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JSW – 3Q19E results preview

It appears that the global hard coal/coke/steel industry has entered a strong downcycle, finishing over 2 years of extraordinary performance. Our belief is that the prevailing custom’s war between the USA and China has accelerated (or perhaps triggered) global economic slowdown, clearly initiating a negative chain of reactions in the steel industry (leading to a major slowdown in steel demand in Asia, inducing disruptive exports from Asia and damaging global coke and hard coal demand). As a consequence global hard coal price benchmarks plunged from US$ 200 per tonne in 1H19 to around US$ 150 per tonne currently. The situation in Europe has become especially critical, in our view. The European downstream market was particularly hit by the slowdown in the automotive industry and at the same time it was forced to deal with floods of Asian steel exports which created a substantial supply overhang. European steel mills are cutting production rates and further contributing to a drop in hard coal demand.

Apparently 2020 is likely to be very challenging for JSW. Any wish for a hard coal price rebound in 2020 could prove to be an overoptimistic one. Hard coal prices, if they average at US$ 150 per tonne in 2020, in combination with expected poor coke segment performance, could lead to a lowering of the Company’s FY20 EBITDA to roughly PLN 1 billion. With capex in 2020 expected at PLN 2 billion this should naturally imply a negative free cash flow in 2020 at an alarming level of PLN -1 billion. Given such outlook it is most probable that the Company will quit from paying any dividends. Perhaps only in 2021, the lower capex tied to project finalization and the possible rebound of hard coal prices, could neutralize free cash flows.

Given all the negative developments in the industry and the poor behavior of hard coal prices, we think it is completely justified that the equities of JSW dropped strongly and were a major underperformer recently. Nevertheless we continue to find the equities of the Company as fundamentally undervalued (Buy + Overweight, 12M EFV of PLN 40.0 per share). We think the equities have become just too cheap. In our opinion, the share market price of the Company is clearly discounting a lot. The Company’s current market capitalization is already below its vast net cash position, which suggests that the Company is treated as if it will be forever burning cash. Yes, we must admit that this year and probably in 2020, the free cash flows of JSW are bound to be strongly negative. But all this should be influenced by the culmination of the Company’s mining projects (which should improve cash flows in later years), the purchase of PBSz (which should also provide LT benefits) and the transfer of capex payments from 2018 into 2019. We think it would be unwise to extrapolate such a situation beyond 2020, especially since we think a rebound in hard coal prices will probably occur sooner or later.