JSW Steel Limited- Stock Report

Date: 3rd Jan, 2012 Ticker: 50228 Price: Rs 512.75 Recommendation: BUY Price Target: Rs 750

Authors: Devika Singhania Kshitij Golwalkar Sandeep Singhvi

Investment Thesis
Largest Steel Producer in India (Installed capacity): With current production capacity at 7.8 mt the company is expanding the production expansion to 11mt by increasing the plant sizes at Vijayanagar and West Bengal plants. Given its iron ore processing facilities and the lack of same in the case of other steel producers, JSW Steel is likely to secure the majority of the iron ore from e-auctions as the iron ore being auctioned is majorly of lower grade. Backward Integration and Forward Integration: As a part of backward integration US Coking coal mines were acquired in West Virginia. The production from these mines is expected to reach 3 mn tones in 3 years. Further Iron ore mines in Chile have been acquired. The mines are ready to supply coal to international customers. As a part of forward integration, JSW has entered into a joint venture with UK based sever field Reeve Structures for a specialty plant. It also entered into a JV with Composite Metal Decking for cutting edge technology Strategic Acquisition of Ispat Industries: JSW acquired 45.53% stake in Ispat Industries. Ispat Industries has a capacity of 3.3 mtp and is scalable to 5mtpa. Ispat has strong technical fundamentals and cutting edge technology. Thin slab casting facility and the compact strip mill give its product a cutting edge in the market. JSW will be able to derive synergies through full integration. Investment in Technology: JSW is always investing in new technologies to reduce the cost of production. Plants at Vijayanagar were commissioned to utilize low grade iron ore. Plants were also tested for blast furnaces which in turn reduces the fuel consumption. Further to improve the fuel consumption various projects like coke dry quenching are being tested. Industry and margins to rebound: JSW Steel expects a minimum EBITDA/t of INR6, 000/t in Q3FY12 as compared to INR6, 900/t in Q2FY12. The QoQ decline is due to the continuing use of high cost of coking coal and INR depreciation. However, in Q4FY12, the company expects benefit of lower coking coal cost (after considering INR depreciation) and higher production as mentioned above, to come in. For FY13, the company is expecting a minimum EBITDA/t of USD175 as full benefit of more benign raw material prices and production ramp-up kicks.

JSW Steel Limited

03rd Jan , 2012

Business Description
Shareholding Pattern
Public 33% Promoters 38%

Banks & Fis 5%

FIIs 24%

JSW Steel Limited engages in the manufacture and sale of iron and steel products in India and internationally. The company offers hot rolled coils, plates, and sheets; cold rolled coils and sheets; galvanized sheets and coils; wire rods and special steel RCS, and rounds and spring steel flats; prepre painted galvanized coils, sheets, and profiles; and galvanized corrugated sheets under the Jindal Vishwas brand name. It also generates power. The company was formerly known as Jindal Vijayanagar Steel Limited and changed its name to JSW Steel Limited in June 2005. The Companys Upstream Product includes Mild Steel Hot Rolled Coils; Mild Steel Hot Rolled Plates & Sheets; and Tolerances. The Company can supply HR Coils / Plates and Sheets to a range of Indian and International and Specifications. The Company's diverse applications include Automobile - Hot tions & cold forming; Infrastructure viz power, roads, dams, bridges, ports, refineries etc.; Railways; Storage Tanks; Pipes; General Engineering; Machine & equipment building; Pre - engineered building system; and Transmission Towers. The Companys Downstream Products include Hot Rolled Plates; Cold Rolled Close Annealed (Crca) Sheets & Coils; and Galvanized Sheets & Coils. The Company's diverse applications include Automobiles; Electrical Panels; Furniture; White goods; Transformers; Oil Barrels & Drums; and General Transformers; Engineering.

