Thematic Report | October 2011

Metals

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Metals | RoIC v/s RoCE: The Return Roulette

RoIC v/s RoCE: The Return Roulette

Page No.

Summary

.....................................................................................................................

1-2

RoCE will keep declining but core RoIC remains healthy

...............................

3-6

Superior capital allocation drives equity value

faster despite modest RoIC

................................................................................

7-10

Companies

.............................................................................................................11-50

Ferrous

Tata Steel ............................................................................................. 12

Jindal Steel & Power .......................................................................... 18

SAIL .................................................................................................... 23

JSW Steel ............................................................................................ 27

Sesa Goa.............................................................................................. 31

Non-Ferrous

Hindalco ............................................................................................... 34

Hindustan Zinc .................................................................................... 39

Sterlite Industries ................................................................................. 42

Nalco ................................................................................................... 47

Metals | RoIC v/s RoCE: The Return Roulette

Metals

RoIC v/s RoCE: The Return Roulette

Re-investment challenges drag RoCE; Stocks at deep discount to NAV

THEME SUMMARY:

We have observed distinct inter-relations of RoIC, RoCE and

ASR (annualized stock return) among large-cap metal companies:

1. Superior capital allocation boosts ASR, even if RoIC is modest in some cases

(Tata Steel, JSW, Nalco)

2. RoCE keeps declining due to rising share of CWIP (SAIL, Jindal Steel & Power,

Hindalco) or un-invested capital (Hindustan Zinc)

3. Capital deployment into group companies and/or unrelated businesses

suppresses RoCE and hurts ASR (Sesa Goa, Sterlite Industries).

Stock recommendations:

Reiterate Buy on Tata Steel; downgrade Sesa Goa to

Neutral (from Buy); and upgrade Nalco to Neutral (from Sell).

Companies

Ferrous

Tata Steel

Jindal Steel & Power

SAIL

JSW Steel

Sesa Goa

Non-Ferrous

Hindalco

Hindustan Zinc

Sterlite Industries

Nalco

RoCE to keep declining due to rising share of CWIP, un-invested capital

The aggregate RoCE of key Indian metals companies will keep declining though the

aggregate RoIC (pre-tax) is still healthy at about 40%. A large share of un-invested capital

and capital work in progress (CWIP) will drag RoCE though RoIC will not deteriorate. Over

2000-05, the share of un-invested capital rose as margins and cash flows grew faster than

companies could reinvest. Post 2005, Indian metals companies made big investments in

core business. Project execution slowed significantly in FY11 and FY12 due to delays in

receiving government approvals and problems related to land acquisition. Consequently,

the share of CWIP in total capital employed (CE) increased from 11% in FY08 to 23% by

end-FY11, and is expected to rise to 27% by end-FY12. At end-FY11 only 49% of CE was

invested in the core business. This (IC/CE) ratio will fall to 45% in FY12 and FY13.

Superior capital allocation drives equity value faster despite modest RoIC

Over FY07-12 metals companies generated average RoIC of 61% but the annualized

stock return (ASR) was just 16% due to continually declining RoCE. JSPL and JSW Steel

delivered superior ASR due to superior capital allocation and execution despite below

average RoIC. Hindustan Zinc, Sterlite and Sesa Goa generated the best RoIC but ASR

was dragged due to investor concerns on allocation of capital to group companies. High

priced acquisitions dragged the ASR of Tata Steel and Hindalco. Nalco suffered due to

declining RoIC and slow reinvestment.

Sep-10

Sep-09

Sep-08

PriceAv. Prem.

Price Av. Prem.

Price Av. Prem.

3QCY10

(%) P/BV 3QCY09

(%) P/BV 3QCY08

(%)

544

198

1159

665

168

104

167

105

-32

3

28

158

-15

-15

30

15

1.5

2.2

1.6

4.4

1.2

2.4

1.4

2.0

445

166

686

510

103

80

165

72

-51

-4

-34

129

-36

-35

46

-7

1.7

2.0

1.4

4.6

0.9

2.0

1.5

1.7

592

141

729

300

124

97

147

54

-31

3

24

74

-9

-6

63

-8

Sep-07

Price Av. Prem.

P/BV 3QCY07

(%)

1.9

2.1

1.8

4.0

1.4

2.6

1.6

1.6

590

158

672

136

146

67

158

73

107

34

-5

Discount or premium to stock price/NAV and historical P/BV

Company

Sep-11

CMP Prem.

(INR)

(%)

433

107

592

488

130

62

116

118

-57

-53

-62

87

-42

-56

-20

15

P/BV

0.9

1.1

0.8

2.5

0.8

1.3

0.8

1.7

P/BV

1.5

2.8

1.7

Tata Steel

SAIL

JSW Steel

Jindal Steel

Hindalco

Nalco

Sterlite Inds

Hind Zinc

-20

3.4

-22

1.0

-27

2.0

220

2.0

62

2.6

Source: MOSL

October 2011

1

Metals | RoIC v/s RoCE: The Return Roulette

Stocks trade at deep discount to NAV

The combined balance sheet of Indian metals companies is strong as, at the end of FY11,

their combined net worth was INR2t and net debt was INR730b, implying net debt-to-

equity ratio of only 35%. Barring Jindal Steel, Hindalco and Hindustan Zinc, other metals

companies trade at either their deepest discount or lowest premium to NAV.

SAIL, Hindalco, JSPL, JSW Steel face project execution headwinds

SAIL undertook INR720b capex but execution is sluggish due to inefficiencies. JSPL and

Hindalco are executing multiple green-field projects but slow government decision making,

environmental and land acquisition issues slowed the projects. JSW Steel has been the

best executor of projects but faces shortage of iron ore due to mining ban in Karnataka.

Although SAIL and JSW Steel are trading at 50-60% discount to NAV, valuations still

appear steep due to falling margins. Hindalco's and JSPL's business is strong and their

stocks are attractive at current valuations.

Hindustan Zinc's RoIC improves, capital allocation strategy unclear

Hindustan Zinc's RoIC will improve due to its rising silver production. However, RoCE will

keep declining due to a rising share of un-invested capital. The company has a huge pile

of cash and equivalents but is not able to invest them.

Sterlite, Sesa Goa: Investment in group companies causes concern

Sterlite Industries and Sesa Goa invested large amounts of capital in group companies,

VAL and Cairn India respectively. Sterlite Industries' large investment in VAL is now return

dilutive due to a shortage of bauxite and coal. Sesa Goa has only 12% of capital employed

in the iron-ore business. We downgrade Sesa Goa to

Neutral

due to a rising risk to

volumes though valuations are not steep.

Tata Steel, Nalco: RoIC improves after years of decline

Only Tata Steel and Nalco will report improvement in RoCE in FY13 due to completion of

high margin projects. Both stocks trade at 50-60% discount to NAV. Tata Steel will

commission INR156b capex in Jamshedpur to increase capacity by 3mtpa. Nalco is

expanding alumina capacity. Upgrade Nalco to

Neutral;

re-iterate

Buy

on Tata Steel.

Comparative valuations

Rating

Ferrous

Tata Steel

SAIL

JSW Steel

JSPL

Sesa Goa

Non-ferrous

Sterlite Inds.

Hindustan Zinc

Nalco

Hindalco

Buy

Sell

Sell

Buy

Neutral

Buy

Buy

Neutral

Buy

433

107

592

488

223

116

118

62

130

8,507

8,969

2,669

9,221

4,058

7,866

10,055

3,225

5,246

62.3

10.2

77.4

40.1

49.0

15.2

11.6

4.1

17.6

60.8

10.2

50.2

42.8

46.5

20.1

15.4

5.1

18.5

78.4

9.6

54.4

52.9

40.9

20.4

16.8

6.6

19.3

7.1

10.5

11.8

11.4

4.8

5.8

7.6

12.1

7.1

5.5

11.2

10.9

9.2

5.5

5.7

7.0

9.4

6.8

5.4

7.1

7.4

9.0

5.8

3.9

4.1

5.3

5.4

4.3

7.7

6.1

7.8

6.1

2.7

2.9

3.4

5.1

1.4

1.1

0.8

2.5

1.1

0.8

1.7

1.3

1.3

1.2

1.0

0.7

2.0

1.0

0.7

1.4

1.2

1.1

CMP MCAP

(INR) (USD m)

EPS (INR)

FY11

FY12E

FY13E

P/E (x)

FY12E

FY13E

EV/EBITDA (x)

FY12E

FY13E

P/BV (x)

FY12E

FY13E

CMP = Current Market Price (as on 11 October 2011)

Source: MOSL

Note: ASR =

Annualized stock return (Sum of average stock prices in 2QFY12 and dividends divided by average stock prices in 1QFY07)

RoE =

Return on equity is calculated as fully diluted EPS over book value per share adjusted for goodwill (average of book values of the

current and the last financial year)

RoCE =

Return on capital employed is calculated as EBIT + other Income + profit from associates/capital employed (average of capital

employed for the current and the last financial year)

RoIC =

Return on invested capital is calculated as EBIT/invested capital (averagte of invested capital for the current and last financial year)

NAV =

Net asset value is the sum of replacement costs (plants and mines), net working capital, investments, CWIP less net debt.

