Metals & Mining June 21, 2010

Steel Authority of India

Bloomberg: SAIL IN Equity Recommendation: HOLD
Reuters: SAIL.BO
VISIT NOTE

Analyst contact
Visit note – key takeaways Chandrani De, CFA
Tel: +91 22 3043 3210
Expansion on schedule, benefits expected FY12 onward chandranide@ambitcapital.com

While no major capacity additions are planned in FY11, the company expects to be
able to report production and sales volume growth through improved efficiency.
FY12E should see significant (~1.5mt) sales volume growth led by the 2mtpa IISCO
expansion. Most of the other capacity additions continue to be planned for FY13. We Recommendation
also are positive on the product mix changes that should lead to realisation
improvement as well as process changes that would bring about cost improvement. CMP: Rs202
Target Price (March 2011): Rs235
Capex in FY11E and FY12E expected to rise further to Rs.120bn and Rs.140bn Previous TP: Rs235
The total capex spend for expansion, modernization and raw material augmentation Upside/Downside (%) 16
is Rs.370bn, Rs.230bn and Rs.100bn respectively. Of this total spend, capex in FY11E EPS (FY11): Rs19.6
and FY12E is expected to be Rs.120bn and Rs.140bn respectively, up from Rs.105bn
in FY10.
Stock Information
Pricing environment –not out of the woods yet Mkt cap: Rs832,482mn/US$18,029mn
In line with decline in prices across metals, and led by concerns of demand in Europe 52-wk H/L: 267/139
and slowdown in China, global steel prices have corrected in recent weeks. CIS HR
3M Avg. daily vol. (mn): 10
export HRC prices have dropped to US$580/t from the recent high of US$715/t,
while Chinese domestic HRC prices have fallen to US$620/t. While the company did Beta (x): 1.3
not indicate its specific outlook on prices, it hopes to see improvement in 3QCY10. BSE Sensex: 17877

Iron ore reserves to continue being a key competitive strength Nifty: 5353

The company has in-principle approval from the Jharkhand state government for Stock Performance (%)
renewal of reserves of 0.8bn tonnes. Regarding the other 1bn tonne reserves at 1M 3M 12M YTD
Chiria, the company has proposed setting up a 12mtpa greenfield plant in the state Absolute -0.7 -18.5 32.2 -16.6
and is awaiting government’s suggestions for the site. In total, the company has a
Rel. to Sensex -8.6 -19.9 7.4 -18.5
comfortable 3bn tonnes of iron ore reserves, which provides for 80 years of
production, even at the expanded capacity levels of 23mtpa of saleable steel.
Performance (%)
Valuation 20,000
18,000
300
250
We maintain our HOLD recommendation with a March 2011 TP of Rs235. Recent 16,000
14,000
200
capex trends have been healthy and backward integration with iron ore protects the 12,000 150
company against price escalation of the raw material. Backended expansion plans 10,000 100
however limit upward potential for the stock price in the near future, in our view. The Jun-09 No v-09 A pr-10
stock is currently trading at 6.5x EV/ EBITDA and 10.3x P/E on our FY11 estimates. Sensex S A IL

Source: Bloomberg,
Exhibit 1: Key financials
Year to March (Rs mn) FY08 FY09 FY10 FY11E FY12E
Net sales 395,765 431,768 406,002 477,781 573,207
EBITDA 118,820 91,656 99,904 127,890 158,210
Adj. Net profit 75,359 61,262 66,984 80,902 98,513
Adj. EPS FD 18.2 14.8 16.2 19.6 23.9
EBITDA Margin % 30.0 21.2 24.6 26.8 27.6
Return on Equity % 32.4 21.6 20.0 20.3 20.8
P/E (x) 11.1 13.6 12.5 10.3 8.5
EV/ EBITDA (x) 6.2 8.0 7.8 6.5 5.6
Source: Company, Ambit Capital research

Ambit Capital and / or its affiliates do and seek to do business including investment banking with companies covered in its research reports. As a result, investors should be aware that Ambit
Capital may have a conflict of interest that could affect the objectivity of this report. Investors should consider this report as only a single factor in making their investment decision.

Please refer to disclaimer section on the last page for further important disclaimer.
Ambit Capital Pvt Ltd Steel Authority of India

Key highlights
FY11 volume growth driven by efficiency improvement …
While no major capacity additions are expected in FY11 (the company has
expanded Salem capacity marginally from 0.2mt to 0.3mt and expects production
at the enhanced capacity soon), it should be able to post production and sales
volume growth of 5-6% through improved efficiency of the existing facilities. We
note that in FY07 and FY08, SAIL recorded ~5% volume growth despite installed
capacity being the same, and utilization being in excess of 100%.