Trend in Y-O-Y sales growth

Crude Steel Production Trend

The Company is the manufacturer of Galvanized steel products in India. It is marketed under the brand name Galvplus. Its diverse applications include Roofing/Cladding; Doors/Windows; Structural Engineering; Automobiles; Air Engineering; Conditioning/Ducting; Insulation; Partition Profiles; Furniture; Appliances; and Trunks/Barrels/Drums/Buckets. The companys key highlights for the year 2010 2010-2011 Highest Ever Crude Production FY11- 6.43 mt FY11 Highest Ever Sales Volume FY11-6.10mt Highest Every Gross Turnover FY11- Rs 25,131 crores Highest ever EBIDTA- FY11- Rs 4,856 crore EBIDTA Strengthened Balance sheet- consolidated net debt to equity ratio sheet improved to 0.84 at FY11 ( 1.65 FY10) Consolidated weighted average debt cost has come down to 6.56% in FY11

Industry Overview and Competitive Positioning

The Indian steel industry ranks fifth in the world with estimated crude steel production of 67 mt in calendar year (CY) 2010. The share of India in global share crude steel production has increased from 3% in 1998 to 4.7% in 2010. As a consuming market, India presents a high growth potential with a low annual per capita finished steel consumption of 48 kg, as compared with 405 kg in China. The structure of the Indian steel industry comprises of primary producers, secondary producers and he small scale stand-alone processors, with an estimated installed capacity of 73 mtpa of crude steel alone during 2009-10, comprising main producers (22.5 mtpa), major secondary producers (17.2 mtpa), 10, major and others (33 mtpa). Crude steel production capacity has increased from around 48 mtpa during 2004-05 with almost all of the increase being accounted for by private producers. By comparison, 05

JSW Steel Limited

03rd Jan , 2012

crude steel capacity of public sector producers Steel Authority of India Ltd. (SAIL) and Rashtriya c producersSteel Ispat Nigam Limited (RINL)has remained stagnant at 15.8 mtpa. has ISPs: There are three ISPs or main producers who convert iron ore into steel through coke oven: oven BF/BOF route. These are SAIL, Tata Steel or TSL, and RINL which, among them, have nine operational , units. In 2009-10, the main producers had a combined crude steel production capacity of around 10, 22.5 mtpa: SAIL (12.84 mtpa), TSL (6.8 mtpa), and RINL (2.9 mtpa). Major Secondary Producers: These are steel plants which make steel by melting scrap and/or : HBI/DRI in EAF/IF. A few of the plants also have upstream DRI/hot metal production facilities (e.g., Essar Steel Ltd. or ESL, Ispat Industries Ltd. or Ispat, and JSW Ltd). These three secondary producers secondary had a combined crude steelmaking capacity of around 17.2 mtpa in 2009-10 Threat of substitutes - Medium Steel faces competition from substitutes such as Aluminium, Plastic and Copper. However, various technical and economic factors prevent large-scale substitution. scale Bargaining Power of BuyersMedium to Buyers High
Diversified set of users prevents significant buying power with buyers. However, individual nations often initiate actions, which affect global trade. Further, consolidation amongst steel producers has resulted in greater producer discipline, and lesser market fragmentation.

Inter-Firm RivalryHigh The steel industry is highly fragmented. In he India, apart from the 2 integrated players, there are 3 secondary players, and various small- and small medium-sector producers.

Bargaining Power of SupplierHigh Supplier Suppliers of raw Material (Coal, Iron ore, Power have high bargaining power.

Entry BarriersMedium to High Medium Production of most steel products is highly ion capital-intensive. Companies require regular intensive. infusions of fund both for new equipment and regular maintenance and upkeep of existing equipment.

Global Steel Industry The world crude steel-making capacity has increased from around 1,062 mt in 2000 to an estimated making 1,700 mt in 2009, followed by an increase to 1,800 mt in 2010.Growth rates have improved rowth during2004-08, mainly driven by a significant increase in China. Between 2002-09, capacity 08, 2002 09, expansions in China have accounted for 63 63-65% of worldwide capacity expansions. In recent years, China has been the main cause of expanding world steel demand and production. main Historically, China has been unable to satisfy domestic demand with domestic supply. However, Chinas unprecedented steel production expansions are changing this situation. While China plans to continue massive expansions in capacity, domestic demand growth has slowed. With overcapacity, it nue also seems likely that China could flood the world with potentially dumped exports. At the least, increased Chinese production could replace imports, resulting in excess production capacity in the rest of the world. Oversupply could be a feature of the market in the future, with excess supply in many Asian countries likely to be exported to the industrialized nations in Europe and North America. Demand Potential The present finished steel consumption per capita per annum is about 50 kg in India, compared to 200 kg in the world, and 429 kg in China. Indias per capita steel consumption has remained lower

