Steel Authority of India Limited (BOM:500113)

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Amit Amin

Geoffrey Jordan

Steel Authority of India Limited (BOM: 500113) is the second largest steel maker in India by market cap and sales, and is 86% owned by the Indian government.^[1] The company sells over 80% of its steel in India,^[2] which is used primarily to build manufacturing plants, infrastructure, and consumer products like cars and washing machines.^[3]

The company has grown production at an average rate of 4.5% since 2001, when it was restructured, which involved selling off many of its power plants, cutting costs, and bringing down its level of debt.^[4] As the 2008 Financial Crisis worsened in late 2008 and early 2009, however, global demand for steel fell while new steel production capacity was coming into the market, causing steel prices to fall.^[5]

SAIL also faces stiff competition - 99.8% of the worlds steel is made by its competition.^[6] That means that pricing is highly competitive. However, the company is the 19th largest steel producer in the world and the second largest in its primary market, India, as measured by crude steel production.^[6] As the Indian Government holds a 86% stake in SAIL and retains voting control, it can and has forced the company to pursue social, rather than profit maximizing objectives.^[1] For example, the company forced SAIL to keep prices steady in 2008 despite rising global steel prices in order to control rising inflation.^[1]

Company Overview

Business & Financial Metrics

First Quarter Fiscal 2011 Performance^[7]

During the first quarter of fiscal 2011, SAIL announced net sales of Rs. 9,029 crore, an increase of less than 1% from the prior year. EBITDA totaled Rs. 2,229 crore, down 8% from the prior year. Profit after tax was Rs. 1,177 crore, a decrease of 11.5%.

Fiscal 2009 Performance

As of May 2009, SAIL had a market cap of Rs. 60,303 Cr. (~$12.5bn), which makes it the second largest steel producer in India by both market cap and production. SAIL produces and sells semis (partially finished steel), long products (like rods), flat products (like sheets and coils), tubular products (pipes), and railway products.^[8] These steel products are used for the general construction of products such as manufacturing plants, cars, and houses. Sales in 2008, excluding Q1, were Rs. 321bn, up 20% from 2007, but profit before tax was down 9%, from Rs. 78 billion. Revenues increased because steel prices increased, but profits were down because raw material prices rose even faster than steel prices.

The company plans to increase capacity and production by 70% by 2010 to 2011 by spending Rs. 530 billion.^[9] To keep interest expense under control, which was at Rs. 1 billion in 2008^[10], the company intends to maintain a debt to equity ratio under 1. The company has room to borrow, as its current ratio in 2008 was 0.13, much lower than 1.72 in 2004.^[11]

Business Segments

SAIL manufactures steel and special steel, both of which are made from hot metal, crude steel, and pig iron.^[12] Less than 5% of steel sold is special steel. Special steel is like regular steel, but has unique composition and shape specifications dictated by the customer.

Crude and Finished Steel (62.2% of production by tonnage)

Crude steel is an intermediate form of finished steel. Both crude and finished steel production have grown only 3% since 2006, and even then only as capacity utilization surpassed 100%, at expense.

Hot Metal (35.6% of production by tonnage)

Hot metal is the liquid form of pig iron, which is then purified with crude steel to produce saleable steel. The company has been able to meet its own demand for hot metal, and then some. In 2008 it produced 7% extra hot metal, after its expansion plan in 2009 and 2010 it intends to produce 13% extra hot metal, and by 2020, 20% extra hot metal.

Special Steel (1.2% of production by tonnage)

Special steel is difficult to make. As demand for any particular type of special steel is low, economies of scale are difficult to create. At the same time, there is less competition in this market. For that reason, from 2007 to 2008 the company increased special steel production by 130%. An example of special steel are high grade plates, which have higher strength and toughness than regular plates, and may be used to build a high traffic bridge.^[13]

Pig Iron (0.9% of production by tonnage)

Pig iron is the product of mixing iron ore with coke (a processed form of coal). The company does not produce enough pig iron to satisfy the requirements of its hot metal segment. In 2008 it had to purchase 33% of its pig iron. From 2010 to 2020, as interfirm demand rises faster than supply, it estimates it will have to purchase approximately 40% of its pig iron. These deficits expose the company to the rises and falls in the price of iron ore prices, although the company has entered into some long-term contracts.

