Stock Pick From The Steel Sector

Low Priced Scrip is hidden gem, today's underdog, a stock with future potential that is expected to fetch returns within 1 year. This is a stock picked carefully based on a fundamental analysis of the company.

The company recommended as the Low Priced Scrip for this issue is a leading Maharatna PSU company in the steel sector.

Here Is Why:

• Steel prices are likely to go up, leading to better realisations for SAIL.
• Having done a whole lot of backward integration, it remains insulated from rising iron ore prices.
• Capacity expansion to take its total capacity to 18 MTPA by March 2013.

After underperforming for most part of the last two years, the steel sector is poised to break out on the upper side. The outlook for 2013 for this sector is good. There are both domestic as well as international factors that are going to help the performance of this sector. On the domestic front, the recent reforms initiated by the government will help infrastructure spending to go up and will in turn drive the demand for steel. Internationally too, rising global and Chinese manufacturing PMI numbers augur well for the steel sector. In this background, we are recommending state-owned Maharatna company SAIL as our Low Priced Scrip for this issue, as we expect it to be an outperforming stock in 2013.

It is not just the sector dynamics that will help company, but there is certain inherent strength within the company too that will help it perform better fundamentally as well on the bourses. SAIL is the largest producer of crude steel in the country with a total installed capacity of 13.80 Million Tonnes Per Annum (MTPA) at the end of Q2FY13. The company has undertaken a massive capacity expansion plan, under which it is expanding its current capacity of 13.80 MTPA to 23.46 MTPA. It expects its capacity to touch 18 MTPA by March 2013, while the rest is expected to come up in a phased manner. Most of its expansion will be financed through internal accruals and therefore, will not impact its debt-to-equity ratio, which currently stands at 0.8x.

Besides this, steel and iron ore price prices are expected to rise due to a recovery in the global markets. The World Steel Association (WSA) indicates that the demand for steel will recover in CY13 to 4.5 per cent after rising by 3.6 per cent in CY12. This will definitely help the company to improve its realisations. However, the rise in iron ore prices, one of the key raw materials in steel making, will not hurt SAIL as it has captive iron ore mines. Rather, this factor will increase its competitiveness. Another important development that will help the company is the softening of coking coal prices, which will ease the pressure on margins going ahead. The world’s biggest coking coal exporter, BHP Billiton, expects the prices to remain around USD 165 per tonne in the March quarter against USD 170 per tonne in Q3FY13.

On the financial front, the company has been reporting a rather subdued performance in the last two quarters. Its revenues remained flat at Rs 23888 crore in H1FY13. The EBITDA margins, however, improved by 10 basis points to 12.32 per cent as its realisations increased by 1.7 per cent on yearly basis. The net profit during the same period declined by seven per cent to Rs 1239 crore. This, however, will change in the second half of the fiscal as the situation improves. Due to the increasing steel demand and the addition of new capacity, SAIL would report better revenues in the H2FY13. Its EBITDA margins would also be better due to a decline in the coking coal prices.

On the valuations front, the scrip is trading at a Price-to-Earnings of 11.6x its annualised EPS of Rs 8.35. Being a PSU, SAIL is consistently paying dividends and at its current price, the stock carries a dividend yield of two per cent. On an EV/BITDA basis, SAIL is trading at 6.35x which is cheap compared to Tata Steel’s EV/EBITDA of 7.3x. We advise our readers to enter the counter with a target price of Rs 111, giving it an upside of 15 per cent.