October 2011

2

Metals | RoIC v/s RoCE: The Return Roulette

RoCE will keep declining but core RoIC remains healthy

Indian metals companies post RoIC of 40%, but RoCE to decline





Un-invested capital, rising CWIP drag down RoCE, RoE.

Stocks: Tata Steel, Nalco's RoCE to improve in FY13; Sesa Goa: Best RoIC,

largest RoCE slippage; Hindustan Zinc RoIC to improve, RoCE to fall every

year; Hindalco's RoCE to slip due to project delays, RoIC to improve; Jindal

Steel and Power's large CWIP/CE ratio drags down RoCE; SAIL, JSW Steel's

declining RoIC drags down RoCE.

For key Indian metals companies' return on capital employed (RoCE) on a pre-tax basis

and return on equity (RoE) are declining despite no deterioration in returns on invested

capital (RoIC on a pre-tax basis).

We have analyzed nine listed metals companies with the largest capital employed to study

their return profiles. We find their RoIC is a healthy 40% and not deteriorating, but RoCE

will keep declining.

Metals sector return ratios (%)

RoE

100

RoIC (pre-tax)

RoCE (pre-tax)

Metals sector aggregate

RoIC is a healthy 40%, but

RoCE will keep declining

80

60

40

20

0

FY01 FY02 FY03 FY04 FY05 FY06 FY07 FY08 FY09 FY10 FY11 FY12 FY13

Source: Company/MOSL

End-FY11 deployment

of capital:

Productive (49%)

CWIP (23%)

Non-core business (28%)

Un-invested capital, rise in CWIP drag down RoCE, RoE

RoE, RoIC and RoCE moved in tandem until FY05. Thereafter, there was a divergence

between RoIC and RoE & RoCE. Although RoIC peaked in FY07, RoE and RoCE peaked

a couple of years earlier. Metals companies shied away from returning cash-flow to

shareholders. Companies retained a large portion of earnings with the objective of

reinvestment in the core business and for acquisitions. However, a significant portion of

the capital remained un-invested for long periods either due to slow project execution or a

wait for the right acquisition target. At the end of FY11, only 49% of capital employed was

responsible for generating core operating cash flow. About 23% of the capital employed

was lying as capital work in progress and 28% was not invested in the core business. Un-

invested capital as a percentage of capital employed (UnIC/CE) moved from 10% to 30%

over the past 10 years. Capital work in progress as a percentage of capital employed

(CWIP/CE) rose sharply since FY09, implying slower execution.

October 2011

3

Metals | RoIC v/s RoCE: The Return Roulette

Rise in non-operating capital (%)

CWIP/CE

48

UnIC/CE

CWIP/annual capex ratio (x) implies slow execution

2.8

2.1

36

1.4

24

12

0

0.7

0.0

Source:MOSL

Tata Steel, Nalco to improve RoCE in FY13

The sector RoCE will continue to decline as the share of capital work in progress and

share of un-invested capital in total capital employed remains high, though we do not

foresee deterioration in RoIC. The sector RoCE will decline 3.4pp to 15.8% in FY13.

Among the nine companies under study, only Tata Steel and Nalco will improve their

RoCE in FY13. Tata Steel’s RoIC will improve due to volume growth in the high margin

Indian business and share of CWIP in total capital employed will decline due to

commissioning of a new blast furnace by the end of FY12. Nalco’s RoIC will improve and

it will reduce its CWIP/CE ratio due to commissioning of its alumina refinery expansion

unit. As a result, Nalco’s RoCE will improve in FY12 and FY13.

Returns on capital employed (RoCE, in %)

Average

JSW Steel

110

90

70

50

30

10

-10

Tata Steel

JSPL

Nalco

Sesa Goa

Hind. Zinc

Hindalco

SAIL

Sterlite Inds

Among the nine companies

under study, only Tata Steel

and Nalco will improve their

RoCE in FY13

Returns on invested capital (RoIC, in %)

Average

SAIL

265

210

155

100

45

-10

Tata Steel

JSW Steel

Hindalco

JSPL

Nalco

Sesa Goa

Hind. Zinc

Sterlite Inds

Source:MOSL

October 2011

4

Metals | RoIC v/s RoCE: The Return Roulette

Sesa Goa: Best RoIC but largest slippage in RoCE

Sesa Goa will post the sharpest decline of 52% in RoCE to 22.9% over FY11-13 though

RoCE will still be second best in sector, trailing Hindustan Zinc. This is largely due to an

increase in rail freight, royalty, export duty and volumes though iron-ore prices are firm.

The share of invested capital in the core business in capital employed, or IC/CE, will

decline from 25% in FY11 to 11% in FY13. RoIC will still remain high at 124% in FY13,

the best in sector.

Return on capital employed (RoCE, %)

S/N

1

2

3

4

5

6

7

8

9

Company

Tata Steel

SAIL

JSW Steel

JSPL

Sesa Goa

Hindalco

Nalco

Hind. Zinc

Sterlite Inds

Average

FY01

13.4

4.9

-

19.0

6.6

-

23.2

25.7

-

15.5

FY02

8.9

-1.1

-

16.3

9.8

-

13.5

10.8

-

9.7

FY03

18.9

5.2

-

17.8

13.1

14.7

16.3

21.5

-

15.4

FY04

30.2

22.0

-

23.2

52.3

14.1

22.3

48.6

19.7

29.0

FY05

49.6

62.2

-

30.1

105.2

14.8

37.2

37.6

16.1

44.1

FY06

39.9

34.5

16.3

20.6

81.9

13.3

40.4

65.2

28.0

37.8

FY07

24.1

46.6

23.4

16.5

66.2

18.4

49.0

106.6

57.5

45.4

FY08

21.8

50.4

17.7

19.9

98.4

10.5

28.0

59.4

33.0

37.7

FY09

15.5

29.2

9.7

32.8

69.1

4.4

19.3

24.8

16.0

24.5

FY10

5.2

23.5

11.0

27.5

47.3

8.6

10.6

29.9

15.1

19.8

FY11

13.2

12.8

11.1

21.6

47.3

10.3

13.3

28.3

15.1

19.2

FY12E

10.9

12.0

7.4

17.4

29.1

9.7

15.4

30.3

17.7

FY13E

12.3

10.2

8.1

16.9

22.9

9.9

18.9

26.6

16.7

16.7

15.8

Source: MOSL

Hindustan Zinc: RoIC to improve consistently but RoCE to fall every year

Hindustan Zinc will improve its RoIC in FY12 and FY13 due to strong growth in silver

volumes. However, RoCE will keep declining due to a rising share of un-invested capital

in total capital employed. Sterlite Industries improved FY12 RoCE due to better RoIC in

the zinc business and increased share in capital employed due to acquisition of international

zinc assets and HZL's improvement in RoIC. However, Sterlite's other businesses are

facing headwinds.

Return on Invested capital (RoIC, %)

S/N

1

2

3

4

5

6

7

8

9

Company

Tata Steel

SAIL

JSW Steel

JSPL

Sesa Goa

Hindalco

Nalco

Hind. Zinc

Sterlite Inds

Average

FY01

16.7

2.4

-

22.9

6.9

-

30.8

23.7

-

17.3

FY02

9.5

-8.0

-

21.6

10.1

-

18.6

8.4

-

10.0

FY03

22.0

3.1

-

24.9

13.3

23.7

19.2

18.2

-

17.8

FY04

38.1

24.4

-

29.5

59.6

22.1

24.9

81.1

26.9

38.3

FY05

73.5

86.8

-

34.6

148.5

23.9

40.8

62.4

25.0

61.9

FY06

60.0

47.9

19.9

26.8

137.5

20.0

51.3

105.9

41.9

56.8

FY07

60.0

71.9

29.8

27.2

124.4

30.6

82.0

237.6

83.6

83.0

FY08

32.0

98.5

21.7

31.1

257.8

15.5

53.1

149.1

59.3

79.8

FY09

19.2

63.6

13.2

45.7

193.9

6.0

39.0

58.9

31.6

52.3

FY10

5.6

60.5

15.9

42.3

134.0

11.8

16.0

86.1

31.6

44.9

FY11

18.6

40.4

14.3

35.0

159.3

15.6

22.9

74.2

26.2

45.2

FY12E

16.5

39.2

11.1

29.8

99.8

15.6

24.1

86.5

FY13E

18.6

30.6

11.1

31.7

123.6

16.7

33.5

96.6

31.0

31.2

39.3

43.7

Source: MOSL

October 2011

5

Metals | RoIC v/s RoCE: The Return Roulette

Hindalco: RoCE to slip due to project delays but RoIC to improve

Hindalco's RoCE is likely to decline moderately due to rising CWIP/CE ratio due to delay

in greenfield projects in India though RoIC will continue to improve over FY11-13.

