Industry Analysis on Steel Sector Anagram Stock Broking (Fin)

8/6/2019 Industry Analysis on Steel Sector Anagram Stock Broking (Fin)

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A REPORT ON

INDUSTRY ANALYSIS ON STEEL SECTOR

BYTARIQ SALEEM

ISFS05142

PROF. ARINDAM BANERJEE(Faculty Guide)

REPORT SUBMITTED IN PARTIAL FULFILMENT OF THEREQUIREMENTS OF MS (FINANCE) PROGRAM OF ISFS

2006

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http://www.orkut.com/Community.aspx?cmm=11157702


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DECLARATION

I declare that this Project Report entitled Industry analysis on steel sector is a bonafied work,which I have executed for the award of the Degree MS - Finance from ICFAI School of

Financial Studies, Hyderabad.

I further declare that it is my original work as a part of my academic course, it has not beensubmitted else where for the award of any degree or diploma of any other University or Institute.

(Tariq saleem)

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CERTIFICATE

This is to certify that the project report entitled Industry Analysis on steel sector is anoriginal work done by the student under my supervision.

Date: Prof. Arindam Banerjee

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ACKNOWLEDGEMENT

I am so grateful to Mr. K Sampath kumar , regional manager of Anagram Stock Broking,Hyderabad for permitting me to do the project work in their esteemed organization by giving

necessary information and providing great support.I would like to convey my heartiest thanks to Prof Arindam Banerjee , faculty guide, ICFAI

School of Financial Studies for his continuous support.

I thank Mr. Sridhar, Mr. Perwez and Mr. Rajesh for their cooperation during the project.

I thank to Prof. Lalitha Shankar , SIP Coordinator, ISFS for her cooperation during this SIP.

I am also thankful to my family and friends for being a source of inspiration and support throughout the project period.

(TARIQ SALEEM)

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TABLE OF CONTENTS

1. EXECUTIVE SUMMARY .6

2. HIGHLIGHTS..........................8

3. FINAL MAIN TEXT..................................10

4. CURRENT PROBLEMS....64

5. RECOMMENDATIONS.65

6. CONCLUSION66

7. REFERENCES...................68

8. APPENDIX....69

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EXCUTIVE SUMMARY

Economy

Indian economy is registering a robust growth. For last four yearsit has registered a growth rate of more than 7.5% in GDPconsecutively. Services & industry have contributed to higher GDP. Improvement is quite pronounced in manufacturing, capitalgoods & consumer durables that have registered a double digitgrowth rate. Six core industries i.e. electricity, coal, finishedsteel, cement, crude oil& petroleum products have registered alower average growth rate of 5.6%With burgeoning exports whichhave crossed US$100Billion mark in FYO5-06for the fourth

consecutive year. Inflation rate is moderate within 4-5%. Rupeeis stable against US$ .growing forex reserves which is tune US$160bn. Future of Indian economy is quite optimistic & all sector of the economy are expected to do well. Business confidence isall time high .

Industry

Steel industry FYO6 has registered a healthy growth of 5 %higher than that of corresponding period of previous year, aid byautomobile & infrastructure sector. Emerging markets are likely

to account for 65 - 70% of the global steel demand by 2020Among the developed markets, the US, Japan, Germany, Italyand Canada put together accounted for 57% of the demand in1994.but, by 2004, the share of these developed countries haddropped to 41%. The share of China, South Korea, Russia, Indiaand Brazil among the top ten consumers rose from 42% in 1994to 59% by 2004. The emerging markets are expected to accountfor 65-70% of the global demand by 2020 China and India arespearheading growth in crude steel production ,between 1995and 2003, Chinas economy grew at an annual rate of 8.3%, while steel consumption grew at 12.5% per annum.This has to be compared with growth in steel consumption in therest of the world, which was 1.4% per annum over this period.China has a gross fixed capital formation of close to 42% of itsGDP. The country therefore, is in a very steel-intensive phaseof development and a key driver for global demand

International & Domestic prices have declined on fears of excesssupply This has been visible across the globe, especially in

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the CIS, European and US markets.. The average price in thedomestic market during April-November 2005 has rise by3% y-o-y as against a rise of 29% in April-Nov 2004.

Although India is the eight largest consumer of steel globally, it s

steel consumption is lowest in the world. Steel demand in Indiaover the last 10 years (fy95 fy05) grew at CAGR of 6.3% . theproduction of finished steel grew at a much faster pace of about8% during the same period .ratio of gross capital formation toGDP for India is currently low compared to china. Indias ratio isabout 26% as against 42% for china. However, this ratio hasbeen rising over the last 3 years, which will definitely propeldemand for steel .Roads, ports, power & housing account for 40% of the steel demand in India. Automobile /white good sector will further drive the growth in India. CAGR during (fy96- fy06) for passenger vehicles has grown at a rate of 11% .in fy06, growthin this segment was exceptionally good at 18 % on the back,rising income level. Thriving middle class population & a softinterest rate regime ,it is expected the demand for passenger car to grow at 12-15 % over next year which will ultimately givethrust to steel demand.

Outlook

In fy06 ,the consumption of steel continues to remain strong,growing at over 9% YOY compared to 5.9 % & growth visible infy04 The world economy is expected to grow - on an average- at3% in 2006 and 2007. This will drive steel demand upwards,globally, over the next year. The global demand for steel isexpected to grow by about 3% in CY 2005, followed by nearly5% in 2006. The growth in China is expected to slow down - fromover 17% in 2004 to 10% in 2005 and to about 8.3% in 2006.However, it is expected a recovery in 2006, par ticularly inthe rest of the world, excluding China. After a stagnantgrowth in 2005, regions other than China are expected togrow at nearly 4% in 2006.The Indian Steel sector is fairlycompetitive and dispersed. Which are fully geared up for facingany eventuality.

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December, 2005

HIGHLIGHTS

India is the 8th largest producer of steel in the world, but per capitaconsumption is one of the lowest. It accounts for 3.2% of the world steelproduction of 835mt.

In FY05, India produced 42mt (million tonnes) of finished steel.

The demand for steel in India is derived from other sectors of theeconomy like automobiles, consumer durables and infrastructure.

Over the last few years the performance of the Indian steelindustry has been adversely affected due to over-capacity, cheap imports,

economic slowdown, declining global steel prices and anti dumping dutyimposed by USA on Indian exports. However, few recent events like thecapacity curtailment by the OECD countries, price and demand hike portendgood prospects.

According to the routes of production, the industry can be classifiedas, Integrated Producers and Secondary Producers with the products beingIron ore, Pig iron, Sponge iron, Flat steel products, Long products and Alloysteel products.

SAIL ranks 13th and TATA Steel 57th among worlds 80 largest steelproducers. TATA Steel is the lowest cost producer in the world as well.

During April-October 2005, exports of iron & steel bars/rods andprimary and semi-finished steel reduced sharply by 28% while imports of

iron and steel went up by 6.5%.


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The New Industrial Policy, 1991 opened up the sector to the privateplayers.

National Steel Policy, 2004-05 was framed to inject further competition into the industry and provided a clause of Buy Indian Act.

The Vision 2020 brought out by the Ministry of Steel last year aims at increasing steel demand by 200% in the country by the year 2020.This implies a CAGR of more than 5.5%.

A trust, Indian Steel Alliance, has been formed, whoprepared a five-year programme for creating demand of steel.


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Flow chart of Indian steel industry

I N D I A N S T E E L

I N D U S T R Y

P ub l ic S ec to r

P r i v a t e S e c t o r

I n t e g r a te d

P r o d u c er s

S e c o n d a ry P r o d u c e rs

I nt e gr at ed

P r o d u c e rs

S e c o n d a r y P r o d u c e r s

I r o n O r e P i g I r o n S p o n g e I r o n F l a t S t e e l P d t s L o n g P d t s A l l o y S t e e lP d t s

On the basis of routes of production, the Indian steel industry can be divided intotwo types of producers-

Integrated Producers are those that convert iron ore into steel. Thereare three major integrated steel players in India, namely Steel Authority of India Limited (SAIL), Tata Iron and Steel Company Limited(TISCO) andRashtriya Ispat Nigam Limited (RINL).

Secondary Producers are the mini steel plants (MSPs), which make steelby melting scrap or sponge iron or a mixture of the two. Essar Steel, IspatIndustries and Lloyds steel are the largest producers of steel throughthe secondary route.

Structure of the Industr y Number Capacit y Mn tones Capacity Utilization (%)

Main Producers 3 19.3 104

Other Main Producers 3 6.4 97

Total 25.7

Secondary Sectors

Sponge Iron Producers 120 13.0 75

Mini Steel Plants 650 14.7 58

Re-roller s 1200 15.0 55

Source : Ministr of steel


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Based on product categories (and major producers), the industry can be dividedas follows :

PRODUCTS

PLAYERS FEATURES

Iron Ore

National MineralDevelopmentCorporation, KudremukhIron Ore Co, Sesa Goa,SAIL, Tata Steel

India ranks 6th in production of iron ore in theworld

Accounts for about 6% of total globalproduction

Pig Iron

RINL, Sesa Industries,Usha Ispat, MalvikaSteel, Kalinga Steel,Kirloskar Ferrous, SAIL

Total capacity is 6.8mt per annum

Growth is dependent on automobile,engineering and railways

Hot Rolled

Coils/Sheets

(HRC)

SAIL, Tata Steel, Essar Steel, Ispat

Industries, JindalVijaynagar

HRC is used in automobiles, engineering andconsumer durables

Sheets are used in LPG cylinders, tubes, pipes,drums, auto

components, ship building and boilers

Mainly used for further processing to CRC

Cold Rolled

Coils/Sheets

CRCSAIL, Tata Steel, IspatIndustries, Jindal Groupof Companies, UttamSteel, Bhushan Steel

Used for manufacturing coated sheets,automotive sector and white goods sector

Total installed capacity of about 5mtpa.

