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JSW Steel's Q2FY19 results (Underperformer) - Profitability to taper off; leveraged on

Q2FY19 Result Highlights: a stable quarter

• JSW Steel (JSTL IN) reported better-than-expected operating results with consol EBITDA of Rs49.1bn, though down 3.9% qoq but ~9% higher than IDFCe. The beat is due to higher than expected steel realisation and higher other operating income (partly due to higher export benefits, scrap sales).
• Standalone EBITDA at Rs48.0bn, was flat on qoq basis. The 3% qoq higher volume at 3.96mt along with flat steel realisation was offset by higher coking coal & power cost. We infer that company was not hit by iron ore cost on a qoq basis due to reduction in prices by NMDC’s Karnataka mines. As a result, EBITDA/t stood at Rs12,126, down 3.7% qoq i.e. Rs464/t.
• During Q2FY19, JSW’s other subsidiaries (Consol-Standalone-JSW Coated and US operation) reported negative EBITDA of Rs225m v/s Rs894m in Q1FY19. Approx. Rs830m EBITDA loss was on account of recently acquired steel facilities in Italy & USA.
• At Q2FY19-end, consolidated net debt excluding trade acceptances was up 14.9% qoq to Rs449.2bn, due to consummation of acquisitions, rupee depreciation (MTM loss of Rs. 10.44bn) and higher working capital.

Key Positives: Stable steel realisation, lower increase in RM cost

Key Negatives: Higher power cost and debt, EBITDA loss of subsidiaries

Change in estimates: Increase FY19 EBITDA by 3.8% and FY20 by 1.1% to factor in higher steel prices, partially offset by higher RM cost

Valuation- Reiterate Underperformer with a TP of Rs312

We expect steel margins to compress by 15-20% in 2HFY19 vis-a-vis 1HFY19 EBITDA/t of Rs12,358 as it will be difficult to pass on entire increase in RM cost. JSW’s balance sheet will remain leveraged (FY20E net debt of ~Rs424bn from Rs387bn in FY18) with the aggressive capex plans of ~Rs400bn during FY19-21E to expand Indian operation. Moreover, JSW is the front runner in acquiring Bhushan Power at an estimated value of ~Rs187bn. Though we have not factored the acquisition in our estimates, but if it happened, will knock off ~Rs30/sh from our TP. We reiterate our Underperformer rating with an unchanged TP of Rs312, valuing it at 6.5x FY20E EV/EBITDA.