Jindal Steel and Power: Large CWIP/CE ratio drags RoCE

Jindal Steel and Power's IC/CE ratio has dropped sharply so far in FY12 due to consistently

declining RoIC after peaking in FY09. In FY13, RoIC is expected to improve due to

strong steel prices and start of coal mines for its Angul project. However, RoCE will

continue to slip due to very high ratio of CWIP/CE.

SAIL, JSW Steel: RoCE dragged down by declining RoIC

JSW Steel's RoCE will decline sharply to 8.1%. Despite high operating efficiency, JSW

Steel's RoCE and RoIC will decline due to a ban on iron-ore mining in Karnataka. JSW

Steel has the best invested capital-to-capital employed (IC/CE) ratio of 78% in the metals

sector. SAIL's RoCE is being dragged down by its declining RoIC and very low IC/CE

ratio of 28-33%. SAIL is struggling with rising costs.

Return on equity (RoE, %)

S/N

1

2

3

4

5

6

7

8

9

Company

Tata Steel

SAIL

JSW Steel

JSPL

Sesa Goa

Hindalco

Nalco

Hind. Zinc

Sterlite Inds

Average

FY01

22.0

-17.1

-

25.0

7.6

-

18.3

15.4

-

11.9

FY02

12.4

-55.3

-

22.5

3.4

-

12.7

6.5

-

0.4

FY03

37.0

-16.5

-

27.3

11.1

13.0

15.4

15.3

-

14.6

FY04

49.5

78.8

-

42.8

53.6

15.2

19.4

44.7

32.0

42.0

FY05

63.1

91.6

-

48.3

85.3

17.2

26.3

36.6

18.2

48.3

FY06

44.0

37.7

17.3

36.3

59.1

18.1

26.2

53.5

31.3

35.9

FY07

33.9

42.1

26.6

32.1

46.9

24.9

31.1

80.3

57.9

41.8

FY08

42.2

41.7

22.2

45.5

67.7

20.0

18.6

45.1

24.9

36.4

FY09

65.1

24.2

13.8

59.1

51.9

27.2

12.9

20.8

14.5

32.2

FY10

-8.1

22.0

13.7

40.4

40.8

17.2

7.7

24.9

12.0

18.9

FY11

40.5

11.8

12.8

30.6

40.4

23.1

9.5

24.2

13.0

22.9

FY12E

23.6

10.9

6.7

25.0

24.6

19.8

10.6

25.8

15.2

FY13E

23.4

9.5

6.9

24.4

18.9

17.7

12.4

22.4

13.4

18.0

16.6

Source: MOSL

Stocks trade at deep discount to NAV

The combined balance sheet of Indian metals companies is strong as, at the end of FY11,

the combined net worth was INR2t, and the net debt was INR730b, implying net debt-to-

equity ratio of only 35%. Barring Jindal Steel, Hindalco and Hindustan Zinc, all other

metals companies are trading at either their deepest discount or lowest premium to net

asset value (NAV).

Discount or premium to stock price/NAV and historical P/BV

Company

Sep-11

CMP Prem.

(INR)

(%)

433

107

592

488

130

62

116

118

-57

-53

-62

87

-42

-56

-20

15

Sep-10

Sep-09

Sep-08

PriceAv. Prem.

Price Av. Prem.

Price Av. Prem.

3QCY10

(%) P/BV 3QCY09

(%) P/BV 3QCY08

(%)

544

198

1159

665

168

104

167

105

-32

3

28

158

-15

-15

30

15

1.5

2.2

1.6

4.4

1.2

2.4

1.4

2.0

445

166

686

510

103

80

165

72

-51

-4

-34

129

-36

-35

46

-7

1.7

2.0

1.4

4.6

0.9

2.0

1.5

1.7

592

141

729

300

124

97

147

54

-31

3

24

74

-9

-6

63

-8

Sep-07

Price Av. Prem.

P/BV 3QCY07

(%)

1.9

2.1

1.8

4.0

1.4

2.6

1.6

1.6

590

158

672

136

146

67

158

73

107

34

-5

P/BV

0.9

1.1

0.8

2.5

0.8

1.3

0.8

1.7

P/BV

1.5

2.8

1.7

Tata Steel

SAIL

JSW Steel

Jindal Steel

Hindalco

Nalco

Sterlite Inds

Hind Zinc

-20

3.4

-22

1.0

-27

2.0

220

2.0

62

2.6

Source: MOSL

October 2011

6

Metals | RoIC v/s RoCE: The Return Roulette

Superior capital allocation drives equity value faster

despite modest RoIC

Despite average sector RoIC of 61%, stocks' returns were just 16%







The capital allocation strategy of metals companies is crucial to stock

performance.

Stocks: Jindal Steel and Power's stock performed best despite below-average

RoIC over FY07-11; Sesa Goa's stock performed well but much inferior to high

RoIC. Hindalco posted the worst annualized stock returns (ASR) on equity dilution

and falling RoIC.

Although Hindustan Zinc generates impressive RoIC, deteriorating RoCE will

drag down stock performance; CWIP drags down SAIL's RoCE, fixed costs

depress RoIC; Capital misallocation hit Sterlite's stock performance; Tata Steel

invested in low generating RoIC business, but the worst is behind it; Nalco's

return ratios are improving but its low IC/CE and RoIC dragged down ASR.

FY07-11 cash flow (INR t)

Operating profit

Equity raised

Debt raised

Total incremental CE

Cash flow deployment

Interest

Tax

Dividend

Capex

Of which CWIP

M&A

Working capital

Uninvested

Total deployed

0.4

0.5

0.2

1.5

0.9

0.8

0.1

0.4

4.0

2.5

0.6

1.0

4.0

An equal weight portfolio of key metal stocks yielded annualized stock returns (ASR) of

only 16% against average annual RoIC of 61% over FY07-11, due to inefficient allocation

of capital and project execution delays. Only Jindal Steel and Power (JSP) and JSW Steel

(JSTL) delivered better annualized stock returns than the average RoIC they generated

over FY07-11. The sector's RoIC remains very attractive at 40% and above. With nearly

50% of capital employed still not invested in core operating business, the sector portfolio

ASR may still remain a drag because RoCE will continue to decline. Besides a fundamental

analysis of the businesses, the capital allocation strategy of metals companies has emerged

in importance.

Over FY07-11 metals companies generated operating profit of INR2.5t and distributed

only INR200b or just 8% as dividend. On the other hand, they raised equity of INR564b

and debt of INR963b during the period. Thus, nearly INR4t was added to capital employed

over five years. Out of this INR4t, about INR543b went towards tax, INR378b towards

interest, INR200b towards dividend, INR800b towards M&A, totaling INR1.9t. INR1.5t

was used as capex, of which 57% is still lying as CWIP. About INR128b is the increase in

working capital. INR300b-400b is lying un-invested with the companies. On a net basis,

capital employed increased by INR2.9t, and invested capital increased only INR1.5t. Even

if RoIC were to come under pressure due to macroeconomic uncertainty, a cut in un-

invested capital may still drive stock performance.

Average RoIC (%) over FY07-11

174

121

Annualized stock returns (%) over FY07-1QFY12

52

31

20

12

10

7

67

Average 16%

4

3

0

46

43

36

Average 61%

27

19

16

Source:MOSL

October 2011

7

Metals | RoIC v/s RoCE: The Return Roulette

Cash flow statements (FY07-11)

Company

ASR

(%)

RoIC

(%)

PAT

Net

Operating

Oper. Wkg.

profit capital

1

2

3

4

5

6

7

8

9

JSPL

Sesa Goa

JSW Steel

Hind. Zinc

SAIL

Sterlite Ind.