Revenue Streams

Of the steel that the company produces, it earns the majority of its revenues from hot rolled steel coils and hot rolled steel plates, with the rest coming from semis, railway materials, bars, and cold rolled coils. However, because the company is based in India and does not have an ADR (and therefore does not file with the United States SEC), the calculation of product revenues was based on the following assumptions: the company's steel production and sales were the same each month of the year, the company sold all of its steel at global prices, and none of its steel was used internally.^[14][12]

• Hot Rolled Steel Coils(~40% of revenues): Steel coils are used in heaters, chemical processing equipment, furnace parts, engines, oil burner parts, dryers, oven equipment, petroleum refining equipment and gas turbine parts.^[15]

• Hot Rolled Steel Plates(~42% of revenues): Steel plates are used to construct bridges, steel structures, ships, large diameter pipes, storage tanks, boilers, and pressure vessels.^[16]

Trends and Forces

Falling Steel Prices Squeeze SAIL's Margins

Despite less than a 1% increase in production, revenue rose more than 23% from 2007 to 2008 because the price of steel also increased.^[10][17] At its high point, steel sold for double as much in 2008 as it did in 2007.^[14] Now, as the price of steel falls to a six year low, the company will likely lose revenues. SAIL has been especially effected by the decline in steel prices because it does not sell long-term contracts.^[18] This is in contrast to many of its competitors, like Tata Steel, which does.^[19] At the same time, SAIL's lack of long-term contracts protected it from building up excess capacity. Tata expected its long-term contracts to hold and rapidly expanded its production capacity. As the global economy continues to slow many of those contracts have been canceled, leaving the company with more debt but fewer revenues.^[19]

Multiple factors determine the price of steel, including: global economic cycles, new construction, and global production capacity. Economic growth in general drives greater production and construction, activities that consume steel. As the global economy began slowing down in 2008, steel prices fell by almost 50% in the six months after July, after having nearly doubled in the six months before.^[14] In the first quarter of 2009, economic activity slowed even more. New construction is driven by economic growth, but the percent of GDP spent on fixed-asset production (new construction), which usually consumes steel, varies from situation to situation. In Q1 2009, China spent nearly triple, as a percent of its GDP, on new construction, as compared to a more developed economy like the U.S.^[20] Production capacity also determines steel prices. If there is a surplus of production capacity, steel prices will remain low, if there is not, steel prices will rise. From the 70s to the turn of the century, production capacity rose at an annual rate of .6%.^[21]Then, both undergoing and expecting rapid growth, steel companies increased capacity at more than 7% per year. As demand and demand forecasts began to fall in 2008 and Q1 09, the world was left with 300-400 million metric tonnes of unused capacity.^[5]

Falling Raw Materiel Expenses Save SAIL Money

SAIL produces 66% of its pig iron, all of its hot metal, some of its coal, and little of its energy. That's more than most of its Indian competitors, who are smaller, which reduces its exposure to fluctuations in raw material prices. Going further, the company buys a portion of its materials through long-term contracts, which further reduces its expose to price fluctuations. Nevertheless, despite less than a 1% increase in production, raw material expenses rose 40% from 2007 to 2008.^[10] That rise closely tracked the Baltic Dry Index - BDI (BALDRY), which measures a daily average of prices to ship raw materials. Similarly, as the BDI fell over 80% from its peak in mid 2008 to Q1 2009, raw material expenses are likely to fall. Specifically, SAIL needs thermal coal, coking coal, iron ore, natural gas, and steel scrap, only some of which it produces itself. Raw material prices are determined by many of the same factors that determine the price of steel, with some important differences. From late 2007 to mid 2008, steel prices rose by more than 2/3rds,^[14] but the BDI doubled. From mid 2008 to early 2009 the BDI fell by more than 90%, but steel prices fell by less than 50%.^[14]

