Ranked amongst the top ten public sector companies in India in terms of turnover, Steel Authority of India Limited (SAIL) is a fully integrated iron and steel maker, producing both basic and special steels for domestic construction, engineering, power, railway, automotive and defence industries and for sale in export markets.

Capacity Expansion will ensure volume growth: SAIL is all set to bank on the domestic consumption of steel primarily driven by the ongoing infrastructure development in the country with its ambitious expansion plans which will increase its crude steel capacity to 23.2mt from 14mt currently.

Value-added Segment: SAIL is banking on the robust demand witnessed for finished and premium steel segment by expanding its value added steelmaking capacity. The value added or premium segment commands 20-25% premium over semi-finished or crude steel.

Strong demand led by domestic consumption: India's finished steel demand is expected to grow at 12% CAGR over FY 10-13, led by strong demand from Automobiles, consumer durables and Engineering sector. India will remain a net steel importer over FY11-13, as demand is likely to outpace supply.

Valuation: At the current price of 188, the stock is trading at just 11.96x and 10.84x times of our estimated FY11E & FY12E earnings. We thus recommend a `Accumulate' with a Price target of Rs 214.

Venturing into premium segment: SAIL is currently selling both raw steel and semi finished, whereas the contribution from value-added segment is low. Going forward company plans to eliminate this segment completely and add different value added products, which commands premium over raw steel. It plans to introduce products like auto grade CR products, galvanized coils, sheets, plates, pipes to meet up to API 100 grade specification. It also plans the production of rails and wheels to meet the increasing demand requirements of the Indian railways, Universal beams/ Heavy beams in the size up to 1100mm to support increasing infrastructure requirements. The value added or premium segment commands 20-25% premium over semi-finished or crude steel.

Capacity expansion will ensure volume growth: Company has planned capex of over Rs 50000cr to increase its crude steel capacity to 23.2mt from 14mt currently. The company has also planned capex for technological up gradation/ modernization, value addition, production mix improvement. Technological up gradation/ modernization will reduce SAIL's operating cost/ton by around 15-20% over the next three years. The massive capacity addition should help the company to strengthen its leadership position in Indian Steel Industry.

SAIL is setting up a Finex plant at the existing Bokaro plant through a JV with Posco in ratio of 49:51, for which DPR is yet to be completed. The iron will be supplied through the FINEX process (0.5mt) and end product capacity is envisaged at ~1.5mt, of which 0.5mt is CRGO steel. The incremental 1mt steel will be supplied through the Bokaro plant as cold rolling mill ordered has a capacity of 1mt, whereas SMS-3 will have a capacity of 1.8mt.

Captive mines to provide hedge against raw material price volatility: The raw material accounts for over 64% of the total expenditure. The company is in process to secure major raw material from its captive sources. SAIL is fully integrated with respect to iron ore, which is sufficient enough to back its expansion plans. Currently company uses captive mines for iron ore and it has been allotted Chhiria mines which have proven reserve of 2bt of iron ore.

SAIL has started production of 10000 tpa coal at Tasra collieries, the expected capacity to produce is 4mt in the near future, which will reduce their raw material cost and improve operating margin. In addition to this the company has formed JV with Tata Steel to explore Coking Coal. The main advantage of having a captive mine is that it insulates the company from volatility in raw material prices and protects its margin.

Domestic focus; SAIL's entire steelmaking maneuvers are based in India. It is focused on the domestic market and exports little. Ahead, it expects exports to comprise around 15% of the expanded volume. A favorable product mix (60% longs, 40% flats) could make it one of the best beneficiaries of India's infrastructure growth story. The company is one of the key suppliers to the infrastructure sector, with around 60% of its sales going to this sector. Around 32% of its sales goes to the government sector.

The company is well positioned to be benefitted the infrastructure story of India. Large proportion of its product mix will find its application in construction and engineering.

Strong balance sheet with good dividend track record: Company enjoys healthy balance sheet with a low debt-equity ratio in the range of 0.18 to 0.39 in last four years, which ensures that SAIL undertake capex without overstretching its balance sheet.

Attractive Dividend Pay-out: SAIL has been rewarding its shareholder by offering regular dividend since 2005. The average dividend yield of the company stood at 2.73%. With huge cash on the book and being one of the most profitable maharathna in government entities, we believe the management of SAIL would continue to reward its shareholders with higher dividend pay-out.

Key strategic alliance to further boost profitability: Company has signed MOU with Kobe Steel, Japan for exploring feasibility of ITmk3 technology for use of lean iron ore fines & non coking coal. Company is in 50-50 JV with NTPC for 250 MW power generation. Due to this JV, company's power cost will reduce. There is a possibility of joint collaboration with Nippon Steel in the iron and steel area. Company has also proposed owing a port/joint ownership in a port venture in Orissa. This will further reduce logistics cost for the company.

Economies of Scale: SAIL has been enjoying the benefit of improved productivity per employee with its workforce came down by ~58% (annualized rate of 5.4%) during the past ten years from 208765 in FY2000 to 114160 at the end of FY10. The company's employee's remuneration as a % of net sales saw an improvement, its net employee cost stood at 13.37% for FY10, as against 19.82% in FY09 and 19.91% during FY08.

The labour productivity has improved to 228tons of crude steel per labour employed during the H1 of FY11 against 214tons of crude steel produced per labour during FY08.

KEY CONCERNS:

Rise in input cost: The backward integration (Coal) of the SAIL would be completed by next 2-3 years, any adverse moment in coking coal prices could have its bearing on earning visibility of the company.

Fall in prices: Any negative movement in product prices can have its effect on the realization of the company, thereby affecting the profit earning capabilities of the company.