Exhibit 2: Sales volume and growth

15.0 14.7 20%

14.0 15%
12.8 10%
13.0 12.3 12.1
11.9 5%
12.0 11.3 11.3
0%
11.0 -5%
10.0 -10%

FY2011E

FY2012E
FY2006

FY2007

FY2008

FY2009

FY2010
Saleable Steel sales volume (MT) Growth in Saleable Steel sales volume

Source: Company, Ambit Capital research

… while FY12 volume growth would be driven by capacity addition

FY12E should see larger volume growth led by the 2mtpa IISCO expansion – while
individual facilities (e.g. the coke oven) will come up earlier, integrated
commissioning is expected in June 2011.

Exhibit 3: Capacity expansion schedule

Actual FY10 Capacity post Timeline for integrated
production expansion commissioning

Bhilai Steel plant 4.40 6.50 Mar-13

Durgapur Steel plant 1.90 2.80 Mar-13
Rourkela steel plant 2.00 4.00 Dec-12
Bokaro steel plant 3.50 6.50 Dec-12
IISCO Steel plant 0.40 2.40 Jun-11
Alloy Steels plant 0.20 0.40 Mar-13
Salem steel plant 0.20 0.30 Jun-10
Visvesvarya Iron & Steel plant 0.10 0.20 Mar-13
Total 12.60 23.10
Source: Company
The other major capacity additions are all expected to come up in FY13. Since the
addition to downstream capacities is actually higher than addition to saleable steel
capacity, there will be significant improvement in product mix with semis being
eliminated. The company expects the Medium section mill at Durgapur to start in
December 2012 while Cold rolling mill at Bokaro will start in December 2011.

Steel Authority of India June 21, 2010 2

 Ambit Capital Pvt Ltd Steel Authority of India

Besides volume expansion and product mix improvements, the modernisation plan
also should lead to cost improvements. At present, 22% of the steel is produced
through the Open Hearth method (at Bokaro and IISCO). This method will be
replaced by the BOF method while the ingot method (currently 33% of volumes)
will be done away with totally in favor of the continuous casting method.
The capex spend for the expansion, modernization and raw material augmentation
is Rs.370bn, Rs.230bn and Rs.100bn respectively. Of this total spend, capex in
FY11E and FY12E is expected to be Rs.120bn and Rs.140bn respectively, up from
Rs.105bn in FY10.

Exhibit 4: SAIL quarterly trend in sales volume Exhibit 5: SAIL quarterly trend in realisations

Sales Volume (MT) 50,000 Net sales realisation (Rs/t)

3.8 3.6
4.0
3.4 45,000
3.5 3.0 3.0 3.0 2.9
2.7 2.6 2.8
3.0 2.5 2.4 40,000
2.5
2.0
35,000
1.5
1.0
30,000
0.5
0.0
25,000
Q1FY08
Q2FY08
Q3FY08
Q4FY08
Q1FY09
Q2FY09
Q3FY09
Q4FY09
Q1FY10
Q2FY10
Q3FY10
Q4FY10

Q1FY08

Q2FY08

Q3FY08

Q4FY08

Q1FY09

Q2FY09

Q3FY09

Q4FY09

Q1FY10

Q2FY10

Q3FY10

Q4FY10
Source: Company, Ambit Capital research Source: Company, Ambit Capital research

Pricing environment – is the end of the tunnel in sight?

While the company did not indicate its specific outlook on prices, they hope to see
an improvement in steel prices in 3QCY10.
In line with decline in prices across metals, and led by concerns about demand in
Europe and the slowdown in China, global steel prices have corrected in recent
weeks. CIS HRC export prices have dropped to US$580/t from the recent high of
US$715/t while Chinese domestic HRC prices have fallen to US$620/t.