JSW Steel Limited

03rd Jan , 2012

than China because of higher share of services in Indias GDP. The estimated urban consumption per capita per annum was around 95 kg in India during 2007, and is expected to reach approximately 165 kg in 2019-20. The growth is expected to driven by anticipated growth in construction, automobile, oil and gas transportation, and infrastructure sectors of the economy. The Government also proposes to undertake measures to promote usage of steel in bridges, crash barriers, flyovers and building construction. The rural consumption of steel in India remains at around 2 kg per capita per annum, primarily because steel is perceived to be expensive. The Government has set a target for raising the per capita rural consumption of steel to 4 kg per annum by 2019-20, implying a CAGR of 4.4%. The demand for HR products such as coils, sheets, plates and strips is dependent on demand for further-processed steel, such as cold-rolled, as well as those products in which it is a direct raw material, such as construction, automobiles, oil and gas pipelines and shipbuilding. The demand for CR products depends on demand in the appliance, automotive, construction, container, and other industries in which it is used. Demand for coated steel is influenced by demand in the automotive and construction industries. The demand for steel originating from various sectors indicates that construction, and machinery/equipment sector constitute more than 60% of the demand for steel. Other major endues sectors include automobile, consumer durables, and oil & gas. As compared with global trends, the share of construction and automobiles is lower in India but rising.

Investment Risks
Lower availability of raw material: JSW does not own any iron ore mines in India. With changes in the procurement system of iron ore in Karnataka, there have been delays in procurement and supply of raw materials. Because of shortage of raw materials, the plant at Vijayanagar has been operating at ~30%. Future supply is expected to be back to normal, but huge risks in the future looms over JSW. Rising cost of raw material: As the raw material costs rises, will put pressures on margins in the future. In the past year we had seen raw material costs rise by almost Rs 800 per ton. Under the new e auction system the prices of raw material will rise further. High Forex Exposure: With high fluctuations in the exchange rate, a loss of Rs 5.13 bn was reported in the financials. Exposure to foreign currency risks remains high due to import of raw material and foreign currency loans. Government Regulations: Land acquisition and illegal iron ore mining have been two key issues affecting expansion plans in India. With new mining act even royalty would be doubled. Investor concern is that what other government intervention is likely and how would it affect the industry USD /INR

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JSW Steel Limited

03rd Jan , 2012

Valuation of JSW Steel

Approach 1: Assets (Replacement) Value Approach: Total Adjusted Assets at replacement value (Rs. Crore) Total Adjusted Liabilities at replacement value (Rs. Crore) Intrinsic value of Equity (Rs. Crore) # of shares (Crore) Value of Share Current Market Price Premium Premium (%) 49,118 30,944 18,174 220.46 824.34 512.75 311.59 61%

Refer Exhibits 1 to 4 for detailed working for valuation using Assets (Replacement) Value. Following key notes be considered while evaluating this valuation approach: Net Assets for Ispat Industries is also valued on replacement value approach JSW Steels investment (45.53%) adjusted Brand value (goodwill) is computed assuming 50% of SG&A expense at the multiple of 4 years Replacement value computed separately for each category of PPE Approach 2: Earning Power Value (EPV): Adjusted EBIT After Tax (in Rs. Crore) Real WAAC Adjusted EBIT / Real WACC (in Rs. Crore) Less: Liabilities (in Rs. Crore) No. of Share (in Rs. Crore) Price per share (in Rs.) Current Market Price Premium Premium (%) 4,221 8.75% 48,271 34,253 220.46 636.00 512.75 123 24%

Refer Exhibits 5 to 7 for detailed working for valuation using EPV approach. Following key notes be considered while evaluating this valuation approach: EBI T is adjusted for cyclical variations by averaging EBIT / Sales ratio over 5 years EBI T is adjusted for SG&A and depreciation beyond normal growth Approach 3: Comparable Firms Approach: Comparables JSW Steel Tata Steel SAIL Bhushan Steel Visa Steel Mean Median Earnings/ Book/EBIDTA per share (Rs) Price per share using mean (Rs) Price per share using median (Rs) P/E 6 4.8 8.3 6.7 6.6 6.7 86 569 579 P/B 0.7 0.7 0.9 1.1 1.8 1.1 1 737 833 748 EV/EBIDTA 5.1 6.3 6.9 11.5 8.9 8.4 7.9 123 1,037 975