SAIL Faces Growing Competition From Larger Foreign Firms

In the steel industry economies of scale of manufacturing are large, as the bigger the plant, the lower the cost to produce. SAIL's production of crude steel accounted for less than .2% of global production in 2007, which in turn was lower than the production of 18 other companies.^[6] The company plans to increase capacity and production by 70% by 2010 to 2011, but its Indian competitors are similarly ambitious.^[9]Nevertheless, because of its #2 position in India it's margins are higher than most domestic competitors. At the same time, as foreign firms turn to India to sell their unsold steel, prices are declining rapidly. The price of imported metal was less than 20% that of domestic metal in April.^[22] Left without intervention, domestic prices will be forced to decline, as they did in late 2008 and early 2009.^[22] Wanting to avoid such a situation, a 25% import duty was proposed but rejected in May.^[23]

Competition

Steel Authority sells two types of products: special steel, and regular steel. In the special steel market competition is not as great, because there is not as much demand. Likewise, SAIL earns only a portion of its revenues from selling special steel. Regular steel is homogeneous. The steel made by a U.S. firm is likely to be functionally similar to that made by an Indian firm. Therefore, competition in this market is large. With price out of the companies control, what's important is size and efficiency. Steel Authority has an advantage in India, as it's the country's second largest steel producer, but its economies of scale, as judged by annual crude steel output, are surpassed by 18 other steel companies in other countries.^[6] Some of its largest competitors include:

• ArcelorMittal (MT): The largest steel manufacturer in the world, ArcelorMittal exports steel to India and will be producing 24 tonnes within the country by 2012.^[24]
• Tata Steel Limited (TATASTL-BY): Tata Steel is SAIL's largest domestic competitor, producing the most steel of any Indian company, and wishes to double its production capacity by 2011.^[25] Tata has the highest margins out of all of the large Indian steel manufacturers.
• JSW: JSW is more diversified than SAIL, albiet much smaller, and like Tata, the company plans to double production capacity by 2011.^[26]

References

1. ↑ ^{1.0 1.1 1.2} Equity Master - SAIL: Restructuring for real?
2. ↑ PRDomain - SAIL wipes out accumulated loss
3. ↑ Steel World - Flat Steels- Focus on HR Coils Upswing in production, consumption
4. ↑ SSRN - Restructuring Steel Authority of India
5. ↑ ^{5.0 5.1} Financial Express - Global steel crisis offers opportunities for efficient mills
6. ↑ ^{6.0 6.1 6.2 6.3} World Steel Association - Top steel producers 2007
7. ↑ SAIL First Quarter Fiscal 2011 Results
8. ↑ SAIL: Sales - Product Mix
9. ↑ ^{9.0 9.1} Business Standard - Steel Authority of India
10. ↑ ^{10.0 10.1 10.2} SAIL: Investor Relations - Financial Results Q3 2008
11. ↑ Rediff Money - SAIL Ratios
12. ↑ ^{12.0 12.1} SAIL: Investor Relations - Ten-Year Digest
13. ↑ CNRS - Application of value added steel in road infrastructure development
14. ↑ ^{14.0 14.1 14.2 14.3 14.4} Steel On The Net - MEPS Steel Product Price Levels across 2008 - 2009
15. ↑ Stainless Steels - Products
16. ↑ Champak Steel - Products
17. ↑ SAIL: Investor Relations - Financial Results Q4 2007
18. ↑ SAIL: Exports - FAQ
19. ↑ ^{19.0 19.1} Wall Stree Journal - http://online.wsj.com/article/SB124212708800310361.html
20. ↑ China Financial Scan - Q1 2009
21. ↑ BCG - Beyond the Boom
22. ↑ ^{22.0 22.1} mydigitalfc - Steel industry divided over safeguard duty
23. ↑ Live Mint - India will not impose steel safeguard duty
24. ↑ MyDigitalFC - ArcelorMittal's India plants to start operations by 2012
25. ↑ Financial Express - Unabated appetite for global growth
26. ↑ JSW: Investor Relations - Steel Presentation
27. ↑ Rediff Money - SAIL
28. ↑ Rediff Money - Tata Steel Ltd.
29. ↑ Rediff Money - Bhushan Steel
30. ↑ Rediff Money - Ispat Industries
31. ↑ Rediff Money - JSW Steel
32. ↑ Rediff Money - Jindal St & Pwr
33. ↑ Welspun Gujarat
34. ↑ Rediff Money - Adhunik Metaliks