Grew at a CAGR of 11.2% between FY93 andFY99.

Galvanized

Sheets

Used in fabrication work like car bodies, ducts,consumer durables and roofing.

Mills are capital intensive

Installed capacity is 1.6mtpa

Demand could get a boost by the governmentsinitiative to boost housing demand.


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LongProducts

SAIL, RINL, Tata Steel

Includes bars, structural products, wire rods,angles and rounds

Used in construction and heavy engineering

Account for about 50% of total demand for steel in India

Total installed capacity is 22mtpa

Alloy Steel

Products

Mukand Steel, Musco,SAIL, Kalyani Steels,Usha Martin, Sunflag

Iron

Value-added steel for specific application

Stainless steel is one of the highest valueadded product

Used in auto components, ball bearing,engineering items, springs, boilers, utensils

Against a demand in the range of 1.5mtpa, thesector has an estimated installed capacity of 3.0mtpa


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Performance of the steel industry

Over the last few years the performance of the Indian steel industry has been adverselyaffected by the over- capacity, cheap imports, economic slowdown, declining global steelprices and also anti dumping duty imposed by USA on Indian exports. Most major steelcompanies have thus been reporting losses, except forTISCO, MONNET ISPAT,JSW STEEL& SAIL

Consumption

After liberalization, there have been no shortages of iron and steel materials in thecountry. Apparent consumption of steel increased from 15mt in FY92 to 36.5 mt in FY05and recorded a growth rate of 6.5% per annum over 1997-2006 . The consumption of finished steel during the current year at 38 mt was marginally higher (0.6%) than theconsumption in the corresponding period of last year. The predominant traditional steelconsuming sectors in India are as listed in Table 1.

Traditional steel consuming sector

Infrastructureandconstruction

Construction activities of all housing, buildings, factories, roadsand bridges, power projects and transmission systems,railways and defense projects

Transportation Passenger cars, trucks, buses and other automotive

Consumer items andcapital goods

Consumer durables (refrigerators, washing machines,electric irons, steel furniture, LPG cylinders and kitchen wares)

Capital goods (machinery, equipments, farm tools andOthers Containers, packaging for food preservation and pipelines

Domestic industries like housing, infrastructure projects, power projects, fertilizer projects, auto sector, white good sector have shown a slump in demand for steel. Steelindustry has thus been facing a demand recession. In recent times, impetus is givento the demand from the non-traditional sector, particularly in the construction,rural and agro-based industrial sectors. The figure alongside gives the product- wisepercentage consumption of finished


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Demand-supply scenario

In the last five years, the steel demand (based on apparent consumption) has grown at acompounded average growth rate of around 4.3%. The government has forecast the steeldemand using a GDP elasticity of demand for steel at 1.33. The earlier forecast by thegovernment appointed working group has placed the demand at an ambitious 38.68million tonnes including that for exports by the year 2004-05. The projections also includedomestic production of 38.01 million tonnes. Clearly, these targets look unrealistic giventhe slow growth in demand from witnessed so far in the plan

In addition, the light and heavy engineering and automobile industries (vital end usesectors for flat products) are not doing too well either. Capacity additions especially thatfor HR products from companies such as Ispat Industries are held up due to project costescalation and the resultant needs to tie up additional funds.

On the whole, the domestic demand-supply scenario is not expected to show a dramaticimprovement in the next two years. The overall steel demand will only show a moderategrowth.

Steel consumption worldwide is likely to rise by 5.5% this year the highest figure since1997, according to World Steel Dynamics projections. World steel prices arenow close to the levels seen in late 1998, when they touched their lowest points in 20years. With about $200 bn steel consumed a year worldwide in sectors like construction,automobiles; low price for the material means the reduction in price pressures for manycustomers and Industrial companies.

Global scenario

In 2004 World Crude Steel output at 902 million metric tons was 6% more than theprevious year.

China remained the worlds largest Crude Steel producer in 2004 also (282 million metrictons) followed by Japan (208 million metric tons) and USA (142million metric tons). Indiaoccupied the 9 th position (38.8 million metric tons).

USA was the largest importer of steel in 2004 followed by China and Germany.

Japan was the largest exporter of steel in 2004 followed by Russia and Ukraine.

Other significant recent developments in the global steel scenario have been:

The crisis of excess capacity and prevalence of market distorting practices in the globalsteel market has induced protectionist measures from a number of steel tradingcountries. To address these issues a series of high-level inter-governmental meetingshave been held under the auspices of the OECD. As a part of the long-term solution toglobal steel over-capacity, the proponents of the OECD steel deliberations are of theview that subsidies and related government support have caused and are causingsignificant distortions in the steel markets and these will be required to be reduced andwhere possible eliminated.


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In March 2002 the US President announced imposition of temporary safeguard measureson import of key steel products into USA. In retaliation to the US action EU has alsoimposed provisional safeguard measures against import certain steel products. China,Canada and Thailand are some of the other countries that have initiated safeguardinvestigations against import of steel products into their countries.

Indian Scenario

India produces 40 42 million tons of steel per annum, which is mainly constructionsteel. India imports its entire requirement of specialized steel such as for razor blades,car body etc. The 3 4 integrated steel plants produce 24 m tons and the small steelManufacturers produce 8 m tons. The important ports for steel import and export areViziq and Chennai. India also exports construction steel to countries like China, which isof excess. The important organizations are Steel Corporation of India and the Small SteelProducers Association.

Market scenario

After liberalization, with large scale addition to steel making capacity, there is noshortage of iron and steel materials in the country.

Apparent consumption of steel increased from 14.84 million tonnes in 1991-92 to 42.85million tones in 2004-05.

The production of steel in 2002-03 is 42.85 million tones as against 30.63 million tonnesin 2003-04 thereby registering an increase of 14 %.

The demand of steel has been firmed up both at home as well as internationally.

Efforts are being made to boost demand particularly in rural areas and also to increaseexports.

Prices of iron and steel have witnessed a steady rise over the last few months. Domesticprices have firmed up in the face of strong demand both domestic and foreign.

Production

Steel industry was de-licensed and decontrolled in 1991 and 1992 respectively.

India is the 8 th largest producer of steel in the world.

In 2004-05, finished steel production was 42.85 million tonnes.

Pig iron production in 2004-05 was 8.76 million tonnes.

Sponge iron production was 9.45 million tones in 2004-2005.

In 2004-05, nearly 32% of crude steel production was by public sector the remaining 68%b i


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In 2004-05, the integrated steel plants produced 43.5% of finished steel and theremaining 56.5% was by the secondary producers.

Last seven years production performance is as under:-

1998-99 1999-2000

2000-01 2001-2002

2002-03 2003-04 2004-05

Pig Iron 3.30 3.39 3.00 3.18 5.26 7.95 8.76Sponge Iron 5.00 5.32 5.11 5.34 6.90 8.12 9.45

Finished Steel 22.72 23.37 27.82 30.63 32.85 37.63 42.85

In Million Tons

Budget impact 2006

Proposals Impact

No Change in import duty on Neutral

Reduction in import duty on Positive

Increase in import duty onferrous scrap from 0 to 5%

Negative for mini-steel plants ( using EAF route) -

Increases raw material cost.. Positive for sponge

Reduction in import duty onalloy steel from 10 to 7.5%

Double benefit for alloy steel manufacturers -

Duty on raw material (scrap) increased; import duty onfinished good has been reduced. However overallvolumes of reduced .however ,,im ort of allo steel in

Reduction in import duty on Some relief for alloy steel manufacturers


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INVESTMENT SUMMARY

Steel prices to rally

Steel prices have been declining sharply during April 2005 to early 2006 after witnessing a sharp increase since FY02. however there will be recovery in FYO6.Subsequently, developments in China (in terms of dynamics of demand andproduction cuts) would play a critical role in determining further price movements. the recentrecovery in steel prices is not just a technical bounce back but is driven by fundamentalreasons and with the strong availability of the basic raw materials. the outlook for Indiancompanies is looking good. The best picks in the sector are Tata Steel, Monnet IspatJSW Steel and SAIL .rationale is based on the following observations.

Declining Inventory levels :

A huge inventory was the key reason for the sharp fall in steel prices in 2005.However, the inventory levels have since declined. The stock levels in Asia tooreduced in tandem with the decline of steel inventories across the globe to normallevels. The declining inventory levels coupled with the anticipated increase insteel prices has led to re-stocking of steel and to an increase in steel demand. Thiswas evident from the increase in fresh orders placed by the traders in Asia duringearly 2006.