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JSW Steel Limited

03rd Jan , 2012

EXHIBITS

Exhibit 1- Valuation of JSW Steel using APV method

Mar-312007 ASSETS Cash And Equivalents Short Term Investments Total Cash & ST Investments Accounts Receivable Other Receivables Notes Receivable Total Receivables Inventory Prepaid Expenses Other Current Assets Total Current Assets Gross PPE Accumulated Depreciation Net Property, Plant & Equipment Long-term Investments Goodwill Other Intangibles Deferred Tax Assets, LT Deferred Charges, LT Other Long-Term Assets Total Assets Mar-312008 Mar-312009 Mar-312010 Mar-312011 Sep-302011 Adjust ment to Sep 2011 100% Adjusted Value (Sep 2011)

3,394.6 170.6 3,565.2 2,459.6 1,521.2 0 3,980.8 10,121.1 990.1 6,303.4 24,960.6 125,132.3 (23,136.6) 101,995.7 2,279.3 39.1 23.9 1,950.1 0.1 131,248.8

4,714.8 2,157.5 6,872.3 5,390.6 1,285.0 0 6,675.6 21,817.4 3,636.5 4,362.6 43,364.4 236,510.9 (30,633.2) 205,877.7 2,538.3 7,831.3 2,139.0 1.3 261,752.0

5,093.0 27.5 5,120.5 3,990.5 0 3,990.5 29,245.6 2,984.8 9,615.5 50,956.9 316,848.5 (40,676.7) 276,171.8 3,938.5 7,831.3 2,771.6 1,445.0 343,115.1

3,030.4 2,137.7 5,168.1 6,963.9 0 6,963.9 28,667.4 4,467.4 11,570.5 56,837.3 334,773.6 (53,227.3) 281,546.3 4,144.3 8,991.9 2,543.4 2,801.7 356,864.9

20,480.0 2,701.4 23,181.4 9,504.1 0 9,504.1 44,097.0 8,018.5 13,549.7 98,350.7 387,897.8 (68,475.8) 319,422.0 26,436.9 10,932.0 3,761.4 2,762.3 461,665.3

17,107.5 17,107.5 11,954.4 27,350.5 39,304.9 64,728.5 121,140.9 418,317.8 347,203.8 24,391.2 11,975.3 3,025.8 507,737.0

17,107.50

17,107.50 90% 10,758.96

90%

24,615.45 35,374.4

90%

58,255.65

58,255.7 Note 1 314,883.59 0.00 314,883.6 Note 2 Note 3 22,961.00 39,568.12

100%

3,025.80

491,176.1

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JSW Steel Limited

03rd Jan , 2012 Adjust ment to Sep 2011 132,360.9 132,360.9 184,183.0 25,988.2 342,532.1 309,441.9 181,734.19 220.46 824.34 100% 25,988.20 100% 75% 99,270.68 99,270.7 184,183.00

Mar-312007 LIABILITIES Accounts Payable Accrued Exp. Short-term Borrowings Current portion of LT Debt Current portion of Capital Leases Current Income Taxes Payable Other Current Liabilities Total Current Liabilities Long-Term Debt Capital Leases Def. Tax Liability, Non-Current Other Non-Current Liabilities Total Liabilities Value of Equity # of shares outstanding Value per share 5,068.0 1,567.8 2,557.8 912.9 294.3 15,874.9 26,275.7 38,259.6 10,125.3 74,660.6

Mar-312008

Mar-312009

Mar-312010

31-Mar-11

Sep-302011

Adjusted Value (Sep 2011)

14,971.1 2,900.5 9,270.7 494.4 28,698.2 56,334.9 112,091.5 12,518.4 180,944.8

17,867.5 2,068.2 18,427.1 11.5 96.5 62,596.0 101,066.8 147,030.1 33.5 14,213.2 262,343.6

17,062.8 1,695.0 7,185.9 11.8 341.4 61,627.8 87,924.7 154,513.4 19.3 19,649.5 262,106.9

24,874.3 1,680.4 8,343.7 153.6 585.4 78,873.7 114,511.1 155,588.5 657.8 23,256.3 294,013.7

Exhibit 2- Valuation of Adjusted Gross Block for Replacement Value computation in Exhibit 1 Amount in Rs. Crore Freehold land Leasehold land Building Plant & Machinery Furniture & Fixtures Vehicles & aircrafts Software Mining concessions Port concessions Gross Block 206 152 4,687 26,969 98 169 41 359 1 32,684 Gross Block 263 195 5,999 34,518 126 216 53 460 1 41,832 Adjustment 100% 100% 75% 75% 75% 75% 75% 75% 75% Adj. Gross Block 263 195 4,500 25,888 94 162 40 345 1 31,488

