Sell Jindal Steel & Power - Nirmal Bang

Regulatory Overhang + Single-Digit RoIC = De-rating; Sell

We assign a Sell rating to Jindal Steel & Power (JSPL) because of regulatory overhang, which will lead to a sharp deterioration in incremental return ratios. In the 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 captive coal mine allocation, which along with the company's large size, makes it more vulnerable to regulatory actions like ceiling on merchant power price or demand for free power (as witnessed in Orissa). We expect RoE and RoCE to decline from 21.9% and 12.2% in FY12 to 15.3% and 9.1% in FY14E, respectively, while RoIC 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, we still feel the pain is not over. The negative news flow is unlikely to stop, which coupled with distressed earnings due to delay in key projects will continue to lead to de-rating of the stock. Considering the above weakness, we feel a major portion of the price damage has already taken place, but there's likely to be a sizeable time correction going ahead.

Our estimates substantially below consensus projections: Our FY14E EBITDA/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 is taking 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 stopped approving mining leases due to a Supreme Court directive that all natural resources should be auctioned. This, coupled with the recent CAG (Comptroller and Auditor General of India) recommendation that coal mines have to be allocated via the auction route would prolong the pain, acting as a headwind on the stock.

Jindal Power's (JPL) 2x600MW plant doesn't figure in coal linkage list: The list of power plants for coal linkage under fuel supply agreement (FSA) doesn't include JPL's first two units of 4x600MW as per the minutes of Standing Linkage Committee's (SLC) meeting. Though it is not the end, it has definitely led to uncertainly in respect of coal sourcing. For the remaining 2x600MW units, JPL has to rely on imported and eauctioned coal, which erodes the returns profile sharply.

Iron ore sourcing at Angul plant remains a concern: JSPL has indicated sourcing of iron ore either from a third-party mine or in-house pellets. We would like to highlight that in the wake of the controversy surrounding Sarada mines, it would be difficult for JSPL to secure third-party mines at lucrative rates, while in-house pellet usage would transfer profits from one unit to another, rather than adding any incremental profits.

Valuation: JSPL trades at EV/EBITDA of 8.6x/8.2x FY13E/FY14E, respectively, higher than the past 10 years' median of 6.7x. We expect the stock to trade at lower multiples due to likely deterioration in return ratios. We assign a Sell rating to it with a TP of Rs300 (SOTP for steel and power business apart from CWIP at a discount).

Source : Equity Bulls

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