Demand remains buoyant: The strong economic growth seen in the Asian region andthe BRIC countries is expected to be supported by a strong GDP growth. According to IISIestimates, global steel demand is estimated to grow by 7.3% in 2006 and a further 5.8% in 2007. This growth is expected to be propelled by the fast growingeconomies of BRIC country

Asia driving global demand growth

( mn t)

1,400

14%

1,2

00

12%

1,000

10%

800 8%

600

400

200

-


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6%

4%

2%

0%

2002 2003 20042005E 2006E2007E

A sia, Ocenia Restof the w orld Growth


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Production cuts would help curb supply: Steel players in theEuropean Union and America have been able to sustain high steel pricesby resorting to production cuts. In the Asian markets too, Japaneseproducers have been curbing production in an effort to ease the excess supplyscenario. Even the Chinese National Steel Policy has a focused approach

towards higher consolidation and discourages smaller steel units. Higher consolidation would lead to better co- ordination and to more effectiveproduction cuts. A possible slow downin domestic steel consumption in Chinamay result in higher exports and this is a cause of concern. It is believed thatproduction cuts would help partially ease the situation and dilute the impactof China turning netexporter.

Production cuts -Critical

(mntonnes)55

(mn tonnes)105

10050

95

45

90

40

85

35Jan- Feb- Mar-Apr- M

Jun- Jul-A

S Oct-N

8

D Jan- Feb- Mar-050505

05ay-

05

0505

ug-05

ep-05

05ov-

05

ec-05

06 06 06

Asia, Ocenia (LHS) Rest of w orld (LHS) Total (RHS)

S

ou r c e: I I S I


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Rising costs of production will help in stabilizing steel price: The cost of producing steel has seen a sharp increase in the past few years due to risingraw material prices. While iron ore have registered 71..5% higher prices,coking coal and coke prices too witnessed a sharp increase. This has resulted inan increase in the cost of production for steel. This would further impact thecost structure of non- integrated players who outsource iron ore requirements.Indian players, being self sufficient in their iron ore requirements, are insulatedfrom the above risk. This further improves the competitiveness of Indian players

vis--vis their global peers thus making them more attractive.Most of the Chinese players depend upon imports to meet iron orerequirements. Chinese steel producing companies have very thin profit marginsand any increase in iron ore prices would further impact cost structures andcould lead to closure. The closure of such units would further ease thesupply pressure in the region leading to firming up of steel prices.

Iron ore prices to rise 15-19%, coking coal prices to drop.

The global iron ore industry is fairly consolidated with three playerscontrolling almost 70% of the total iron ore supply. A steep increase in Chinesesteel production and the resultant increase in demand for steel from China(which depends mostly on imported iron ore to meet its requirement) led to asharp increase in 2005-06 iron ore price contract. With steel prices coming off their peak, there is a view that iron ore prices should decline. However, the high levelconsolidation among iron ore suppliers would help them push for a further increase in iron ore prices. Its expected iron ore for 2006-07 will be at 15-19%higher levels. However, the fresh coke making capacities (coming up), coupledwith the declining sea freight rates would translate into a reduction in cokingcoal and coke prices and provide some respite to steel producers.

Indian players best placed in the industry

The Indian players are best placed to take advantage of the positives expectedin the steel industry, going forward. The key reasons for the same are as follows:

Domestic market poised to show rapid growth:

The Indian economy is expected to witness robust growth, going forward. The

upswing in construction on the back of strong growth in the housing sector, and thereal estate boom in the commercial space coupled with thegovernments increased focus on infrastructure development would lead To stronggrowth in construction. regression analysis of domestic steel consumption withGFCF-Construction (proxy for industrial growth) and IIP-Transport (proxy for growthin automobile growth) indicates 9% CAGR growth over the next two years. Thisapart, Indias per capita steel consumption is much lower than global peersand much lower given its level of per capita income. Thus, the domestic market,which is the key market for the Indian steel players, is poised for rapid growth.


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Indian players are insulated from the risk of rising iron ore prices

most of Indian steel players own captive iron ore mines. While the expectedrise in iron ore prices is likely to put pressure on the cost structures of globalsteel players, the Indian players are seen insulated from the same. Thus, the rise insteel prices, consequent to the increase in iron ore prices, would flow directly to the

bottom line of Indian players. Moreover, India is not self-sufficient in coking coaland hence has to depend upon imported coking coal to meet its requirements. Withglobal coking coal prices expected to soften, going forward, the cost structure of Indianplayers would further improve.

The top picks

Integrated players and companies with huge volumes growth over the next two years

Given Indias self-sufficiency vis--vis the key raw material (captive iron ore mines)and the resultant low cost of production, and the robust 9% growth expected in thedomestic market, the integrated Indian players seem well placed. Thus, whilenon-integrated players would suffer a squeeze in operating profit margins,players like Tata Steel and SAIL would be insulated from this risk. Thisapart, the estimated softening of coking coal prices would further improve thecost of production of Indian players like SAIL. The top picks from the sector are

companies that are well integrated or those that areexpected to witness strong volumes growth after starting of fresh capacities.Tata Steel and SAIL (with captive iron ore mines) would be insulated from thestrengthening iron ore prices and result in improved competitiveness vis--visglobal peers. The higher volumes would drive revenue growth for Monnet Ispat.Jindal Steel and Power would benefit not only from higher volumes but its valuationstoo would get boost owing to its foray into the power business. With consolidationexpected to increase globally, it is believed that the EV/EBIDTA would bethe most apt ratio for valuing integrated players. However, the non-integratedplayers like Monnet Ispat, Jindal Steel and Power have been valued on a P/E

basis given their exposure to other businesses like power.


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Valuation comparison

Company Year Sales EBITDA PAT EPS EV/E P/EMONNETISPAT

FYO5

FYO6

FYO7 E

5227

8643

10432

1520

3058

3636

1178

2298

2704

36.2

52.5

61.8

7.2

4.4

3.3

6.1

4.2

3.6

JSWSTEEL FYO5

FYO6

FYO7 E

61801

72239

80539

16843

20185

23831

8568

7330

9195

54.6

46.7

58.6

4.4

3.9

2.9

4.5

5.3

4.2


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SAIL FYO5

FYO6

FY07 E

258492

287770

304940

69774

91899

97376

39851

54829

58220

9.6

13.3

14.1

3.9

2.9

2.6

6.9

5.0

4.8TATASTEEL

FY05

FY06

FY07 E

151394

175303

180402

59311

71456

71357

35060

43726

44619

63.3

79

80.6

4.2

3.2

2.7

7.3

5.8

5.7


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Global steel prices have been low, recovery underway

The increase in inventory in Asia had resulted in a sharp drop in steel pricessince April 2005. However, inventory levels have declined. Re- stocking of steelcoupled with the production cuts planned in China and the rising cost of producingsteel makes it is believed that steel prices have Been low and the recovery issustainable in the near term. Thus, we expect steel prices to continue to increaseuntil June 2006. However, as prices recover, the supply, particularly in China,would increase. This would result in the steel prices once again coming under pressure. Thus, while prices would recover, the increase would automatically becapped by the rising supply. Hence, it is believed that steel prices wouldstabilize subsequently. The extent of success of Chinese production cuts wouldbe critical to any further movement in steel prices. On an average basis, it isexpected steel prices to increase by around 8-10% in FY07E and declinemarginally thereafter.

Average HR coil prices - CIS

($/tonne)

500

450

400

350

300

250

200

Source: Cris Infac, IIL

Inventory liquidation has helped bring down the overall inventory levels: Thesteel prices had witnessed a steady increase in the past few years. The robustgrowth in steel production in China had pushed up the raw material pricesthereby resulting in a sharp increase in steel prices, which reachedUSD560/tonne (HR Coil CIS) in March 2005. The expectations of a further increase in steel prices resulted in a huge inventory build-up. However, withconsumption in China slowing down, the overall steel consumption was lower thananticipated. This resulted in building-up of inventory, which translated into a sharp dipin steel prices. Steel prices thus declined by almost 30% during April-December 2005 to USD395/tonne. With the excess inventory now liquidated, restocking at


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the trader levels coupled with higher than expected consumption in China led to arecovery in steel prices.


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While demand remains buoyant, rising production remains a concern: In the past four years,buoyed by strong growth in China, global steel consumption has grown at a CAGR of 7.1%. The thrust of the Chinese government on building the countrys infrastructurewas the key growth driver. According to the latest short range outlook by International Ironand Steel Institute (IISI), global apparent steel demand is expected to grow by6.5% over the next two years (2006-2007). Although the rate of growth in China would decline (from16.7% in 2005 to 13% in 2006 to a further 12.1% in 2007), it would continue to drive

global steel consumption growth. The rest of the world (ROW) (excluding China) is expectedto grow by 4.7% in2006 and 2.7% in 2007.

IISI Apparent Finished Steel demand forecast2001 2002 2003 2004 2005E 2006E 2007E

Europe (25) 174 174 178 168 160 167 169

CIS & other Europe 39 38 39 69 73 76 79

NAFTA 137 140 133 149 136 143 145

Central & South America 26 25 26 33 33 35 38

Africa 16 18 18 21 22 24 25Middle East 23 25 28 31 35 38 41

Asia Pacific 356 401 451 504 555 605 653

World 771 820 873 974 1,013 1,087 1,150

Growth 6.4% 6.4% 11.6% 4.1% 7.3% 5.8%

Source: IISI

China has been aggressively scaling up steel production in order to meet its domesticrequirements. The rapid infrastructure growth and the resulting rise in steel demand hadresulted in the setting up of huge steel making capacities. With China growing at a robustpace in the past two years, it remained a net importer of steel despite the robust ramp up of

production capacities. However, with demand growth in China slowing down, it has turned intoa net exporter of steel. As can be seen from the following graph, while China has been a netexporter in semi-finished steel for some time, it has turned net exporter of steel products in January2004


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China turns net-exporter (mn tonnes)2.0

1.51.00.5

0.0

-0.5

-1.0

-1.5

-2.0-2.5

-3.0

-3.5A pr -04 Jul- 04 Oc t- 04 Jan -05 A pr -05 Jul- 05 Oc t- 05 Jan -06

Steel produc ts Semis Total

Moreover, a further increase in crude steel capacity in China during 2006and2007 would result in higher exports. Thus, the demand-supply balance in the Asianregion could change which will impact in the near term. However, the impact would befelt more on select steel products rather than semi-finished steel.

