80
44.3
48.9
Employee costs
2,750
4,149
5,913
6,961
7,510
% of sales
2.5
3.2
3.2
3.4
3.0
Power & fuel costs
6,577
8,742
11,298
12,407
12,958
% of sales
5.9
6.7
6.2
6.1
5.2
Admin. & other expenses
13,099
18,875
28,920
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56/80
23,581
25,494
% of sales
11.8
14.4
15.9
11.6
10.3
EBITDA
58,513
63,162
67,932
70,649
80,061
EBITDA margin (%)
52.8
48.2
37.3
34.7
32.4
Depreciation
10,006
11,510
13,865
14,777
17,917
EBIT
48,508
51,652
54,067
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57/80
55,872
62,145
Interest expenses
3,576
2,596
3,600
8,221
13,570
Other income
603
815
1,419
751
900
Exceptional loss (gain)
0
0
0
5,741
0
PBT
45,535
49,871
51,886
42,661
49,475
Provision for tax
9,189
11,830
11,863
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58/80
9,790
11,379
Effective tax rate (%)
20.2
23.7
22.9
22.9
23.0
PAT before MI
36,346
38,040
40,023
32,871
38,096
Minority interest
755
659
574
568
583
profit of associates companies
139
158
200
466
520
PAT after MI
35,730
37,539
39,649
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59/80
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60/80
103,237
140,169
180,176
211,196
247,479
Shareholders' fund
104,168
141,103
181,111
212,131
248,413
Long-term borrowings
53,298
73,776
111,796
160,596
208,196
Short-term borrowing
32,745
65,952
59,112
68,312
77,212
Total loan fund
86,043
139,728
170,908
228,908
285,408
Minority interest
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61/80
1,659
2,335
3,071
3,639
4,222
Deferred tax liability
8,455
10,055
11,920
13,388
15,095
Total liabilities
200,325
293,221
367,010
458,065
553,138
Application of funds
Gross fixed assets
131,582
192,433
222,803
281,653
399,342
Less: Accumulated dep.
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62/80
32,608
43,998
57,863
72,639
90,556
Net fixed assets
98,974
148,435
164,940
209,013
308,786
Capital work in progress
79,470
93,809
136,520
177,670
159,981
Total fixed assets
178,444
242,245
301,460
386,683
468,766
Goodwill on consolidation
1,007
1,018
918
918
918
Non-current investments
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63/80
3,185
2,979
3,776
4,242
4,762
Inventories
14,308
27,734
35,795
37,654
47,335
Sundry debtors
7,533
11,537
13,068
13,157
16,107
Cash and bank balances
1,128
4,784
1,635
3,437
5,359
Loans and advances
45,541
70,593
93,425
111,884
128,274
Total current assets
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64/80
68,510
114,648
143,922
166,133
197,074
Trade payables
16,586
9,336
12,514
12,949
16,600
Other current liabilities
13,792
27,270
29,104
36,661
41,700
Provisions
20,522
31,063
41,449
50,300
60,083
Net current assets
17,611
46,980
60,856
66,222
78,692
Misc. exp. not written off
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65/80
78
0
0
0
0
Total assets
200,325
293,221
367,010
458,065
553,138
Source: Company, Nirmal Bang Institutional Equities Research
Exhibit 33:Cash flow
Y/E March (Rsmn)
FY10
FY11
FY12
FY13E
FY14E
EBIT
48,508
51,652
54,067
55,872
62,145
(Inc.)/dec. in working capital
4,010
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66/80
(13,300)
(23,403)
(370)
(13,383)
Cash flow from operations
52,517
38,351
30,664
55,502
48,762
Other income
603
815
1,419
751
900
Depreciation
10,430
11,510
13,865
14,777
17,917
Interest paid (-)
3,576
2,596
3,600
8,221
13,570
Tax paid (-)
7,630
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67/80
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68/80
10,481
21,410
12,200
11,900
Inc./(dec.) in long-term debt
(174)
44,883
11,634
49,196
47,986
(Inc.)/dec. in investments
2,057
273
(797)
(6,591)
(550)
Equity issue/(buyback)
441
113
38
0
0
Cash from financial activities
8,910
55,750
32,285
54,806
59,336
Others
1,978
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69/80
276
212
(5,741)
0
Opening cash
6,694
1,128
4,784
1,635
3,437
Closing cash
1,128
4,784
1,635
3,437
5,359
Change in cash
(5,566)
3,656
(3,149)
1,802
1,922
Source: Company, Nirmal Bang Institutional Equities Research
Exhibit 35: Key ratios
Y/E March
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70/80
FY10
FY11
FY12
FY13E
FY14E
Per share (Rs)
EPS
38.4
40.2
42.4
35.1
40.7
Book value
111.9
151.1
193.7
226.9
265.7
Valuation (x)
P/E
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71/80
10.6
10.1
9.6
11.6
10.0
P/BV
3.6
2.7
2.1
1.8
1.5
EV/EBITDA
7.9
8.1
8.1
8.6
8.2
EV/sales
4.2
3.9
3.0
3.0
2.7
M-cap/sales
3.4
2.9
2.1
1.9
1.5
Return ratios (%)
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72/80
RoE
34.3
26.6
21.9
15.4
15.3
RoCE
20.6
14.3
12.2
9.9
9.1
RoCE Adj CWIP
33.6
21.3
19.4
16.3
12.8
RoIC
10.3
2.8
3.2
1.0
5.3
Margin ratios (%)
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73/80
EBITDA margin
52.8
48.2
37.3
34.7
32.4
PBIT margin
43.7
39.4
29.7
27.4
25.2
PBT margin
40.8
37.8
28.3
20.9
20.0
PAT margin
32.0
28.5
21.6
16.0
15.4
Turnover ratios
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74/80
Asset turnover ratio (x)
1.2
1.5
1.2
1.4
1.6
Avg. collection period (days)
24.8
32.1
26.2
23.6
23.8
Avg. payment period (days)
121.9
53.4
42.2
37.5
38.0
Solvency ratios (x)
Net debt-equity ratio
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75/80
0.8
1.0
0.9
1.1
1.1
Interest coverage ratio
16.4
24.3
18.9
8.6
5.9
Source: Company, Nirmal Bang Institutional Equities Research
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Disclaimer
Stock Ratings Absolute Returns
BUY > 15%
HOLD 0-15%
SELL < 0%
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Team Details:
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Name
Email Id
Direct Line
Rahul Arora
CEO
+91 22 3926 8098 / 99
Hemindra Hazari
Head of Research
+91 22 3926 8017 / 18
Sales and Dealing:
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Pradeep Kasat
Dealing Desk
+91 22 3926 8100/8101, +91 22 6636 8831
Michael Pillai
Dealing Desk
+91 22 3926 8102/8103, +91 22 6636 8830
Nirmal Bang Equities Pvt. Ltd.
Correspondence Address
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