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JSW Steel's Q3FY20 results (Underperformer) - Optimism factored in numbers; expensive valuation

Q3FY20 Result Highlights: Lower prices offset higher volumes

• JSW Steel (JSTL IN) reported adj consol EBITDA of Rs22.0bn, down 3% qoq (IDFCe: Rs24.1bn), primarily due to lower profits at Indian subsidiaries and continuous elevated losses at overseas subsidiaries.
• JSW’s standalone adj. EBITDA of Rs24.2bn, was up 4% qoq despite higher volumes (4.03mt, up 12% qoq) and lower raw material costs as blended steel realisations declined by Rs2,800/t to Rs35,727/t. Steel realisations were lower due to weak prices in domestic market and downward revision in pricing contracts for auto-customers. As a result, EBITDA/t stood at Rs5,998, down 7% qoq.
• During Q3FY20, JSW’s overseas subsidiaries (US operations, USA Ohio and Aferpi) reported EBITDA loss of Rs3.48bn v/s EBITDA loss of Rs3.55m in Q2FY20.
• At Q3FY20 end, consolidated net debt excluding trade acceptances stood at Rs495.5bn, down ~0.2% qoq.

Key Positives: Higher domestic volumes, lower raw material costs

Key Negatives: weak prices, downward revision in contract price, continuous losses at overseas subsidiaries

Impact on financials: Reduce FY20 EBITDA by ~7.5% to factor in weak results in Q3FY20

Valuation- Reiterate Underperformer with revised TP of Rs223

We expect Q4 EBITDA/t to be ~Rs3,000 higher qoq to ~Rs9,000/t due to higher steel prices. Benefits of lower coking coal should be offset by higher ironore prices. We had already assumed delay in Dolvi expansion by six months (1HFY21E-end). As a result, our FY21E volume estimates remain unchanged at 17mt. We believe that net debt will remain high at ~Rs492bn even in FY21E, restricting equity value. Though uncertainity remains on acquisition of Bhushan Power which if happens will further depress equity value by ~Rs30/sh. Due to improvement in demand outlook and possible volume growth for next two years, we increase our valuation multiple from 6.0x to 6.5x.  As a result, we increase our target price to Rs223, valuing it at 6.5x FY21E EV/EBITDA. The stock is trading expensive at 7.2x FY21E EV/EBITDA. Reiterate Underperformer on the stock.