Exhibit 6: CIS export steel prices (US$/t) Exhibit 7: Steel prices in India (Rs/t)

Steel CIS Export HR coil $ per tonne Black Sea/Baltic Sea Flat HRC Rebar
Steel CIS Export CR coil $ per tonne Black Sea/Baltic Sea
40,000
900 38,000
800 36,000
700 34,000
600 32,000
500 30,000
400 28,000
300 26,000
200 24,000
100 22,000
- 20,000
Jan-09

Mar-09

May-09

Jul-09

Sep-09

Nov-09

Jan-10

Mar-10

May-10
Jan-09

Mar-09

May-09

Jul-09

Sep-09

Nov-09

Jan-10

Mar-10

May-10

Source: Company, Ambit Capital research Source: Company, Ambit Capital research

Steel Authority of India June 21, 2010 3

 Ambit Capital Pvt Ltd Steel Authority of India

As always, declining prices have led to reduced sales volume, as buyers have
withheld purchases, exacerbating the price declines. We believe that in the
international markets, steel prices may be close to bottoming out. In India,
however, domestic prices are still above import parity levels (we estimate these to
be currently at Rs30,500/t), and given the high level of inventory that companies
as well as importers are carrying, an improvement in domestic steel prices could
still be some way away.
Enviable situation of 3bn tonnes of iron ore reserves: In the 2bn tonne iron
ore reserves at Chiria, the company has obtained in-principle approval from the
Jharkhand state government for renewal of the Budhaburu lease with reserves of
0.8bn tonnes, and renewal for another 0.2bn tonnes is expected soon. Regarding
the other 1bn tonne reserves at Chiria, the company has proposed setting up of a
12mtpa greenfield plant in the state and is awaiting the government’s suggestions
for the site. All clearances for the 650mn tonne reserve at Rowghat have also been
obtained, and in total the company has a comfortable 3bn tonne iron ore reserves,
which provides for 80 years of production, even at the expanded capacity level of
23mtpa of salable steel.

Exhibit 8: Consolidated profit & loss

Y/E March (Rs mn) FY2007 FY2008 FY2009 FY2010 FY2011E FY2012E
Net sales 339,505 395,765 431,768 406,002 477,781 573,207
Other operating income 7,922 6,626 5,918 7,564 6,656 6,922
Materials (inc. purchase of
120,782 124,472 185,234 158,082 189,555 237,065
semis)
Stores & spares 26,296 28,872 30,622 25,801 29,563 34,436
Power & Fuel 24,665 27,021 30,221 35,173 31,047 35,539
Employee Costs 51,410 80,168 85,022 54,562 73,027 75,948
Change in stocks (340) (3,289) (19,793) 11,799 - -
Other expenses & adj 21,376 26,326 34,724 28,245 33,354 38,932
Total expenses 244,189 283,571 346,030 313,661 356,547 421,919
EBITDA (inc other op.
103,238 118,820 91,656 99,904 127,890 158,210
income)
Depreciation 12,615 12,835 13,316 13,397 14,409 16,719
Operating profit 90,622 105,985 78,340 86,507 113,481 141,491
Other Income (Losses) 7,575 11,907 18,412 19,350 15,910 16,809
EBIT 98,197 117,892 96,752 105,857 129,391 158,300

Interest expense 3,444 2,594 2,576 4,022 6,439 8,584

Adjusted PBT 94,754 115,298 94,176 101,835 122,953 149,717

Tax 32,550 39,937 32,912 34,848 42,050 51,203

Share of associates income - 1 1 - 1 1
Minority Interest 1 3 3 3 2 2
Adjusted net profit 62,202 75,359 61,262 66,984 80,902 98,513
Extraordinary Income 435 598 1,267 924 - -
Reported net profit 62,637 75,958 62,529 67,908 80,902 98,513
Source: Company, Ambit Capital research

Steel Authority of India June 21, 2010 4

 Ambit Capital Pvt Ltd Steel Authority of India

Exhibit 9: Consolidate balance sheet

Y/E March (Rs mn) FY2007 FY2008 FY2009 FY2010E FY2011E FY2012E
Equity Capital 41,304 41,304 41,304 41,304 41,304 41,304
Reserves & Premium 132,293 190,979 241,701 294,070 356,527 432,578
Borrowings 46,389 38,874 86,665 165,110 225,110 295,110
Defered Tax Liability 14,169 15,685 13,277 13,277 13,277 13,277
Minority Interest 2 4 7 10 12 14
Capital employed 234,157 286,847 382,954 513,771 636,229 782,283

Net Fixed Assets inc CWIP 137,626 153,679 205,093 297,056 401,947 524,528
Investments 370 358 370 370 371 372
Inventory 67,564 69,539 102,432 91,091 100,615 117,906
Receivables 23,536 30,703 30,952 35,595 41,888 48,683
Cash and bank balances 98,108 139,330 184,863 221,227 231,517 245,229
Loans & Advances 18,973 28,235 33,594 33,594 33,594 33,594
Current Liabilities 56,319 65,976 78,796 69,607 78,147 92,475
Provisions 55,700 69,021 95,554 95,554 95,554 95,554
Net working Capital 96,162 132,809 177,491 216,346 233,912 257,383
Capital employed 234,157 286,847 382,954 513,771 636,229 782,283
Source: Company, Ambit Capital research