(For details of Chinas Steel Industry, please refer to Annexure - 1) In the rest of the world, no major fresh capacity additions are expected and therefore the

supply is not going to outstrip demand unless exports from China spill over inEurope.

Chart Asia - Driving crude steel production

('000 tonnes)

300

250

200

150


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100

50

01Q2004 2Q2004 3Q2004 4Q2004 1Q2005 2Q2005 3Q2005 4Q2005 1Q2006

Asia, Ocenia Europre Amer ica CIS Af rica

S ou r c e: I I S I

Rising share of BRIC in apparent steel consumption

(mn t) 2002 2003 2004 Per capita steel consumption

(2004)

Brazil 16.5 16.0 18.4 102.2

Russia 27.8 31.9 33.7 225.7India 28.9 30.3 32.3 30.7

China 186.3 233.6 265.0 206.8BRIC 259.5 311.8 349.4World consumption 820.3 886.4 967.9

Share of BRIC 31.6% 35.2% 36.1%

Source: JPC

However, production cuts and rising iron ore prices indicate towards arise in steel prices:Despite the expected capacity additions especially in China, it is believed that steelprices are unlikely to decline further. Production cuts have been successfully


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implemented in European Union and the US, Asian players including China are takingconcrete measures to implement the same. This apart, while prices of other rawmaterials has been declining; iron ore prices are expected to rise by 15-19% in 2006-07.This would affect the cost structures of non-integrated players especially in China (as itimports more than 50% of its iron ore requirements) thus warranting an increase insteel prices .

Production cuts to look forward: In an effort to ease the pressure of rising supply and a

consequent decline in steel prices, steel players across the globe have been trying tocurtail production. Steel producers in European Union have been implementingproduction cuts in the past few months resulting in steel prices remaining firm in theregion. Asian countries are also planning to curtail production. While Japanese producershave implemented production cuts in the past few months, the Chinesegovernment is also taking initiatives to curb steel production. Chinas National SteelPolicy has indicated the closure of small steel capacities. Recently, member companies of China Iron and Steel Association (CISA) agreed to a 5% cut in production in abid to stabilize prices. Such initiatives would result in improving the over-supplyscenario prevailing in China thereby further justifying an increase in steel prices.However, implementation of production cuts in China would take place in the second half of

2006.

Production cuts -critical

(mntonnes)55

(mn tonnes)105

10050

95

45

90

40

85

35Jan- Feb- Mar-Apr- M

Jun- Jul-A

S Oct-N

80

D Jan- Feb- Mar-050505

05ay-

05

0505

ug-05

ep-05

05ov-

05

ec-05

06 06 06

Asia, Ocenia (LHS) Rest of w orld (LHS) Total (RHS)

S ou r c e: I I S I


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Rising iron ore prices another factor justifying a hike in steel prices: The cost of producing steel varies across the globe depending upon the self-sufficiency in rawmaterials and power charges. While the cost of producing steel is the highest in theEuropean Union (USD445/tonne), it is the lowest in Russia (USD250), the globalaverage being USD370 per tonne. Fresh iron ore contract are likely to be signed at15-19% higher levels and would result in an increase in the cost of production by USD10-13per tonne of steel. This coupled with rising fuel prices have put pressure on the coststructure of steel players. Thus, any decline in steel prices would put further strain on the

cost structure of steel producers leading to closure of unviable units and a correspondingdecline in production.

This would improve the demand-supply gap scenario and cap any decline in steelprices. It is

estimated that almost a third of the capacities in China are operating at very thinprofit margins and any increase in the cost of production would lead to a further deterioration. Hence, it is believed that rise in iron ore prices would translate into a cost-pushincrease in steel prices .

Impact of increase in iron ore contract price

Ex ected increase in iron ore rices 10% 12% 15% 18% 19% 20%Iron ore price - 2005-06 ($/tonne) 42.0 42.0 42.0 42.0 42.0 42.0

Iron ore price - 2006-07 ($/tonne) 46.2 47.0 48.3 49.6 50.0 50.4Increase ($/tonne) 4.2 5.0 6.3 7.6 8.0 8.4

Norm - Iron ore required per tonne of steel 1.6 1.6 1.6 1.6 1.6 1.6Increase in steel cost of production ($/tonne) 6.7 8.1 10.1 12.1 12.8 13.4Source: IIL

Increase of steel prices is result of increase in input prices

Input(US$/T) FYO2 FY03 FY04 DIFF OVER FY 02 % INCREASE OVER 2002Coke 120 200 500 380 31

melting scrap 110 220 300 190 173pig iron 110 220 350 240 21iron ore 28 43 110 82 29freight 9 23 40 31 3

Indian Railways: Comparatively High Tariffs (% total cost)


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SwedenJapan 3FranceCanadaChinaIndia

Power cost high in India (% of total cost )

South AfricaCanada 3KoreaMexicoAmericaIndia

Tariff at Indian & foreign ports (Osaka been indexed )

Osaka 1Singapore 1honking 1TianjinMumbai 4Source: metal & mineral review


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High cost of production - To cap any further decline

Eur ope

445

USA-integrated

388

Japan

378

Austr alia

375

Worldaverage

370

SouthKorea

362

China

335

India

Br azil

266

Russia

250

200 250 300 350 400 450(Average operating cost ($/tonne)

Sour ce:

Indu stry

Domestic steel prices to follow global trends in the long run

Steel is a globally traded commodity. Hence, domestic steel prices have traditionallymoved in line with the domestic cost for steel. Going forward, with Asian steel prices makingan impressive recovery from the lows seen at the end of 2005 and coupled with therobust domestic demand outlook, domestic steel prices would increase. Low Asiansteel prices have been the key reason for capping any increase in domestic steel pricesdespite strong domestic demand.

Domestic steel prices follow global trends

(Rs /tonne)


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40,000

($/tonne)600

35,000

525

30,000

450

25,000

375

20,000

300

15

,000

225

10,000

Jan-95

Jan-96

Jan-97

Jan-98

Jan-99

Jan-00

Jan-01

Jan-02

Jan-03

Jan-04

Jan-05

150Jan-06

Domestic price (LHS) HR coil - CIS (RHS)

Source:CrisInfac

However, with Asian steel prices recovering, steel producers would be able tosuccessfully push for an increase in domestic steel prices. While the onset of monsoon would lead to softening of steel prices domestically(especially long

products), it is understood that the average prices for FY07Ewould still be higher than that in FY06.Domestic demand to grow at a robust 9.4%: Buoyed by stronggrowth expectations for key consumer industries like automobiles and construction, it isexpected domestic steel consumption to grow by a robust 9.4% over the next two years.

Globally growth in steel consumption has a high correlation with GDP

growth.. Thus, it has been forecasted on the basis of domestic steel consumption byevaluating with GFCF-Construction (Gross Fixed Capital Formation) and IIP-Transport. The two variables - GFCF-Construction and IIP-Transport represent the


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two key consumers of steel construction and automobile. regression analysis of the above two variables with domestic steel consumption indicates a steeldemand growth of 9.4% over the next two years. For regression study, it isassumed GDP to grow at 7.4% in FY06 and 7.2% in FY07. IIP-Transport has beenassumed at 11% in FY06and FY07

Domestic demand to remain buoyant

('000tonnes)45,000

(%)14.0

40,000

10.8

35,000

7.6

30,000

4.4

25,000

1.2

20,000 1995- 1996- 1997- 1998- 1999- 2000- 2001- 2002- 2003- 2004- 2005-2006-

-2.0

96 9798

99 0001

02 0304

0506E

07E

Apparent steel consumption CA GR

S ou r c e:II L


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The National Steel Policy, 2005 has also projected domestic steel consumption togrow at a CAGR of 6.9% over the next 15 years. In April- December 2005, domesticfinished steel consumption has increased by9.4%. This further strengthens facts of robust growth in domestic steel consumption .

Domestic steel scenario(mn tonnes) Production Imports Exports Consumption

2004-05 38 2 4 36

2019-20 110 6 26 90

CAGR 7.3% 7.1% 13.3% 6.9%

Source: National Steel policy 2005

The per capita steel consumption in India is very low at 30.7kgs in 2004. It was 207kgsin China, 224kgs in UK and 409kgs in USA. The per capita steel consumptioneven in other developing countries like Argentina and Brazil was at 102kgs and92kgs, respectively.

As can be seen from the graph below, we observe that India is consuming lower steel,which is lower than other developing economies. This apart as India consumes moresteel, its consumption would increase at a higher pace initially given thehigher investments in infrastructure and then stabilize. Thus, India would witnessa strong growth in apparent steel consumption over the next few years.