Tata Steel

Nalco

Hindalco

Total

52

31

20

12

10

7

4

3

0

16

36

174

19

121

67

46

27

43

16

61

127

111

66

205

320

216

262

72

124

1,369

122

117

125

191

246

354

256

53

197

1,537

210

107

174

251

505

372

695

85

294

2,443

-20

-7

14

6

-61

-15

-40

-2

-8

-139

Cash flow

Investing

Tax Capex M&A Others Equity

paid

-26

-39

-18

-59

-164

-78

-139

-214

-14

-216

-77

-312

-206

-364

-23

-18

-74

-11

0

6

-97

67

-180

24

-10

-23

-127

1

19

63

1

155

204

122

564

106

10

107

-6

167

62

420

91

963

Financing

Debt

Div.

paid

-4

-13

-11

-11

-71

-19

-49

-18

-15

-199

(adj) worth

(INR B)

Int.

paid

-17

-1

-40

-1

-18

-21

-186

-94

-378

-73

-523

-117

-828

-35

-48

-43

-194

-542 -1,568

ASR = Annualized total stock return (Sum of avg. stock price during 2QFY12 and dividends divided by avg. stock price during 1QFY07)

Invested capital/capital employed (%)

Company

1

2

3

4

5

6

7

8

9

Tata Steel

SAIL

JSW Steel

JSPL

Sesa Goa*

Hindalco

Nalco

Hind. Zinc

Sterlite Inds

Total

FY01

83

82

-

70

83

-

55

80

-

82

FY02

85

76

-

71

98

55

61

85

-

76

FY03

82

74

-

65

92

66

70

75

80

76

FY04

68

76

-

82

82

61

78

41

53

70

FY05

62

60

90

86

61

63

82

58

51

67

FY06

65

61

77

67

55

69

63

59

68

69

FY07

27

50

76

54

48

54

46

35

60

49

FY08

82

39

69

67

31

73

37

34

38

67

FY09

76

31

60

72

34

76

36

28

30

60

FY10

73

28

71

58

30

69

42

31

38

56

FY11

66

22

67

63

25

63

46

33

47

55

FY12E

58

28

70

51

12

61

47

24

42

FY13E

67

32

78

51

11

57

40

20

45

51

54

Source: MOSL

1. JSP: Best allocation of capital led to the stock's stellar performance

JSP was the best performing stock despite generating below-average RoIC over FY07-

11. It was one of the most efficient companies in allocating capital and the only one in the

private sector that did not raise risk capital in the period. JSP generated operating profit of

INR210b and invested INR237b over FY06-11. It ensured IC/CE ratio remained high at

all times. Despite being in a capital intensive business, it kept CWIP/capex ratio below

sector averages. However, this has changed for the worse now due to delays in executing

projects. CWIP is INR100b. IC/CE ratio is deteriorating due to a delay in its Angul and

Tamnar 2 projects, but RoIC is impressive at 32%.

Sesa Goa failed to reinvest

cash flows in the core

business

2. Sesa Goa: Impressive stock performance, yet much inferior to RoIC

Sesa Goa generated the best average RoIC of 174% over FY07-11, well above the sector

average of 61% during the period. However, ASR was only 31%, which was still second-

best in the sector. Sesa Goa failed to reinvest cash flows in the same business. IC/CE

ratio fell from 55% in FY06 to 25% in FY11. This ratio will fall further to 12% and 11% in

FY12 and FY13 respectively due to the acquisition of Cairn India's stake.

October 2011

8

Metals | RoIC v/s RoCE: The Return Roulette

JSTL superior returns on

superior capital allocation

despite below industry

average ROIC

3. JSW Steel: Superior capital allocation despite inferior RoIC drives stock

JSW Steel (JSTL) posted superior ASR of 20% despite having the second worst RoIC in

the sector over FY07-11. JSTL has had the best IC/CE ratio at all times due to superior

execution skills and this is crucial to superior stock performance. JSTL remains committed

to superior capital allocation, but headwinds will weaken RoIC and RoCE and drag down

stock performance.

4. Hindustan Zinc: RoCE to decline despite improved RoIC

Hindustan Zinc (HZ) delivered ASR of only 12% v/s RoIC of 121% over FY07-11 due to

deteriorating IC/CE ratio. The IC/CE ratio fell from 59% in FY06 to 33% in FY11 and will

deteriorate to 20% in FY13. HZL generated operating cash flow of INR199b, capex has

been a mere INR77b and dividend payout just 6%. Though HZ generates impressive

RoIC, which is improving due to a rising share of high margin silver volumes, deteriorating

RoCE will be a drag on stock performance.

5. SAIL: CWIP drags down RoCE, fixed costs depress RoIC

SAIL's story is similar to HZ's. The core business generated above-average RoIC of

67% and ASR was just 10%. The share of invested capital fell from 61% in FY06 to 22%

in FY11. SAIL generated post-tax and working capital adjusted cash flow of INR281b

and incurred capex of INR312b over FY06-11. However, INR226b of the INR312b capex

is lying as CWIP and dragging down RoCE due to slow project execution. RoIC will

continue to decline due to rising fixed costs. Although the IC/CE ratio will improve, RoCE

will still decline.

Equity dilution and

misallocation of capital

dragged the Sterlite stock

performance

6. Sterlite Inds: Concerns on capital allocation drag down stock performance

Sterlite delivered ASR of 7%, a far cry from its impressive average RoIC of 46% over

FY06-11. It generated operating cash flow of INR279b, of which INR207b was used as

capex and INR73b towards acquisition of Anglo's zinc assets. INR155b of unnecessary

equity was raised, which was largely used to fund capex of associate companies like

VAL. Equity dilution and concerns on capital allocation dragged the stock performance.

Improvement in RoIC due to superior performance of the zinc-lead-silver segment and

higher IC/CE ratio boosted RoCE in FY12, which will deteriorate in FY13.

7. Tata Steel: Low RoIC investment dragged ASR, but the worst is behind it

Tata Steel (TATA) delivered ASR of only 4% but average RoIC was an attractive 27%

over FY06-11. TATA also maintained high IC/CE ratio. Although the average RoIC was

27%, it kept falling from a peak of 74% in FY05 to 60% in FY06 and 5.6% in FY10 before

rebounding to 18.6% in FY11. TATA generated operating cash flow of INR516b, investing

only INR264b as organic capex. It invested about INR491b in the very low generating

RoIC business, which is why it generated average RoIC of 7.7%. INR204b was raised to

fund the acquisition and equity dilution dragged down ASR. There is some weakening of

RoIC in FY12 but it is expected to improve in FY13 due to volume growth in the high-

margin Indian business and a rising IC/CE ratio.

October 2011

9

Metals | RoIC v/s RoCE: The Return Roulette

Start of Nalco alumina

refinery expansion unit to

improve ROIC

8. Nalco: Low IC/CE, RoIC drags down ASR but return ratios improving

Nalco delivered ASR of only 3% and average RoIC of impressive 43% over FY06-11.

Consistently declining RoIC and low IC/CE ratio dragged down RoCE from 49% in FY07

to 13.3% in FY11. However RoIC and IC/CE ratio are improving due to the start of an

alumina refinery expansion unit.

9. Hindalco: Worst ASR due to equity dilution, declining RoIC; RoCE to fall

Hindalco was the worst performing stock over FY06-11, delivering nil returns. Hindalco

generated operating cash flow of INR243b, of which INR194b was used as organic capex.

A large part of the capex (INR131b) was CWIP at the end of FY11. IC/CE ratio is

declining after peaking in FY09 at 73%.

Hindalco raised INR122b through rights and QIP issues, of which INR117b (net of returns

on capital) was used to acquire Novelis. RoIC will improve by 1.1pp to 16.7% in FY13 on

improved margins in the Indian business, but RoCE will decline by 40bp to 9.9% due to a

deteriorating IC/CE ratio, mainly on project delays.

October 2011

10

Metals | RoIC v/s RoCE: The Return Roulette

Companies

Companies

Ferrous

Tata Steel

Jindal Steel & Power

SAIL

JSW Steel

Sesa Goa

Non-Ferrous

Hindalco

Hindustan Zinc

Sterlite Industries

Nalco

October 2011

11

Sector: Metals

Tata Steel

BSE SENSEX

S&P CNX

16,536

Bloomberg

Equity Shares (m)

52-Week Range (INR)

1,6,12 Rel. Perf. (%)

M.Cap. (INR b)

M.Cap. (USD b)

4,974

TATA IN

971.4

714/391

-7/-17/-14

420.8

8.5

CMP: INR433

TP: INR693

Buy

Growth in high margin business to drive RoCE

D/E lowest since TSE acquisition and to fall further













Outperforms other steel stocks after four years of weak stock performance.

RoCE to improve by FY13 as most capital is employed in its core business and

CWIP/CE will decline.

TATA will reduce debt by USD2b, despite using ~USD4b on capex, over two years. It

will generate cash flow of USD8b.

Pension fund deficit concerns unfounded.

Despite an uncertain European outlook, Tata Steel Europe is better equipped to

cope with a downturn.

The stock trades at attractive valuations and at a 58% discount to NAV.

Reiterate Buy.

Y/E March

2011 2012E 2013E

1,508

188

76

78.4

29.0

366.7

5.5

1.2

0.5

4.3

23.4

12.3

18.6

Sales (INR b) 1,188 1,396

EBITDA (INR b) 160

157

NP (INR b)

60

59

EPS (INR)

62.3

60.8

EPS Gr (%) -769.2

-2.4

BV/Sh (INR) 211.4 302.5

P/E (x)

P/BV (x)

EV/Sales (x)

7.0

2.0

0.8

7.1

1.4

0.6

5.4

23.6

10.9

16.5

EV/EBITDA (x) 5.6

RoE (%)

40.5

RoCE (%)

13.2

RoIC (%)

18.6

RoCE to improve as CWIP/CE will decline in FY13

Tata Steel (TATA) has been one of worst performing stocks over FY07-11, delivering

just 4% annualized total stock returns (ASR). This trend has changed over past 12

months as the stock outperformed its peers in the sector as it reversed a declining

trend in RoIC.