Exhibit 10: Consolidate cashflow statement

Y/E March (Rs mn) FY2007 FY2008 FY2009 FY2010E FY2011E FY2012E
Reported profit before taxes 95,188 115,896 95,443 102,759 122,953 149,717
+ Depreciation expense 12,615 12,835 13,316 13,397 14,409 16,719
+ Interest expense 3,444 2,594 2,576 4,022 6,439 8,584
+ Extraordinary expenses (gains) (435) (598) (1,267) (924) - -
- Interest and dividend received (7,703) (11,941) (18,440) (19,350) (15,910) (16,809)
+/- Other adjustments (1,157) 12,412 27,352 924 - -
Cash flows pre working capital
101,953 131,198 118,979 100,828 127,890 158,210
changes
Working capital changes (9,760) (7,380) (25,415) (2,490) (7,277) (9,759)
Direct Taxes Paid (34,453) (38,329) (31,871) (34,848) (42,050) (51,203)
Net Cash from Operating Activities 57,740 85,488 61,693 63,490 78,564 97,247
Net Capex (14,397) (27,600) (57,441) (105,360) (119,300) (139,300)
Loans to Subsidiary & Other
264 45 61 - - -
Companies
Purchase/Sale of investments (169) 16 (10) - - -
Interest and Dividend received 7,028 10,732 11,018 19,350 15,910 16,809
Net Cash from Investing Activities (7,274) (16,807) (46,372) (86,011) (103,390) (122,491)
Equity and Reserves 113 (96) 172 - - -
Borrowings 318 (7,513) 47,791 78,445 60,000 70,000
Interest paid (5,213) (3,401) (2,771) (4,022) (6,439) (8,584)
Dividends paid inc taxes (11,183) (16,449) (14,980) (15,538) (18,446) (22,461)
Others 1,169 - - - - -
Net Cash from Financing Activities (14,796) (27,458) 30,211 58,885 35,116 38,956
Net Increase in Cash & Cash
35,671 41,223 45,532 36,364 10,289 13,712
Equivalents
Source: Company, Ambit Capital research

Steel Authority of India June 21, 2010 5

 Ambit Capital Pvt Ltd Steel Authority of India

Exhibit 11: Ratio analysis

Y/E March (Rs mn) FY2007 FY2008 FY2009 FY2010E FY2011E FY2012E
Total materials cost/Net Sales 43% 39% 50% 45% 46% 47%
Power & Fuel/Net Sales 7% 7% 7% 9% 6% 6%
Labour/Net Sales 15% 20% 20% 13% 15% 13%
EBITDA Margin 30% 30% 21% 25% 27% 28%
Adjusted PBT Margin 28% 29% 22% 25% 26% 26%
Reported Net profit margin 18% 19% 14% 17% 17% 17%
Return on Capital employed 45% 43% 26% 21% 21% 21%
Return on Equity 36% 32% 22% 20% 20% 21%
Gross Debt/ Equity 27% 17% 31% 49% 57% 62%
Net Debt (Cash)/ Equity -30% -43% -35% -17% -2% 11%
Source: Company, Ambit Capital research

Exhibit 12: Per share figures and valuation ratios based on current share price
FY2007 FY2008 FY2009 FY2010E FY2011E FY2012E
Adjusted Basic and Diluted EPS 15.1 18.2 14.8 16.2 19.6 23.9
Reported Basic and Diluted EPS 15.2 18.4 15.1 16.4 19.6 23.9
Book Value Per Share 42.0 56.2 68.5 81.2 96.3 114.7
Net Dividend Per Share 3.1 3.7 2.6 3.3 3.9 4.8

P/E on adjusted basis (x) 13.4 11.1 13.6 12.5 10.3 8.5
P/E on reported basis (x) 13.3 11.0 13.3 12.3 10.3 8.5
P/B (x) 4.8 3.6 2.9 2.5 2.1 1.8
EV/ EBITDA (x) 7.6 6.2 8.0 7.8 6.5 5.6
Dividend yield (%) 2% 2% 1% 2% 2% 2%
Source: Company, Ambit Capital research

Steel Authority of India June 21, 2010 6

 Ambit Capital Pvt Ltd Steel Authority of India

Explanation of Investment Rating

Investment Rating Expected return

(over 12-month period from date of initial rating)

Buy >15%

Hold 5% to 15%

Sell <5%

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Steel Authority of India June 21, 2010 7