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Chart 10: Per capita Income v/s per capita steel consumption

Per capita

income(PPP)

(US$)

45,000

40,000

35,000

30,000

25,000

20,000

USA

Singapore

15,000

10,000

5,000

0

Argentina

RussiaChina

0 100 200 300 400 500 600 700 800Per-capita steel consumption (kg)

Per

capitaincome(PPP)

(US$)

10,0009,0008,0007,0006,0005,0004,0003,0002,0001,000

0

Uruguay

India

Egypt

5 25 45 65 85 105

Per-capita steel consumption (kg)

Source: World Bank & IISI

Housing and government infrastructure spending to spur construction growth: It isexpected the upswing in construction activity to continue, quite optimistic, in viewof the robust growth witnessed in the housing sector. This apart, the governments


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increased focus on infrastructure development would provide a further impetus toconstruction growth.

A rising real income, low interest rates and tax incentives have increased theaffordability of houses. Moreover, the rise of nuclear families has further increasedthe demand for houses. On the other hand, governments increasing fillip

on improving Indias infrastructure would drive steel consumption fromconstruction. According to CRIS INFAC estimates, infrastructure investments tothe tune of Rs2,200bn are expected in 2005-06 to 2007-08, an increase of 29.4% over the period 2002-03 to 2004-05. With higher investments expected in constructionintensive sectors like roads, irrigation and urban infrastructure, constructioninvestments to the tune of Rs1,800bn are expected by FY07. The Tenth Planhas earmarked 63% higher outlay for infrastructure (over the Ninth Plan) toRs476bn.

Rising infrastructure investments - to drive demand growth

(Rs bn)

800

700

600

500

400

300

200

100

-Roads

UrbanInf ra

Irrigation Railw ays Power -Hydel

Pow er -Thermal

Others

2002-03 - 2004-05 2005-06 - 2007-08

Sourc e: Crisinfac


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Auto sector growth momentum to continue: The automobile industry has seen astrong growth over the last two years with the 2-wheeler industry leading theway. While the two-wheeler industry has witnessed a 15 % CAGR volumegrowth over the last two years, passenger cars witnessed a slower growth of 6% inFY06E. Commercial vehicles on the other hand saw flat growth in the same period. Itis expected the two-wheeler industries to continue to witness 13-14% growth

rate over the next two years. The passenger car segment too is expected tobounce back with the excise duty reduction on small cars in the Union Budget2006. Further, the Supreme Court ban on overloading and increase thrust onroad development would lead to a demand push of 8-9% for the Medium andHeavy Commercial Vehicles segment in FY07E. However, the demand for LCV isexpected to be in the range of 17-19% in FY07E.

Table 5: Auto sector growthFY02 FY03 FY04 FY05 FY06E FY07E

M&HCV 94,823 121,349 169,583 212,052 209,318 228,157

LCV 63,718 81,588 107,963 136,335 164,058 193,588Passenger cars 558,361 611,754 821,473 980,595 1,035,700 1,128,913

Two wheelers 4,307,908 4,991,808 5,629,301 6,575,584 7,500,677 8,475,766Source: SIAM and IIL

Raw material prices (barring iron ore) to decline in line

With steel prices

One of the reasons for the rise in steel prices was an increase in the key raw materialprices like those of coke, coal and iron ore. In the past two years, coke prices havemore than doubled while coal prices have risen by over 20%. Iron ore prices have alsowitnessed a sharp 71.5% increase in prices in 2005-06. However, it is expected coke andcoal prices to decline. While rising coking coal capacities would result in a drop in itsprices, falling shipping freight and lower base price would result in a sharp decline in non-coking coal prices. However, iron ore prices would continue to remain firm, going forward,it is expected iron ore prices will increase by15-19% in 2006-07.

Declining coking coal and coke prices to help improve the cost structure for domestic players: Coking coal is the raw material to manufacture coke that is


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used primarily in the manufacture of pig iron. While India has huge coal deposits, cokingcoal reserves account for only 13% of the total coal reserves. Thus, India has beendependent on imported sources, particularly Australia which supplies 90% of Indias import requirements of coking coal. India imported 16.1 million tonnes of cokingcoal (46.4% of its requirements) in 2004-05. With domestic supply is unlikely to increaseover the next two years, import of coking coal would reach 24.2million tonnes (56.7%of its requirements) by 2006-07. Thus, Indias dependence on imported coking islikely to continue and increase, going forward.

Dependence on imported coking coal to continue

(mntonnes)45

40

35

30

25

20

15

10

5

02002-03 2003-04 2004-05 2005-06E

2006-07E

58%

56%

54%

52%

50%

48%

46%

44%42%

40%

Supply (LHS) Imports (LHS) Import (% of demand) (RHS)

Source:

Industr y

Given the high dependence of domestic players on imported coking coal, domesticcoking coal prices would move in line with the international prices. With international cokingcoal prices expected to decline, and the softening of freight rates the landed price of

coking coal would decline. It is thus expected coking coal prices to be at USD135-140 in2006 and decline further to USD120-125 in 2007. This would translate into an improvementin the cost of production of domestic players like SAIL whodepend on external sources to meet coking coal requirements.


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Coking coal prices to decline

($/tonne)170

150

130

110

90

70

50

30

102003 2004 2005 2006 2007

FOB price Freight

Source: Industry, IIL

With coking coal prices expected to be less, and with the addition of fresh coke ovenbatteries, coke prices would also decline, quite optimistic and looking forward . Cokeprices have witnessed very high volatility in the recent past increasing from USD170/tonnein September 2003 to a high of USD520/tonne in March2004. China a major exporter of coke had imposed restrictions on exports in 2004. This created a short-term scarcity of coke in the international markets resulting in a sharp increase in prices. This prompted asurge in the setting up of coke oven batteries required to produce coke from coking coal. Ascoke oven batteries became operational the global coke shortage scenario easedresulting in a drop in coke prices. Coke prices have since been declining and were atUSD150 in January 2006. In India, the integrated steel plants meet most of coke

requirements through captive coke oven batteries. Thus, they are unlikely to be significantlyimpacted by movements in global coke prices.

However, demand-supply dynamics will play a critical role in determination of iron oreprices: Iron ore prices have witnessed a sharp increase in the past two years on theback of sharp increase in steel production in China. With global steel demand expected togrow at a CAGRof 5.7% over the next two years, iron ore demand would see healthy growth,On the other hand, three large players CVRD, Rio Tinto and BHP Billiton control 70% of the global iron ore supply. This has translated into high bargaining power for iron orecompanies. Rising steel production coupled with the high bargaining power of iron oresuppliers had helped them negotiate a 71.5% increase in iron ore prices for 2005-06.

Realizing the potential demand for iron ore, iron ore suppliers are investing heavily toincrease supply. Thus, in 2006, iron ore supply is expected to increase only by 38-40 milliontonnes.The demand-supply dynamics thus indicates an increase in iron ore prices during2006. However, as mining of fresh capacities commences, supply would outstrip demand andput pressure on iron ore prices. It is expected iron ore prices to decline by 10% during2007.With steel production in China is expected to increase, albeit at a slower pace,demand for iron ore is expected to remain strong, Thus, despite the declining steelprices the iron ore prices will further increase .


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Integrated Indian players - best placed

Despite the expected increase in iron ore prices, it is expected the impact on integrated steelproducers would not be significant. Given Indias self- sufficiency in the key raw materials(captive iron ore mines) and the resultant low cost of production, coupled with the robust 9%demand growth expectations in the domestic market, integrated Indian players are wellplaced to tackle the increase in iron ore prices.

Most Indian steel companies are integrated and have own captive mines. Thus, while non-integrated players would suffer a squeeze in operating profit margins in view of theexpectations of rising iron ore prices, Indian players like Tata Steel and SAIL would beinsulated from this risk in view of their captive iron ore mines. Indian players are not self sufficientin coking coal and depend upon imports to meet their coking coal requirements. With coking coalprices expected to soften, the cost of production for domestic players would only improve.Thus, self-sufficiency in iron ore and expectations of softening of coking coal prices would

translated into reduction in the cost of production for domestic players, thereby increasing the costcompetitiveness of Indian players. Currently, the cost of producing steel in India at US$266 per tonne is much lower than the global average of US$370 per tonne. Tata Steel is by far the mostefficient Indian producer and its cost of production works out to US$200 per tonne.

Robust growth expectations in domestic steel consumption would provide further thrust toIndian steel companies. Given the strong growth expectations in the automobile sector coupled with the construction boom being witnessed in the country, it is expected domesticsteel demand (a key market for Indian players) to grow at a CAGR of 9% over the next two years.With domestic demand expected to remain robust, Indian companies would have bargaining power and would thus be to push up steel prices. Thus, Indian steel companies are well placed to face the

challenges that any decline in steel prices or rise in iron ore prices may bring in.

The top picks from the sector are companies that are well integrated or companies that areexpected to witness strong volumes growth with the newly operational capacities. While TataSteel and SAIL (with captive iron ore mines) would be insulated from the strengthening of the ironore prices thereby resulting in an improvement in competitiveness vis--vis global peers,higher volumes would drive revenue growth for JSW Steel and Monnet Ispat. Jindal Steel andPower on the other hand would benefit from higher volumes and valuations too would get a thrustowing to its foray into the power business.