Volume growth in the high margin Indian business will boost RoIC hereon as TATA

expands its capacity by 3mtpa to 10mtpa in Jamshedpur by the end of FY12. Since

TATA is among the few metals companies with most of its capital employed in its core

business, RoCE will improve in FY13. The CWIP/CE will be the smallest for TATA in

FY13. We expect TATA to outperform other metals stocks because sector RoCE will

keep declining.

Indian operations: Strong volume growth and margins too

Shareholding pattern % (Jun-11)

Others

23.4

Promoter

30.6

Foreign

19.7

Domestic Inst

26.3

EBITDA per ton (USD)

Realization (USD/t)

Sales (m tons)

9.0

Stock performance (1 year)

Tata Steel

Sensex - Rebased

750

650

550

450

350

6.2

4.8

FY08

5.2

6.4

6.7

4.8

FY07

FY09

FY10

FY11

FY12E

FY13E

Source: Company/MOSL

October 2011

12

Tata Steel

Volume growth in Indian business to drive return ratios (%)

RoCE

60.0

60.0

RoIC

Lowest D/E since TSE acquisition (x)

39.9

24.1

32.0

19.2

21.8

15.5

5.6

5.2

13.2

FY11

10.9

FY12

12.3

FY13

Source: Company/MOSL

18.6

16.5

18.6

FY06

FY07

FY08

FY09

FY10

Net debt to fall by USD2b

in next two years

Net debt reduction of USD2b despite huge capex

TATA will reduce debt by USD2b to USD8.6b, despite using ~USD4b on capex, over two

years. USD6.2b of operating cash flow and USD1.7b from liquidation of investment,

interest and dividend will generate USD8b in cash flow. After incurring capex of USD4b

and USD2b as payment of interest and dividend, net debt will fall by USD2b. This will

strengthen the balance sheet significantly as net worth will rise to USD11.3b and debt-to-

equity will fall to 0.8x. After adjusting for goodwill of INR153b from net worth, net debt-

to-equity ratio will be 1.1x.

Strong cash flow will reduce net debt by USD2b

FY07-11

INR m

Opr. Cash flow

Capex

M&A

Investments, dividend etc

Equity

Dividend

Interest

Net increase in debt

Note: USD/INR=45.0

516,070

-363,999

-523,417

17,178

204,215

-49,268

-148,334

347,555

USD m

11,469

-8,089

-11,632

382

4,538

-1,095

-3,296

7,724

INR m

277,897

-175,635

0

74,449

5,346

-23,868

-64,264

-93,925

FY12-13

USD m

6,176

-3,903

0

1,654

119

-530

-1,428

-2,087

Source: Company/MOSL

Pension fund surplus would

have increased by GBP209m

Pension fund deficit concerns unfounded

Pension fund surpluses were USD556m and USD401m at the end of March 2011 and

June 2011 respectively. TATA invested 29% of its total BPSP assets of GBP11.3b in

equities and 63% in bonds and the rest of the funds were invested in cash and properties.

Since the end of March 2011 the FTSE fell 10% and bond yields fell 30-70bp.

October 2011

13

Tata Steel

Although it is difficult to accurately gauge the movement of surpluses, it is possible to get

a sense of the possible direction of the movement. We have assumed average duration of

the bond portfolio and pension liabilities to be 10 years each. According to our calculations,

the mark to mark valuation of equities will be down by 10%, or about GBP317m, assuming

similar returns as the FTSE. On the other hand, the valuation of the bond portfolio may

have risen by GBP856m assuming 70bp decline in yield. Pension liabilities would have

risen by GBP329m assuming AA bond yield decline by 30bp. So, on a net basis, the surplus

would have increased by GBP209m. We would also like to highlight that pension funds

have passed the litmus test of the 2008 financial crisis without requiring additional

contribution from TSE.

Surplus pension funds (USD m)

2,140

986

595

729

531

561

534

556

393

401

FY07

FY08

Mar-09

Jun-09

Sep-09

Dec-09

Mar-10

Mar-11

Jun-11

Sep-11E

Source: Company/MOSL

European outlook uncertain but TSE now better equipped

The earnings outlook for TSE (Tata Steel Europe) is uncertain due to economic problems

in Europe and other western countries. Weaker demand may force some production cuts

and margins will come under pressure for a couple of quarters. It is worth noting here that

TSE operates as a converter though margins are thin. The structure of finished products

and raw material contracts has undergone major change to better withstand volatility in

commodity prices since the financial crisis of 2008. Finished steel contracts have now

moved closer to spot prices and quarterly pricing. Similarly, iron ore and coking coal contracts

moved from annual pricing to quarterly and monthly pricing.

Raw material and sales

contracts structure

undergone change to

withstand volatility in

commodity prices

Operation restructuring at several units reduced fixed costs significantly. On our recent

visit to TSE, we learned the company is now moving towards value-added products to

move up the value chain and reduce earnings volatility. The Ijmuiden plant has the best

operating efficiencies and product mix in the world. TCP (Teesside Cast Products) has

been sold. Therefore, we understand TSE is now better equipped to withstand a financial

crisis. After achieving significant fixed-cost reduction, TSE aims to improve margins and

has stepped up investment. Recently, TSE announced USD1.1b capex for the Imjuiden

unit to expand saleable steel capacity and further improve operating efficiencies. We

believe TSE will be able to improve productivity and capital efficiencies year after year as

it replicates its best practices across the group.

October 2011

14

Tata Steel

TSE: Volumes and margins

EBITDA per ton (USD)

26.9

23.3

18.2

17.1

18.1

18.4

Realization (USD/t)

Sales (m tons)

38

2.8

FY07

98

84

-11

51

43

49

FY08

FY09

FY10

FY11

FY12E

FY13E

Source: Company/MOSL

Valuations attractive

TATA's earnings will grow 29% in FY13 driven by 33% volume growth in the high margin

Indian business as capacity expansion at Jamshedpur is completed by the end of March

2012. RoIC and RoCE will improve. The balance sheet is stronger now due to generation

of USD2.65b over nine months by way of sale of TCP (USD470m), settlement (USD130m)

of arbitration for breach of off-take agreement, stake sale in the Riversdale parent company

(USD1.1b) and TRF (USD150m) and rights issue (USD800m). Despite USD4b of capex

over 2 years, net debt will come down by USD2b by the end of FY13. Net debt-to-equity

(less goodwill) ratio will fall from 2.4x at the end of FY11 to 1.1x by the end of FY13.

TATA has investments in Tata Motors (TTMT) worth USD526m, coking assets in

Mozambique worth USD1b and iron ore assets in Canada worth USD367m, totaling nearly

USD2b. These assets will start generating cash flow over 6-12 months, yielding RoIC of

20-25% (ex-TTMT).

TATA traded at premium to NAV (taking into account replacement cost for fixed assets)

until FY07. After the acquisition of Corus, the stock traded at a discount to NAV because

of low margins in the international business. At CMP of INR433, the stock trades at a

deep discount of 57% to NAV. Such discounts to NAV were only seen in 2009 (~51%).

NAV calculations

Process

Capacity

(mtpa)

A. Minining

Iron ore

Coal

B. Manufacturing

Crude steel

Hot rolling

Cold rolling

C. Investments

14

7

28

28

8

Specific

replacement

cost (USD/ton)

120

85

650

200

300

Value

(USD m)

1,680

612

26,200

18,200

5,600

2,400

28

158

1,468

481

987

29

163

1,512

496

1,016

1,179

1,214

Sub

total

(USD m)

2,292

(INR b)

103

Value

per share

(INR)

106

D. Capital work in progress

E. Total asset value (A+B+…+D)

F. Net debt

G. Net asset value (NAV)

Note: USD/INR =45; No. of shares= 971m; As on March 2011

October 2011

15

Tata Steel

Tata Steel trades at a deep discount to NAV (INR b)

NAV

1400

Net Debt

2 Mcap

Net w orth

Tata Steel trades at a deep

discount of 57% to NAV, last

seen in 2009

1050

700

350

0

FY07

FY08

FY09

FY10

FY11

Source: Company/MOSL

Note: Net worth (not adjusted for goodwill of INR 153b)

The stock trades at attractive valuations of 5.5x PE, 4.3x EV/EBITDA, 1.2x P/BV for

FY13E and at 57% discount to NAV. We value the stock at INR693 per share based on

the SOTP method. Reiterate

Buy.

Tata Steel: SOTP valuation

2011

India

EBITDA per ton (USD)

Sales (m tons)

EBITDA-India

Target EBITDA multiple

EV (India) - (a)

INR/share

TSE and other subs.