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JSW Steel Limited- Stock Report

Exhibit 3- Valuation of Ispat JSW (as on June 30, 2011) for valuation of investments in JSW Steel Assets Fixed Assets Land Building Plant and Machinery including railway sidings Others Less: Depreciation Net Block CWIP Investments DTA Current Assets , Loans and Advances Inventories Sundry Debtors Cash and Bank Balance Loans Advances and Deposits Less: Current Liabilities and provisions Current Liability Provisions Enterprise Value Less: Debt Less: Preference Share Equity Value Number of Shares Value Per share Current Price Calculation of Investment Value Book Value Replacement value Using replacement value 2,014 computed above (4,423 * 45.5%) 282 2,296 Book Value 148 540 12,048 712 6,194 7,255 63 163 1,309 2,055 395 601 542 % 100.00% 90.00% 80.00% 80.00% 0.00% Replacement Value 148 486 9,639 569 0 10,842 376 163 1,309 1,644 316 601 542 0 (3,420) (46) 8,916 6,934 969 1,013 100.00% 100.00% 100.00% 100.00% (3,420) (46) 12,327 6,934 969 4,423 238.68 18.53 9.54

100.00% 100.00% 80.00% 80.00% 100.00% 100.00%

Ispat Industries

2,157

Others

282 2,439

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JSW Steel Limited- Stock Report

Exhibit 4 - Valuation of Goodwill Mar-31Mar-31Amount in Rs. Crore 2007 2008 SG&A 6,985 10,392 Sales 85,544 123,455 SG&A / Sales 8.17% 8.42% Average SG&A / Sales - 50% for sales maintenance - 50% for brand building Assuming 4 year multiple for goodwill calculation Goodwill Exhibit 5 Computation of Adjusted Earnings Mar-31Mar-31Mar-31Mar-31Mar-312007 2008 2009 2010 2011 85,544 123,455 158,863 188,970 238,616 22,854 28,128 21,289 28,922 33,230 26.72% 22.78% 13.40% 15.31% 13.93% Sep-302011 287,405 38,426 13.37% 17.58% Mar-312009 11,931 158,863 7.51% Mar-312010 11,590 188,970 6.13% Mar-312011 14,040 238,616 5.88% Sep-302011 14,921 287,405 5.19% 6.88% 3.44% 3.44% 287,405 * 3.44% * 4 39,568

Sales EBIT EBIT / Sales Average EBIT / Sales Average EBIT / Sales Sales - 12 months Q2 2011 Average EBIT Adjustments: Depreciation & amortization SG&A Adjusted EBIT before tax Tax (@32.8%) Adjusted EBIT after tax Computation of WACC Risk Free Rate Beta Market Risk Premium Cost of Equity Cost of Debt Effective Tax Rate D/E Ratio D/V WACC Inflation Real WACC

17.58% 287,405 50,537 EBIT Averaged for adjustment for cyclicity in EBIT and Revenues

17,149 (Refer Exhibit 6) (4,863) (Refer Exhibit 7) 62,823 (20,609) 42,214

8.55% 1.48 5.00% 15.93% 5.75% 32.80% 1.11 0.53 9.57% 9.39% 8.75%

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JSW Steel Limited- Stock Report

Valuation using EPV Adj. WACC / Real WACC Less: Liabilities # of shares Price per share 482,714 342,532 140,181 220.46 635.86

Exhibit 6 Adjustment for depreciation Mar-312007 125,132 85,544 1.46 Mar-312008 236,511 123,455 1.92 Mar-312009 316,849 158,863 1.99 Mar-312010 334,774 188,970 1.77 Mar-31- Sep-302011 2011 387,898 418,318 238,616 287,405 1.63 1.46 1.70 287,405 489,820 418,318 0 17,149 17,149

PPE Sales PPE / Sales Average PPE / Sales Sales PPE needed for growth Actual PPE Maintenance CAPEX Reported Depreciation & amortization Adjustment to be made in EBIT

Exhibit 7 Adjustment for SG& A SG&A Sales SG&A / Sales Average SG&A / Sales Sales SG&A needed for growth Actual SG&A Adjustment to be made in EBIT 6,985 85,544 0.08 10,392 123,455 0.08 11,931 158,863 0.08 11,590 188,970 0.06 14,040 238,616 0.06 14,921 287,405 0.05 0.07 287,405 19,784 14,921 (4,863)

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