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TATA STEEL LIMITEDAcquisitions and cost efficiencies leading the way

Tata Steel in one of the lowest cost steel producers in the world. In line with the decline in steelprices, However volumes growth and cost efficiencies has lead to lowering of steel prices. With steelprices firming up coupled with the company strategys of growing up will translate into robust growth

Tata Steel is one of the lowest cost producers of steel in world. This is in view of itscaptive iron ore mines and efficient operations.

Focus towards value-add products, branded products and automobilegrade steel products have resulted in more stability to the companysrealizations. This has partially insulated the company from the vagaries of steelprice volatility.

Tata Steel has been looking for acquisitions in the global market. While thecompany has already acquired NatSteel Asia, it is in the process of completing theacquisition of Millennium Steel. The company has also shown interest in further acquisitions in South Africa. Once the operations of these companies with TataSteel is complete, there will be tremendous cost savings leading to marginexpansion for these companies which will flow into Tata Steels bottom-linemaking its valuations more attractive.

Tata Steel is trading a P/E of 5.8x FY07E earnings and an EV/EBIDTA of 3.2xFY07E. Given its low cost production facilities, the high share of value-addedand branded products, it is expected this stock will create a rally.


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Financial snapshot

YE March FY05 FY06 FY07ENet Revenue 144,989.5 151,393.8 175,303.3Change (%) - 4.4 15.8EBIDTA 60,453.6 59,311.2 71,455.6Change (%) - (1.9) 20.5Net Profit 34,741.6 35,059.8 43,725.5

Change (%) - 0.9 24.7EPS (Rs) 62.7 63.3 79.0P/E (X) 7.3 7.3 5.8ROCE (%) 53.2 41.6 40.8

ROE (%) 48.6 36.1 34.1

Stock data

Bloomberg Tata inShares outstanding(million) 554Market capitalization(Rs billion) 255Market capitalization(US $ million) 5582Three month average volatility 46635563

Share price performance

Sensex 10412Nifty 3050Ltp(in rupees) 53252 week high(in rupees) 67952 week low(in rupees) 329


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Shareholding pattern

Holdings percentagePromoter 26.8Foreign 22.5Mf/uti/banks 20.9Public 29.9

Valuations

Tata Steel is trading at a P/E of 5.8x FY07E and3.2x EV/EBIDTA. Given thecompanys expansion plans at its existing facilities and strategy of growing coupledwith steel prices now recovering, it is believed that the company is poised for steadygrowth . In view of Tata Steels fully integrated steel facilities. However, it is to benoted that didnt take into the factor the incremental revenues that NatSteel Asia andMillennium Steel, which would make the valuations further attractive.

Business and financial profile

With steel prices now bottoming out and showing signs of recovery, it is believedthat higher volumes and control over costs will drive Tata Steels growth goingforward. The company is not only increasing its capacities at existing locations andsetting up new Greenfield projects, but is also aggressively looking at the overseasmarkets for growing inorganically. Capacity expansions to drive volumes growth TataSteel is a fully integrated steel producer. The company has its own captive ironore and coal mines. While Tata Steels entire iron ore requirements are met

through captive sources, almost 68% of the coal requirements are met internally. AtJamshedpur, the company plans to increase its capacity by 1.8mn tonnes(predominantly billets) and increase its crude steel capacity to 6.8mn tonnes. This apart,the company has also entered into MOUs with the Jharkhand, Orissa and

Chhattisgarh Governments for the setting up of steel plants. Thus, the companywill be able to register steady volumes growth . Focus on branded and automotivesales brings stability to realisationsTata Steel has been aggressively promoting thesale of branded and value- add products. During FY06, branded sales accounted for 27% of the total domestic revenues. This apart, the company has identified automotivesteel as a key focus area and has been consistently increasing its market share in the


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same. This has not only resulted in higher average realizations for the company but hasalso reduced the susceptibility of realizations to volatility in steel prices thereby reducingthe companys overall business risk.

Tata Steels average realizations are less volatile

Price decline during FY06 for...(US$/tonne) Tata Steel Comparable global peer

HR 140 154CR 117 170Galvanized 154 190Total Flat products 132 165Source: Company

Control over costs to help offset steel pricing pressure:

Tata Steel is one the worlds lowest cost steel producers. The company has been

gradually reducing its dependence on imported coal. During FY06, Tata Steelreduced the ash content in West Bokaro coal from 15% to13.8%. This resulted ina reduction in the imported coal requirement from

46% in FY05 to 32% in FY06. This apart various other initiatives like reduction inthe coke consumption rate and a 26% improvement in labor productivity to 326 tonnes per man p.a. have enabled the company reduce its overall cost of production. Revenues fromrecent acquisitions make valuations further attractive Tata Steel had recently acquiredNatSteel Asia and in the process of completing the acquisition of Millennium Steel.NatSteel Asia reported net profits of Rs1.29bn in FY06. Once the acquisition of Millennium Steel is completed, it too would add to Tata Steels EPS. This apart, given that

Tata Steel is looking for further acquisitions; any development on this front would make thevaluations attractive. NatSteel and Millennium Steel operate at low operating profitmargins. While the operating profit margin at NatSteel for FY06 was 5.9%, it was9.2% for Millennium Steel. Once the 1.8mn tonne capacity expansion at Jamshedpur is complete (expected by FY08), the billets requirements of its subsidiaries will besourced through the same. This will lead to a tremendous reduction in the cost of production of these subsidiaries, leading to an expansion in their operating profit margins.This will further add to Tata Steels EPS making its valuations further attractive.

Financial profile of Millennium Steel

(US$ mn) FY05 FY06 Net sales 419 464

EBIDTA 65 43EBIDTA Margin 15.5% 9.3%

Net income 30 9 Net income margin 7.2% 1.9%Source: Company


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Financial profile of NatSteel Asia

(Rs mn) 16th Feb-Mar-05 FY06 Net sales 5,440 40,520EBIDTA 195 2,390EBIDTA Margin 3.6% 5.9%

Net income 75 1,285 Net income margin 1.4% 3.2%Source: Company

Financial aggregates

PROFIT & LOSSFY05 FY06 FY07 E

Net sales 144989 151393.8 175303YOY(%) 35.3 4.4 15total expenses 84535.9 92082.5 103847.7

inc/dec in stock -2895.5 -1087.7 -1309raw material cost 30204.2 30243.2 34849.7staff cost 12910 13529.7 13529.7

power & fuel cost 7120 8192.2 9280.1other manufacturing exp 22867.8 24584.8 28296.1EBITDA 60453.6 59,311.20 71,35YOY(%) 73 -1.9 20EBITDA(%) 41.7 39.2 40other income 1900.3 2545.8 3716.4PBIDT 62353.9 61857 7517interest 2288 1184.2 981.gross profit 60065.9 60672.8 74190.8depreciation 6187.8 7750.5 8846PBT & extraordinary 53972.8 52394.6 65344.9

extraordinary items -905.3 -527.7 0

PBT 52972.8 52394.6 65344.9(current tax) 18336.6 16058.9 20028.2(deferred tax) -105.4 1275.8 1591.8tax/PBT 34.4 33.1 33PAT 34741.6 35059 4372adjusted net profit 33741.6 35059 43725.5YOY(%) 99 0.9 24


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KEY RATIOFYO5 FY06 FY07 E

EPS(RS) 62.7 63.3 7CEPS(RS) 73.7 79.6 97.8book valve(Rs) 151 199.6 263.9dividend\ share 14.8 14.7 14.7debt - equity 0.3 0.2 0ROCE(%) 53.2 41.6 40ROE(%) 48.6 36.1 34

BALANCE SHEETIn Rs million FYO5 FY06 FY07 Eequity capital 5536.7 5536.7 5536.7preference capital 0 0reserves 78056.9 104997 140602.8net worth 83593.6 110533.7 146139.5total borrowing 27397 26495.3 23771.8deferred tax 8294.2 9570 11161.2total liabilities 119284.8 146599 181072.5gross block 130850.7 155850.7 175850.7(accumulated depreciation) 58454.9 66205.4 75051.4net block 72395.8 89645.3 100799.3

CWIP 18726.6 10000 1000investment 24326.5 37772.5 58060.5current assets 40835.8 47234.6 51496.9inventories 18724 23104 26370.8debtors 5818.2 6304.1 7299.8cash 2467.2 4000 400loan & advances 13826.4 13826.4 13826.4current liabilities 26898.3 27027.1 28258.2provision 10101.6 11026.4 11026.4net current assets 3835.9 9181.2 12215.5miscellaneous expenses 0 0 0total assets 119284.8 146599 181072.5

CASH FLOW


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in rs million FY05 FY06 FY07 Enet profit 34741.6 35059.8 43725.5depreciation & written off 6187.8 7750.5 8846deferred tax -105.5 1275.8 1591.1change in working capital -2944.6 -3812.5 -3031.5other income 1900.3 2545.8 3716.4operating cash flow 35979.1 37727.9 47415other income 1900.3 2545.8 3716.4capex -18731.7 -16273.4 -20000

investments -2385.3 -13446 -20288.2investing cash flow -19216.7 -27173.6 -36571.8dividend -8213.7 -8119.7 8119.equity 2932.2 0debt -6425.1 901.7 2733.financing cash flow -17571 -9021.5 -10843.2others 768.4 0net change in cash -40.2 1532.8 0opening cash 2507.4 2467.2 4000closing cash 2467.2 4000 4000

VALUATION FY05 FY06 FY07 E

PE(X) 7.3 7.3 5Cash PE 6.3 5.8 4.price/book valve(x) 3.1 2.3 1.dividend yield 3.2 3.2 3market capitalization/sales 1.8 1.7 1.6EV/Sales(x) 4.4 4.2 3EV/EBDITA(X) 4.4 4.2


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STEEL AUTHORITY OF INDIA LIMITED

Unlocking its hidden potential

SAIL is Indias largest steel producer with a capacity of 12 million tonnes. Lower steel prices coupled with an increase in coking coal prices impacted performanceFY06. With steel prices now recovering coupled with the stabilizing coking coal prices,it is expected that Worst is over for the company. it is believed that sail will

witness a 11.3% growth in revenues in FY07E. This apart, the4130companys plans of modernization of its blast furnaces and merger with IISCO

(and the consequent access to its large iron ore reserve would result in tremendousvalue unlocking for the company. Therefore it should be in ones portfolio .