EBITDA per ton (USD)

Sales (m tons)

EBITDA

Target EBITDA multiple

EV (TSE) - (b)

INR/share

Target EV (c=a+b)

Net Debt (d)

INR/share

D/E x (adj for goodwill)

Investments (e)

INR/share

Equity value (f=c-d+e*50%)

INR /share

Target Price (INR/share)

371

6.4

114,329

6.5

743,136

765

51

17.1

45,628

5.0

228,138

235

971,274

481,352

496

2.4

96,815

100

538,330

561

561

2012E

390

6.7

122,002

6.5

793,015

816

43

18.1

35,130

5.0

175,648

181

968,662

421,302

434

1.4

96,560

99

595,641

613

613

(INR Million)

2013E

367

9.0

150,684

5.5

828,762

853

49

18.4

40,900

4.5

184,051

189

1,012,813

387,426

399

1.1

96,560

99

673,667

693

693

Source: Company/MOSL

October 2011

16

Tata Steel

Financials and Valuation

Income Statement (Consolidated)

Y/E March

Net Sales

Change (%)

Total Expenses

EBITDA

% of Net Sales

2010

1,023,931

-30.5

943,505

80,427

7.9

2011

1,187,531

16.0

1,027,575

159,956

13.5

44,148

115,808

27,700

2,809

90,917

30,103

121,020

32,459

26.8

88,561

-603

664

89,827

59,724

-n/a-

2012E

1,395,816

17.5

1,238,763

157,053

11.3

46,644

110,409

29,058

6,035

87,386

39,120

126,506

29,856

23.6

96,649

-346

1,140

98,135

59,015

-1.2

(INR Million)

2013E

1,508,487

8.1

1,320,639

187,848

12.5

51,785

136,063

35,206

6,793

107,651

107,651

32,789

30.5

74,862

-69

1,186

76,117

76,117

29.0

Ratios (Consolidated)

Y/E March

Basic (INR)

EPS

Cash EPS

BV/Share

DPS

Payout (%)

Valuation (x)

P/E

Cash P/E

P/BV

EV/Sales

EV/EBITDA

Dividend Yield (%)

Return Ratios (%)

RoE

RoCE (pre-tax)

RoIC (pre-tax)

2010

(9.3)

26.7

95.7

8.0

(106.4)

2011

62.3

138.3

211.4

12.0

21.9

2012E

60.8

147.5

302.5

10.0

19.3

2013E

78.4

130.4

366.7

11.0

16.4

Depn. & Amortization 44,917

EBIT

35,509

Net Interest

30,221

Other income

6,859

PBT before EO

EO income

PBT after EO

Tax

Rate (%)

Reported PAT

Min. int. profit (loss)

12,147

-11,837

310

21,518

6,941

-21,208

152

7.0

3.1

2.0

0.8

5.6

2.8

7.1

2.9

1.4

0.6

5.4

2.3

5.5

3.3

1.2

0.5

4.3

2.5

Share of asso. PAT

1,269

Attributable PAT -20,092

Adjusted PAT

-8,255

Change (%)

-109.1

(8.1)

5.2

5.6

40.5

13.2

18.6

23.6

10.9

16.5

23.4

12.3

18.6

Working Capital Ratios

Fixed Asset Turnover (x)1.0

Asset Turnover (x)

1.3

Debtor (Days)

41.4

Inventory (Days)

67

A/c Payables (Days)

83.4

Working Capital T/O (Days)22

Leverage Ratio (x)

Current Ratio

Interest Cover Ratio

Debt/Equity

1.5

1.2

5.2

1.9

4.2

2.4

2.1

3.8

1.4

2.1

3.9

1.1

1.2

1.2

45.5

74

82.0

46

1.4

1.2

41.2

65

75.4

39

1.2

1.3

42.5

68

79.8

38

Balance sheet (Consolidated)

Y/E March

Share Capital

Reserves

2010

8,867

221,516

2011

9,587

346,226

355,814

8,889

621,843

28,920

1,015,466

981,598

615,922

365,676

158,258

46,908

152,982

629,252

240,552

148,163

140,492

100,045

337,610

266,711

70,899

291,643

1,015,466

2012E

9,707

437,082

446,790

8,543

655,046

28,920

1,139,299

1,026,642

662,565

364,077

216,461

24,408

152,982

740,585

249,154

157,642

233,744

100,045

359,213

288,314

70,899

381,372

1,139,299

(INR Million)

2013E

9,707

499,511

509,218

8,474

655,046

28,920

1,201,658

1,207,886

714,350

493,535

107,605

24,408

152,982

823,889

280,688

175,536

267,620

100,045

400,760

329,861

70,899

423,129

1,201,658

Net Worth

230,383

Minority Interest

8,841

Total Loans

531,004

Deferred Tax Liability 16,541

Capital Employed 786,768

Gross Block

976,290

Less: Accum. Deprn.608,126

Net Fixed Assets 368,164

Capital WIP

89,795

Investments

Goodwill on cons.

Curr. Assets

34,890

145,418

457,965

Cash Flow Statement (Consolidated)

Y/E March

2010

2011

159,956

8,773

-71,749

-32,351

64,629

-101,636

-1,521

28,133

3,518

-71,507

60,568

37,874

-7,146

-31,366

59,930

53,052

87,166

140,492

2012E

157,053

-

3,523

-29,856

130,720

EBITDA

80,427

Non cash exp. (inc.) 2,404

(Inc)/Dec in Wkg. Cap.46,465

Tax Paid

-24,586

CF fr. Op. Activity 104,710

(Inc)/Dec in FA+CWIP-69,498

(Pur)/Sale of Inv.

8,398

Acquisition in subs. -3,538

Int. & Divident Income 3,054

CF fr. Inv. Activity -61,584

Eq. raised/(repaid)

24,465

(INR Million)

2013E

187,848

-

-7,881

-32,789

147,178

-72,388

-

-

6,793

-65,594

-

-

-12,502

-35,206

-47,708

33,876

233,744

267,620

Inventory

186,866

Account Receivables116,240

Cash/Bank Bal.

87,166

Others

67,694

Curr. Liab. & Prov.309,464

Account Payables 233,886

Provisions & Others 75,578

Net Curr. Assets 148,501

Appl. of Funds

786,768

E: MOSL Estimates

-103,247

61,620

-

6,035

-35,592

5,346

33,203

-11,365

-29,058

-1,875

93,252

140,492

233,744

Debt raised/(repaid) -29,944

Dividend (incl. tax) -13,209

Interest paid

-32,662

CF fr. Fin. Activity -51,350

(Inc)/Dec in Cash

Add: opening Bal.

Closing Balance

-8,224

95,390

87,166

October 2011

17

Sector: Metals

Jindal Steel & Power

BSE SENSEX

S&P CNX

16,536

Bloomberg

Equity Shares (m)

52-Week Range (INR)

1,6,12 Rel. Perf. (%)

M.Cap. (INR b)

M.Cap. (USD b)

4,974

JSP IN

934.1

735/442

-8/-14/-14

456.1

9.2

CMP: INR488

The best performer

TP: INR729

Buy

Strong project pipeline though challenges remain

Despite its below-average RoIC, Jindal Steel and Power (JSP) has been the

best performing stock among the metals companies under our coverage due

to better capital allocation in high RoI business and timely execution.



Strong volume growth in steel and power, healthy cash-flow. Challenges

now lies in deploying it with equal speed.



Strong project pipeline, but execution has been suffering due to issues

such as land acquisition and regulatory permissions.



Though there are some delays, we like JSP's due to its well planned

expansion projects and rich mineral resources. Maintain Buy.

Y/E March

2011 2012E 2013E

200.1

86.7

49.5

52.9

23.6

241.1

9.2

2.0

3.4

7.8

24.4

16.9

31.7

Sales (INR b) 131.1 169.9

EBITDA (INR b) 63.9

70.0

NP (INR b)

EPS (INR)

EPS Gr. (%)

BV/Sh. (INR)

P/E (x)

P/BV (x)

EV/Sales (x)

37.5

40.1

6.0

150.8

12.2

3.2

4.5

40.0

42.8

6.7

191.9

11.4

2.5

3.7

9.0

25.0

17.4

29.8

EV/EBITDA (x) 9.2

RoE (%)

30.6

RoCE (%)

21.6

RoIC (%)

35.0

Strong volume growth in steel and power businesses

Steel sales will grow from 1.9mt in FY11 to 2.4mt in FY12 due to a ramp-up of

production at Raigarh and 2.7mt in FY13 on account of contribution from Angul projects

during the second half. Pellet production is expected to ramp up from 2.8mt in FY11 to

4.4mt FY12 and FY13. The sale of pellets will decline in FY13 due to increase in

internal consumption at the Angul sponge iron unit.

Power volume will increase as the remaining seven units of a 135MW captive power

plant will be commissioned at Angul and Raigarh. Margins, however, will be under

pressure because of low rates offered by SEBs to captive power plants and high cost

of purchase of third-party coal.

Power, steel volume growth drive RoIC

Steel (kt)

4,000

3,200

Metallics (kt)

Iron ore/Pellets (kt)

Pow er (RHS, Bn kw h)

16

12

8

1,600

800

4

0

FY05

FY06

FY07

FY08

FY09

FY10

FY11

FY12E

FY13E

Shareholding pattern % (Jun-11)

Others,

11.0

Foreign,

24.1

Promoter

58.4

Domestic

Inst, 6.5

2,400

Stock performance (1 year)

Jindal Steel & Pow er

Sensex - Rebased

800

700

600

500

400

0

Source: Company/MOSL

RoCE will still decline

Return on capital employed will decline because the CWIP/CE ratio is growing due to

project delays. The steel melt shop for its Angul project was delayed by nine months to

December 2011. Brownfield expansion of JSP's power project too has been delayed

due to pending statutory permissions.

18

October 2011

Jindal Steel & Power

RoCE will decline (in %)…

RoIC

RoCE

… due to mounting capital work in progress (INR b)

Standalone

Jindal pow er

32.8

27.5

16.5

19.9

21.6

17.4

16.9

15

27

9

9

23

64

30

71

95

73

131

75

3

FY07

FY08

FY09

FY10

FY11

FY12E

FY13E

11

21

7

FY05 FY06 FY07 FY08 FY09 FY10 FY11 FY12E FY13E

Source: Company/MOSL

Cash flow remains healthy

JSP generated operating cash flow of USD3.1b over FY07-11 and invested USD4.9b. In

FY12 and FY13 operating cash flow will be USD2.6b and the planned capex is USD4.4b.

Average cash flow over the next two years is now twice its average cash flow over the

past five years.

Cash flow

FY07-11

INR m

Opr. Cash flow

Capex

M&A

Investments, dividend etc

Equity

Dividend

Interest

Net increase in debt

Note: USD/INR=45.0

140,812

-220,987

-5,037

0

780

-4,454

0

88,885

USD m

3,129

-4,911

-112

0

17

-99

0

1,975

INR m

117,944

-198,169

0

0

0

FY12-13

USD m

2,621

-4,404

0

0

0

-3,597

-80

0

0

83,823

1,863

Source: Company/MOSL

Strong project pipeline

JSPL will set up two green-field steel units in Orissa and Jharkhand with capacity of

3mtpa each and it will enhance its Raigarh steel capacity by 1.6mtpa. Thus, JSP aims at

steelmaking capacity of 12mtpa by the end of FY15.

Steel capacity to grow 4x in four years (mtpa)

Raigarh - existing

Patratu - BoF route

Angul - gas route

Raigarh - gas route

Shadeed - gas route

1.6

4x in 4 years

3.0

1.0

1.6

1.0

1.6

3.0

FY14

3.2

3.0

FY15

Source: Company/MOSL

3.0

FY11

3.0

FY12E

3.0

FY13E

October 2011

19

Jindal Steel & Power

JSP aims to enhance its power capacity by more than 10 times over the next 10 years

through green-field and brown-field projects.

Power capacity to grow 10x in 10 years (GW)

Tamnar 1

Tamnar 2

Goda

Dumka

Subansiri

Etalin

Attunli

0.5

4.0

1.6

1.3

0.7

2.4

1.0

FY18

1.6

1.3

0.7

2.4

1.0

FY19

4.0

1.6

1.3

0.7

2.4

1.0

FY20

2.4

1.0

FY11

1.0

FY12E

1.0

FY13E

1.0

FY14

2.4

1.0

FY15

1.3

0.7

2.4

1.0

FY16

1.3

0.7

2.4

1.0

FY17

Source: Company/MOSL

JSP trades at a premium to

NAV due to significant

growth in the power

sales earnings

Earnings growth to pick up in FY13; maintain Buy

Earnings growth will slow in FY12 due to shrinking margins in the power business. However,

earnings are expected to grow stronger in FY13 due to expectation of improvement in

power rates and the start of the Angul coal mine.

Unlike other steel stocks, JSP has begun to trade at a premium to replacement costs due

to significant growth in the share of earnings from power sales.

We like the stock due to its strong pipeline of projects and cash flow. The stock trades at

a PE of 9.2x FY13E. Maintain

Buy,

with an SOTP-based target price of INR729.

NAV at a premium to replacement costs (INR b)

NAV

700

560

420

280

140

0

FY07

FY08

FY09

FY10

FY11

Source: Company/MOSL

Net Debt

2Q Mcap

Net Worth

October 2011

20

Jindal Steel & Power

NAV calculations

Process

Capacity

(mtpa)

A. Minining

Iron ore

Coal

B. Manufacturing

Crude steel

Hot rolling

Cold rolling

C. Investments

6

12

3

3

0

Specific

replacement

cost (USD/ton)

120

85

650

200

300

Value

(USD m)

720

1,020

2,550

1,950

600

0

86

100

379

135

244

92

107

406

144

261

115

123

Sub

total

(USD m)

(INR b)

1,740

78

Value

per share

(INR)

84

D. Capital work in progress

E. Total Asset Value (A+B+…+D)

F. Net debt

G. Net asset value (NAV)

Note: USD/INR =45; No. of shares=934m; As on March 2011

Sum of the parts valuation

Equity Valuation

Iron & Steel Business

Shadeed

supply contract

Rockland

Bolivia

@20% for 3 years

Jindal Power

Business

Segment

Steel, Power

Steel

Coal

Iron & steel

Power

Power

Power

Method

FY13E PER (x)

FY13E PER (x)

Actual Mkt Cap

Valuation

multiple

10.8

10.8

Value

(INR m) (INR/sh)

319,261

22,716

3,071

21,467

152,089

93,008

69,778

681,389

342

24

3

23

163

100

75

729

Rationale

Strong volume growth and captive mines

1.5mtpa DRI plant, Attractive 22 year gas

Coal tenaments in Australia

10mtpa pellet plant's valuation discounted

1000MW Capacity for Tamnar 1

2400MW capacity for Tamnar 2

1980MW Capacity by 2015

DCF (to equity)

DCF (to equity)

DCF (to equity)

SOTP

EBITDA: Healthy cash flow (INR b)

Steel

Pow er

Earnings per share (INR)

Standalone

Jindal pow er

others

1.0

-0.8

-3.0

-2.6

-1.5

FY05 FY06 FY07 FY08 FY09 FY10 FY11 FY12E FY13E

FY05

FY06

FY07

FY08

FY09 FY10

FY11 FY12E FY13E

Source: Company/MOSL

October 2011

21

Jindal Steel & Power

Financials and Valuation

Income Statement (Consolidated)

Y/E March

Net sales

Change (%)

Total Expenses

EBITDA

% of Net Sales

2009

2010

2011

(INR Million)

2012E

2013E

Ratios (Consolidated)

Y/E March

Basic (INR)

EPS

Cash EPS

BV/Share

DPS

Payout (%)

Valuation (x)

P/E

Cash P/E

P/BV

EV/Sales

EV/EBITDA

Dividend Yield (%)

Return Ratios (%)

EBITDA Margins (%)

Net Profit Margins (%)

RoE

RoCE (pre-tax)

RoIC (pre-tax)

12.2

9.2

3.2

4.5

9.2

0.3

11.4

8.5

2.5

3.7

9.0

0.4

9.2

6.9

2.0

3.4

7.8

0.4

2009

34.3

42.6

75.7

0.9

2.7

2010

37.9

49.7

111.8

1.3

3.4

2011

40.1

53.0

150.8

1.5

3.8

2012E

42.8

57.6

191.9

1.8

4.2

2013E

52.9

70.3

241.1

2.0

3.9

108,510 110,915 131,116 169,865 200,109

97.7

2.2

18.2

29.6

17.8

55,367

53,143

49.0

52,331

58,584

52.8

9,970

48,614

3,576

603

45,641

-107

45,535

9,189

20.2

36,346

755

139

35,837

12.3

67,190

63,926

48.8

11,510

52,416

3,356

820

49,880

49,880

11,840

23.7

38,040

659

158

37,539

4.7

99,876 113,416

69,989 86,693

41.2

43.3

13,296

56,693

5,492

1,917

53,118

0

53,118

12,609

23.7

40,510

660

187

40,036

6.7

15,726

70,967

8,914

2,661

64,713

0

64,713

14,797

22.9

49,916

594

158

49,479

23.6

Depn. & Amortization 9,641

EBIT

43,502

Net Interest

4,567

Other income

624

PBT before EO

EO income

PBT after EO

Tax

Rate (%)

Reported PAT

Minority interests

39,559

-1,448

38,111

8,040

21.1

30,072

10.2

Share of Associates

396

Adjusted PAT

31,906

Change (%)

121.9

49.0

29.4

59.1

32.8

45.7

52.8

32.3

40.4

27.5

42.3

48.8

28.6

30.6

21.6

35.0

41.2

23.6

25.0

17.4

29.8

43.3

24.7

24.4

16.9

31.7

Balance sheet (Consolidated)

Y/E March

Share Capital

Reserves

Net Worth

Minority Interest

2009

155

2010

931

2011

934

(INR Million)

2012E

934

2013E

934

Working Capital Ratios

Fixed Asset Turnover (x)0.9

Asset Turnover (x)

0.7

Debtor (Days)

19.3

Inventory (Days)

11.4

Work.Cap.Turnover (Days)18.2

Payable (Days)

Leverage Ratio (x)