The modernization of existing capacities and the consequent increase involumes to drive revenue growth

The cost structure is set to improve in view of better operatingefficiencies (lower coke consumption, higher labor efficiency and increase

in production through continuous casting route) andexpectations of a decline in coking coal prices.

Self-sufficiency in iron ore requirements insulates the company from theexpectations of an increase in iron ore prices for 2006-07.

Merger with IISCO would further unlock value as SAIL would have

access to IISCOs underutilized iron ore and coal mines .

Financial snapshot

YE March FY05 FY06 FY07ENet revenue 286298.9 285491.9 287770Change(%) - (9.7) 11.3EBIDTA 92732.2 69773.7 91898.7Change(%) - (24.8) 31.7Net profit 68,154.4 39581.4 54828.9

Change(%) - (41.5) 37.6EPS(RS) 16.5 9.6 13.3P/E(X) 4.1 6.9 5.0ROCE (%) 55.9 35.5 42.4ROC(%) 92.9 35.5 38


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Stock data

Bloomberg Sail inShares outstanding(million) 4130

Market capitalization(Rs billion) 277Market capitalization(US $ million) 6056Three month average volatility 15827740


Sensex 10412 Nifty 3050Ltp(in rupees) 8152 week high(in rupees) 9652 week low(in rupees) 41




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Valuation

SAIL is on the threshold of a phase wherein there would be tremendous value unlocking for the company. Better operating efficiencies, modernization of blast furnaces and merger withIISCO would unlock tremendous value for the company over the next few years. SAIL iscurrently trading at a P/E and EV/EBIDTA of 5x and 2.9x FY07E earnings respectively.


Over the next few years, it is expected tremendous value unlocking in SAIL. While themodernization of its existing blast furnaces would result in an increase in capacities, costcutting initiatives like increase in production through continuous casting route, lower coke andpower consumption and higher labor efficiencies would lead to an improvement in its cost structure.The merger of IISCO with the company would provide SAIL with access to its underutilized ironore and coking coal mines leading to a further unlocking of value for the company.

Volumes to drive growth

In the past, a weak financial profile had constrained SAILs expansion plans. However, during thecurrent steel up cycle, SAILs profitability increased manifolds leading to the companybecoming virtually debt free. The company has now envisaged huge capex plans for increasingcapacities by carrying out modernization of its blast furnaces. The company is also increasingits focus on value add products and reducing the share of semis. These initiatives would translateinto a steady volumes growth for the company over the next few years. Thus, it is expected SAILto register a 11.3% growth in net revenues in FY07E to Rs288bn.

Volumes to drive revenue growth

(Rs mn)

320,000

300,000

280,000

260,000

240,000

220,000FY05 FY06 FY07E FY08E

Source: IIL


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Captive iron ore mines provides insulation from rising iron ore prices

SAIL derives its entire iron ore requirements through its five captive iron ore mines.Moreover, with the merger of IISCO with the company, SAIL now also has accessto the high-grade iron ore mines of IISCO. Thus, while the global steel cost of productionwould increase in view of the expectations of an increase in prices of iron ore for 2006-07,SAILs cost structure would be unaffected thus improving its competitive position.

Declining coking coal prices to help improve cost structure

While SAIL meets its entire iron ore requirements through captive sources, the companydepends upon external sources for meeting its coking coal requirements. Whilearound 45% of the coking coal is sourced from Coal India Ltd (CIL), the balance55% is imported. As coking coal prices increased globally, SAILs cost structurewas significantly impacted by the same. Thus, as steel prices declined, the impact onSAIL was higher than other companies. However, with coking coal prices nowshowing signs of softening, it is believed that the worst is over for the company. Goingforward, SAILs cost structure would only improve with the declining coking coalprices. This apart, an increase in production through continuous casting route,higher labor efficiencies and lower coke consumption would further help improve SAILsoperating profit margins. It is expected SAILs operating profit margins to rebound fromthe low of 27% in FY06 to 31.9% in FY07.

Coking coal prices to decline

($/tonne)170

150

1

30

110

90

70

50

3


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0

10

2003 2004 2005 2006 2007FOB price Freight

Source:Industry,

IIL

Merger with IISCO apositive

The merger of IISCO with the company is now complete. SAIL would not only get atax benefit of Rs300crs from the merger in FY06 but the company would also haveaccess to IISCOs under-utilized rich iron ore and coking coal mines. SAIL would alsoimprove IISCOs overall operating efficiencies by enhancing its capacities from 0.8 milliontonnes to 2.5 million tonnes by2012. Thus, the merger would further add to the companysbottom line.



Net sales 286298.6 258491.9 287770.3YOY(%) 33.3 -9.7 1total expenses 193566.7 188718.2 195871.6

inc/dec in stock -3.6772 0 -130raw material cost 3667.2 16702.5 13177.9staff cost 38114.5 37650.9 36731.6power & fuel cost 21955.9 24443.2 27200.7other manufacturing exp 24039.6 25239.2 27796EBITDA 92732.2 69,773.70 91,89YOY(%) 194.8 -24.8 31EBITDA(%) 92732.2 69773.7 91898.other income 7717 5052 5772.PBIDT 100449.2 75275.7 97671.interest 6050.4 4430.3 3765.gross profit 94398.8 70845.5 93875.5depreciation 11269.5 11806.3 12647.5PBT & extraordinary 83129.3 59039.5 81227.9

extraordinary items 10948.5 0PBT 94078.1 59039.1 81277.(current tax) 7480.6 22730.1 31227.8(deferred tax) 18443.1 -3542.3 -4873.7tax/PBT 27.6 32.5 32PAT 68154.4 39851.4 54828.adjusted net profit 68154.4 39851.4 54828.9YOY(%) 171.1 -41.5 37

KEY RATIO FYO5 FY06 FY07 E


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others 835.7 0net change in cash 1609.8 2430.5 0opening cash 1959.5 3569.5 6000closing cash 3569.3 6000 6000

VALUATION FY05 FY06 FY07 E

PE(X) 4.1 6.9Cash PE 2.8 5.8 4price/book valve(x) 2.8 2.2 1dividend yield 5.6 5.6 5market capitalization/sales 1 1.1 1EV/Sales(x) 1.2 1.2 1EV/EBDITA(X) 2.9 3.9


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MONNET ISPAT AND ENERGY LTD

Capacity expansions to drive growth

Monnet Ispat and Energy Ltd (MIEL) is expected to register a robust top line growth on theback of a sharp increase in volumes and higher steel prices. MIEL is increasing sponge ironand steel melting capacities and raising power capacities to 150MW by FY07E from 60MWin FY06E. This coupled with the efforts taken by the company to increasingly meet iron orerequirements through captive sources. The capacity expansions coupled with the recovering steelprices would translate into a higher growth in net revenues during FY07E.

MIPL is increasing its share of captive iron ore and this would bring down theoverall cost of production leading to an improvement in the companys operating profitmargins.

MIPL has identified power as a key focus area for growth, going forward. Thecompany is increasing its power capacity from the current60 MW to 150 MW. This apart,MIPL has also created a 100% owned SPV for setting up a 300 MW integrated power plant atAngul in Orissa. However, as the project is expected to be commissioned in FY09 it is It isexpected to improve the health of the company

Financial snapshot

YE March FY05 FY06 FY07ENet revenue 5226.9 8643.3 10412.3Change(%) .9 65.4 20.7EBIDTA 1519.8 3057.8 3636.2Change(%) (15.1) 101.2 18.9Net profit 1177.5 2298.1 2703.9

Change(%) (3.3) 95.2 17.7EPS(RS) 36.2 52.5 61.8P/E(X) 6.1 4.2 3.6ROCE(%) 13.4 21.5 21.8ROC(%) 32.8 35.7 27


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Stock data

Bloomberg Monnet Ispat InShares outstanding(million) 4130Market capitalization(Rs billion) 32

Market capitalization(US $ million) 155Three month average volatility 40190


Sensex 10412 Nifty 3050

Ltp(in rupees) 19852 week high(in rupees) 33252 week low(in rupees) 118


Holdings percentagePromoter 58Foreign 11.1Mf/uti/banks 7.5Public 23.5

Valuations

The recovering steel prices and higher volumes would help MIPL register an impressivegrowth. This apart, the companys iron ore requirements would be increasingly metthrough captive sources leading to an improvement in operating profit margins. Inview of the above and the companys increased focus on power business, it is believedthat P/E would be 6x FY07E earnings


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MIPLs capacity expansions would drive top line growth during FY07. Moreover,with the company now entering into royalty based agreements with private iron oreminers, there would be a tremendous cost savings for the company leading to animprovement in operating profit margins. Thus, MIPL would be able to register robustbottom line growth during FY06 and FY07.