Current Ratio

Interest Cover Ratio

Debt/Equity

73.7

0.8

0.6

24.8

12.9

14.9

100.0

0.7

0.4

32.1

21.2

27.0

101.8

0.8

0.4

31.0

16.9

21.7

83.8

0.7

0.4

31.0

17.1

19.7

81.1

70,319 103,158 139,965 178,332 224,314

70,474 104,089 140,899 179,266 225,248

45

1,659

2,335

2,978

3,628

86,043 139,766 188,766 247,766

8,455 10,055

11,683 13,744

Total Loans

81,143

Deferred Tax Liability 7,170

Capital Employed 158,832 200,246 293,054 382,693 490,386

Gross Block

117,087 131,625 192,756 217,388 285,786

32,651 44,321 57,714 73,441

98,974 148,435 159,674 212,345

79,470 100,409 167,999 205,549

1,007

3,185

1,018

2,979

1,018

2,979

1,018

2,979

1.8

9.5

1.1

1.3

13.6

0.8

1.6

15.6

1.0

1.7

10.3

1.0

1.9

8.0

1.0

Less: Accum. Deprn. 22,415

Net Fixed Assets 94,672

Capital WIP

Good will

Investments

32,554

5,139

Cash Flow Statement (Consolidated)

Y/E March

Pre-tax profit

2009

38,111

2010

45,535

9,970

3,290

-7,905

-1,424

49,466

2011

49,880

(INR Million)

2012E

53,118

2013E

64,713

15,726

-2,596

-12,002

-2,100

63,742

Curr. Assets

60,661

Inventory

12,403

Account Receivables 5,741

Cash / Bank Balance 6,694

Loans & advances 35,823

Curr. Liab.& Prov. 34,194

Account Payables 21,901

Provisions & Others 12,293

Net Curr. Assets 26,467

68,510 107,863 121,086 143,997

14,308 27,734 28,725 34,186

7,533

11,537 14,439 17,014

1,128

45,541

50,900

30,377

20,522

17,611

4,802

63,790

67,649

36,587

31,063

40,214

14,132

63,790

70,062

38,999

31,063

51,024

29,008

63,790

75,501

44,439

31,063

68,496

Depreciation

9,641

(Inc)/Dec in Wkg. Cap.-11,014

Tax paid

-5,816

Other oper. activities 4,272

CF fr.Op. Activity 35,194

11,510 13,296

-18,929

-1,480

-9,472 -10,231

262

33,252

-82,070

206

-81,864

3

53,723

-1,439

52,287

3,674

1,128

4,802

-500

54,202

(Inc)/Dec in FA + CWIP-42,597 -61,454

(Pur)/Sale of Investments-2,430 1,954

CF from Inv. Activity-45,027 -59,500

Equity raised/(repaid)

1

Debt raised/(repaid) 11,172

Dividend (incl. tax)

-853

Other financing activities

CF fr. Fin. Activity 10,320

(Inc)/Dec in Cash

486

Add: Opening Balance 6,207

Closing Balance

6,694

777

4,900

-1,208

4,468

-5,566

6,694

1,128

-92,222 -105,948

0

0

-92,222 -105,948

0

49,000

-1,679

47,321

9,301

4,802

14,132

0

59,000

-1,919

57,081

14,875

14,132

29,008

Appl. of Funds

158,832 200,246 293,054 382,693 490,386

E: MOSL Estimates

October 2011

22

Sector: Metals

SAIL

BSE SENSEX

S&P CNX

16,536

Bloomberg

Equity Shares (m)

52-Week Range (INR)

1,6,12 Rel. Perf. (%)

M.Cap. (INR b)

M.Cap. (USD b)

4,974

SAIL IN

4,130.4

230/98

-2/-22/-34

443.6

9.0

CMP: INR107

TP: INR113

Sell

Project execution disappoints

Fixed costs still rising; Maintain Sell









CWIP up, drags down RoCE due to project delays; Expansion benefits will

start kicking-in in 2HFY13.

Rising operating costs impact RoE but RoIC will be highest among peers.

Net debt to rise USD3.8b but D/E comfortable if expansion is not delayed.

Stock appears to be expensive, maintain Sell.

Y/E March

2011 2012E 2013E

496.2

74.5

42.2

520.0

79.0

39.8

Sales (INR b) 427.6

EBITDA (INR b) 70.5

NP (INR b)

43.0

EPS (INR)

EPS Gr. (%)

BV/Sh. (INR)

P/E (x)

P/BV (x)

EV/EBITDA (x)

EV/Sales (x)

RoE (%)

RoCE (%)

10.2

-38.2

90.4

10.5

1.2

6.2

1.0

11.8

12.8

10.2

9.6

0.2

-5.8

97.5 104.0

10.5

11.2

1.1

7.1

1.1

10.9

12.0

1.0

7.7

1.2

9.5

10.2

Rising CWIP drags RoCE to 13%; Expansion benefits in 2HFY13

SAIL undertook brown-field expansion across its locations along with modernization

of its existing facilities in 2005. However it faced cost and time overruns due to slow

execution and slowdown in the global economy in 2008. A blast furnace at ISP Burnpur

(2mtpa) is expected to be commissioned by March 2012. However, the BOF will take

some time for commissioning and capacity utilization is unlikely to cross 50% in the

first six months after the start up. Thus, incremental saleable steel volumes will be

available only in 2HFY13.

SAIL is expected to commission two blast furnaces of 2.5mtpa each in Rourkela and

Bhilai in FY13. The delayed commissioning has affected SAIL's return ratios. CWIP

as a percentage of capital employed increased from 8% in FY07 to 45% in FY11 and

is expected to increase to 56% in FY13. This is dragging RoCE as project execution is

slow. RoCE declined from 47% in FY07 to a mere 13% in FY11.

Over FY11-13 we expect SAIL to post volume CAGR of 8% to 13.8mt. However

margins will improve only after the completion of modernization of SAIL's old plants,

addition of downstream facilities and development of new coal mines.

Shareholding pattern % (Jun-11)

Others,

Foreign,

2.5

4.1

Domestic

Inst, 7.5

Promoter

85.8

Volumes will grow but margins will be subdued

EBITDA per ton

11.9

12.3

Sales tonnage

13.8

12.1

11.7

12.7

Stock performance (1 year)

9.4

SA IL

Sensex - Rebased

275

225

175

125

75

9.8

10.3

10.4

11.0

11.3

11.3

218

137

94

44

10

41

261

181

180

173

141

128

124

FY01 FY02 FY03 FY04 FY05 FY06 FY07 FY08 FY09 FY10 FY11 FY12E FY13E

Source: Company/MOSL

October 2011

23

SAIL

INR720b capex benefits to

start only in FY15

Rising operating costs impact RoE; but RoIC will be highest among peers

Over FY07-11, SAIL's profitability was impacted badly by rising coking coal costs, labor

cost and other operating costs. This has impacted RoE, which slipped from 42% in FY07

to 12% in FY11. Ongoing capacity expansion will ensure specific labor cost remains at

similar levels, but per ton labor cost will still be highest among key players. Over 2001-10,

sustenance capex has been just USD11/ton/year, resulting in further deterioration of age-

old machinery. This however is being corrected through its INR720b capex plan and

INR158b (USD269/ton over five years) is being spent on sustenance.

Over FY07-11, the share of invested capital fell from 50% to 22% as it made significant

capex only recently, which is lying in CWIP. However going forward, as the facilities start

coming on stream, IC will increase. RoIC will continue to decline as RoIC on new facilities

will be much lower due to higher invested capital. SAIL is investing INR540b on its

incremental 7mtpa of production which will drag RoIC but it will still be the highest among

its peers (except JSP).

Strong volume growth (attributable)

R

oIC

261

E A per ton

BITD

EBITDA (attributable)

Production

EBIT (RHS)

30.6

Invested Capital (RHS)

RoIC (%)

1,657

181

137

180

173

141

128

124

134

11.7

260

7

113

FY11

4.8

113

47.9

71.9

98.5

63.6

60.5

40.4

39.2

30.6

28.6

FY06 FY07 FY08 FY09 FY10 FY11 FY12E FY13E FY14E

Grow th

Source: Company/MOSL

Net debt to rise USD3.8b but D/E still comfortable

Over FY11-13 SAIL will generate operating cash flow of USD2.5b and invest USD5.4b

in ongoing expansion. Its net debt will increase by USD3.8b after payment of total dividend

and an interest component of USD894m. This will increase net interest costs but net debt-

to-equity ratio will be comfortable.

Cash flow

FY07-11

INR m

Opr. cash flow

Capex

M&A

Investments, dividend etc

Dividend

Interest

Net increase in debt

Note: USD/INR=45.0

399,910

-323,832

2,168

-330

-70,310

-18,123

10,518

USD m

8,887

-7,196

48

-7

-1,562

-403

234

INR m

112,188

-240,995

0

0

FY12-13

USD m

2,493

-5,355

0

0

-25,103

-558

-15,126

-336

169,036

3,756

Source: Company/MOSL

October 2011

24