Capacity expansions to drive growth

MIPL is increasing its sponge iron capacity from 3,00,000 tonnes to 8,00,000tonnes by July 2006 and its steel capacity from 3,00,000 tonnes to7,40,000 tonnes. Thecompany has also identified power as a focus area and would increase power capacities to 150 MW by FY07E. Thus, higher volumes and increase in the share of steel (billets and ingots) would result in a 65.4% growth in net

Revenue of capex plants

Revenues during FY07E.

Aggressive capex plans(tonnes) FY05 FY06 FY07ESponge iron 300,000 300,000 800,000

Steel products 300,000 300,000 740,000Ferro Alloys 58,400 58,400 58,400Power (MW) 45 60 150Source: Company

Company background

MIPL was promoted jointly in 1990 by Sandeep Jajodia and Jindal Strips for themanufacture of sponge iron. The company subsequently increased its sponge ironcapacity and also put up capacities for steel billets/ingots, ferro alloys and power. Thecompanys plants are located at Raipur in Chhattisgarh.


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Captive iron ore supply to improve margins

MIPL depended on external sources for meeting its iron ore requirements. This exposedthe company to the risks of increase in iron ore prices. MIPL has now entered into royaltybased agreements with private iron ore miners to meet iron ore requirements. Thus, theentire iron ore requirements of the 3,00,000 tonne sponge iron capacity and another 60% requirement of the5,00,000 tonne capacity would be met through such mines. As

the average cost of iron ore extraction from such mines would be around Rs1,350 (asagainst the average cost of Rs2,308 for FY05), the average cost of iron ore for FY07 woulddecline to Rs1,650 per tonne thereby resulting in tremendous savings for the company.The operating profit margins would increase by 35.4%.

Operatingprofit margin

(%)36

Operating profit margins to rebound

34

32

30

28

26

FY05 FY06E FY07E FY08E

S ou r c e: I I L


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Net sales 5184.4 5226.9 8643.3YOY(%) 109.7 0.9 65total expenses 3391.4 3707.1 5585.4

inc/dec in stock -133.8 -423.3 -528.9

raw material cost 2843.3 3204.8 4610.2staff cost 131.7 171.2 256.power & fuel cost 173.8 187.5 310.1other manufacturing exp 198.4 254.3 420.7EBITDA 1789.9 1,519.80 3,05YOY (%) 155.8 -15.1 101EBITDA (%) 34.5 29.1 35other income 38.1 95 8PBIDT 1828 1614.8 3137interest 281.9 35.1 122.gross profit 1546.1 1579.7 3015.3depreciation 216.1 249.2 418.4

PBT & extraordinary 1330.1 1330.6 2596.8extraordinary items -8.3 0PBT 1321.8 1330.6 2596.(current tax) 103.7 99.8 194.(deferred tax) 0 53.2 103.tax/PBT 7.8 11.5 11PAT 1218.1 1177.5 2298.adjusted net profit 1218.1 1177.5 2298.5YOY (%) 329.9 -3.3 95

KEY RATIOFYO5 FY06 FY07 E

EPS(RS) 38.7 36.2 52.CEPS(RS) 45.5 45.5 64.4book valve(Rs) 98.4 125.5 200.7dividend\ share 6.1 6.1 6.debt - equity 1.6 1.7 0ROCE(%) 25.8 13.4 21ROE (%) 52.9 32.8 35


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BALANCE SHEETIn Rs million FYO5 FY06 FY07 Eequity capital 315 325 437.preference capital 0 0reserves 2773.9 3754.5 8344.8

net worth 3100.9 4079.5 8782.5total borrowing 4960.7 6844.9 4868deferred tax 441.9 495.1 599total liabilities 8503.5 11419.5 14249.5gross block 4756.9 6255.9 11556.9(accumulated depreciation) 726 975.2 1393.6net block 4030.9 5281.8 10163.3CWIP 455.9 1500 50investment 90.1 569.2 7.current assets 47322.9 4

9732.15149

inventories 836.1 1305.2 2094.2

debtors 591 596.1 985.cash 2734.5 2500 100loan & advances 572.4 572.4 572.4current liabilities 578 604.6 705.provision 229.4 300.6 368.net current assets 3926.6 4068.6 3578.6miscellaneous expenses 0 0 0Total asset 8503.5 11419.5 14295.5

CASH FLOWin Rs million FY05 FY06 FY07 Enet profit 1218.1 1177.5 2298.depreciation & written off 216.1 249.2 418.4deferred tax 0 53.2 103.change in working capital -528.2 376.5 1010other income 38.1 95 8operating cash flow 867.9 1008.4 1730.4other income 38.1 95 8capex -922.5 -2544 -430investments -83.4 -479.1 561.6investing cash flow -967.8 -2928.2 -3658.4dividend -192.3 -196.3 -265.equity 504.9 0 2557debt 2319.3 1884.2 -1976.financing cash flow 2631.9 1687.3 315.3others 65.5 -2 112net change in cash 2597.5 -234.5 -1500opening cash 137 2734.5 2500closing cash 2734.5 2500 1000


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VALUATIONFY05 FY06 FY07 E

PE(X) 5.7 6.1 4Cash PE 4.8 4.8 3.price/book valve(x) 2.2 1.8 1.dividend yield 2.8 2.8 2market capitalization/sales 1.3 1.4 1.1EV/Sales(x) 1.8 2.2 1

EV/EBDITA(X) 5.1 7.2

JSW STEEL LTD.


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On the growth path

JSW Steel Ltd (JSW), a primary steel producer, is the only producer of flat steel in SouthIndia. The company meets most of its coke, power and oxygen requirements through

captive sources. JSW is continuing its focus on lowering its cost of production along withthe managingits debt. The company has also envisage an aggressive growth strategythat would take its capacity from the current 2.5 million tonnes to 7 million tonnesby 2009. At Rs274, JSW is trading at 5.3x FY07E P/E and 3.9x FY07E EV/EBIDT

The phased capacity additions would translate into a robust16.9%growth in FY07E after a 7.4% dip in FY06.

Starting of new coke oven batteries and the resultant increase in captive power generation from waste heat would result in an improvement in JSWs coststructure

JSW is trading at a P/E multiple and EV/EBIDTA of 5.3x and 3.9xFY07E earnings..

Financial snapshot

YE March FY05 FY06 FY07ENet revenue 61801 72239.1 80539Change(%) (7.4) 16.9 11.5EBIDTA 16843.1 20184.6 23,831.4Change(%) (26.3) 19.8 18.1Net profit 8,568 7,329.7 9,195.3Change(%) (1.5) (14.5) 25.5EPS(RS) 54.6 46.7 58.6P/E(X) 4.5 5.3 4.2ROCE(%) 18.5 19.8 21.7ROC(%) 28.6 19.4 20.4

Share data

Bloomberg JDVS IN


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Shares outstanding(million) 147Market capitalization(Rs billion) 36Market capitalization(US $ million) 792Three month average volatility 525044


Sensex 10412 Nifty 3050Ltp(in rupees) 27452 week high(in rupees) 33252 week low(in rupees) 118




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Valuation

JSW Steel has performed exceptionally post Cost reduction. The company is currentlyin the process of increasing its capacities from 2.5 million tonnes to7 million tonnes by 2009.This apart, the cost reduction initiatives and control over interest costs would further help improve

its overall profitability, going forward. At the current price, JSW is trading at a P/E multipleand EV/EBIDTA of 5.3x and 3.9x FY07E earnings.

Business profile

With steel prices expected to sustain at current levels, the higher volumes would drive JSWsgrowth. JSW is expanding capacities in both upstream and downstream products. The company isalso focusing on improving its cost structure by setting up coke oven batteries and generatingmore power through waste gasses. The company has also been successful in bringing down its

debt. The consequent reduction in interest costs would further contribute towards JSWs bottomline growth.

Enhanced capacity to aid volume growth

JSW Steel would be raising crude steel capacity from 2.5 million tonnes to 3.8 million Tonnes byQ2FY07E, to a further 7 million tonnes by March 2009. This apart, the hot strip mill capacitywould also increase to 2.5 million tonnes by June 2006. Additionally, a 1 million tonnecold rolling unit is expected to be operational by H2FY08E. In view of the above, it is expected a

robust volume growth.

Capacity increase to aid growth

(mn t)8

7

6

5

4

3

2

1

02006 2007 2008 2009

Source: Company


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Operating margins to improve

(%)36

33

30

27

24

21FY05 FY06 FY07E

Source: Company

Improved gearing to reduce interest cost

In the past, high interest costs ate into the JSWs profitability. However, post CDR, thecompany has been steadily reducing its debt levels. The gearing ratio has beensuccessfully reduced from 1.5 in FY04 to almost 1 in the current year. Thecompany has resultantly repaid debt to the tune of Rs10.14bn in FY06. The companyhas also successfully brought down the average cost of borrowings from 8.27% inFY05 to 8.01% in FY06

Financial profileimproving

(Rsmn)5,000

(%)15

4,500 12

4,000 9

3,500 6

8/6/2019 Industry A

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