7 January 2013

Update | Sector: Metals

Metals

CWIP valuations demystified

Sanjay Jain

(SanjayJain@MotilalOswal.com); +9122 39825412

Pavas Pethia

(Pavas.Pethia@MotilalOswal.com); +9122 39825413

Metals

Metals: CWIP valuations demystified

Page No.

Summary

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

3-8

Companies

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

9-61

Hindalco

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

10-18

Jindal Steel & Power

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

19-25

JSW Steel

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

26-29

SAIL

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

30-40

Sesa Sterlite

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

41-52

Tata Steel

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

53-60

*Prices as on 1 January 2013

7 January 2013

2

7 January 2013

Update | Sector: Metals

Metals

Implied valuation of CWIP at steep discount

Sesa-Sterlite, Hindalco penalized far more than warranted; Buy











Despite 30-40% earnings growth, the market capitalization of metal companies has fallen

by 30-35% over the last two-three years.

The markets have de-rated metal stocks due to exponential growth in their capital work

in progress (CWIP) and resultant increase in debt.

As the various projects start generating cash flows and capex intensity peaks over the next

two years, net debt should start coming off.

Our valuation exercise indicates that while there is still some downside in Jindal Steel &

Power and Tata Steel, Sesa-Sterlite and Hindalco could see re-rating.

We reiterate Buy on Sesa-Sterlite and Hindalco, and maintain Sell on Tata Steel, SAIL and

JSW Steel. We downgrade Jindal Steel & Power to Sell.

Aggregate CWIP has increased exponentially

Indian metal companies – Sesa-Sterlite, Hindalco, Tata Steel, SAIL, JSW Steel, and

Jindal Steel & Power – have invested INR2.6t over FY08-FY13 as compared to just

INR406b over FY01-07. Rising investment intensity and project delays on account of

various factors have driven an exponential increase in metal companies’ aggregate

CWIP (capital work in progress) to INR1.5t. Net debt has grown even faster to INR2.1t

(~USD38b) due to additional burden of acquisitions like Corus at USD14b and Novelis

at USD6b, despite equity infusion of USD12.5b and operating cash flow of INR2.6t.

Exponential rise in CWIP has driven up net debt

Note: Aggregate of top-6 listed Indian metal companies

Source: Company, MOSL

CWIP/MCap and CWIP/EV at all-time high

The significance/leverage of CWIP has never been as high as it is now, which is evident

from the exponential rise in the ratios (1) CWIP to market capitalization (MCap), and

(2) CWIP to enterprise value (EV). CWIP now stands at 67% of the total market

capitalization of the six metal companies, up from ~10% during FY03-08. Even during

the financial crisis of 2008 when MCap had crashed much below the intrinsic value of

companies, the CWIP/MCap ratio had risen to just 44%. The CWIP/EV ratio has increased

from below 10% until FY08 to 35%.

3

Investors are advised to refer

through disclosures made at the

end of the Research Report.

7 January 2013

Metals

CWIP/MCap has risen sharply to 67%

Except JSW Steel, every company has 10-20%

share in aggregate CWIP

Source: Company, MOSL

Implied valuation of CWIP at heavy discount...

With increasing debt, the markets have de-rated metal companies’ market cap below

the intrinsic value of operating assets (measured as 5x one-year forward EBITDA). In

other words, CWIP is being discounted heavily, perhaps for the right reasons – the IRR

of projects has declined much below the companies’ WACC. We believe investors are

willing to value growth companies at EV/EBITDA of 6-6.5x v/s EV/EBITDA of 5x for

mature steady state companies. This implies that investors are willing to tolerate

CWIP/EV of 20-30% provided overall net debt to EBITDA is maintained within striking

range of 2x. Despite 30-40% earnings growth, the market capitalization of metal

companies has fallen by 30-35% over the last two-three years. Higher CWIP/EV of 35%

is dragging market capitalization, resulting in CWIP/MCap ballooning out of control to

67%. The leverage of CWIP with respect to current valuations has never been so

important – it has the potential to offset commodity price compression if domestic

demand for metals starts accelerating to absorb new capacities and IRR starts improving.

Though earnings have grown, market cap has declined in the last two-three years (INR b)

Source: Company, MOSL

Five companies (Sesa-Sterlite, HNDL, JSP, TATA and SAIL) together will have a CWIP of

INR1.3t in FY14. On calculating the implied valuation of CWIP in the intrinsic value (EV

of 5x EBITDA), we find that CWIP is being valued at a 16% discount. However ex JSP

discount to CWIP is whooping 35%. In case of Sesa-Sterlite, most of the CWIP is

written off. HNDL and SAIL's CWIP is valued at a discount of 33% and 5%, respectively.

However, JSP and TATA's CWIP is valued at a premium of 151% and 33%, respectively.

7 January 2013

4

Metals

Implied valuation of CWIP vs DCF calculation of CWIP (INR b)

S.N. Company

Rating

CMP

Shares

CWIP

FY14

(ac)

235

464

134

200

256

1,289

399

416

255

635

275

1,981

Net

Debt

Implied

EV5xEBITDA

(a)

666

1,006

687

1,061

659

4,079

(b)

CWIP Discount

(%)

ic=a-b (1-ic/ac)

(INR)

1

2

3

4

5

Hindalco

Buy

Sesa-Sterlite Buy

JSP

Sell

Tata

Sell

SAIL

Sell

Total

134

199

462

438

93

(m)

1,991

2,965

935

971

4,130

509

158

33

924

82

82

349

337

-151

795

266

-33

417

242

5

2,994

1,085

16

Source: Company, MOSL

…and at variance with DCF-based valuation

We have juxtaposed the implied valuation of CWIP against our DCF-based valuation.

According to our calculations, CWIP of Jindal Steel & Power and Tata Steel should be

valued at a discount of 40% and 33%, respectively instead of a premium of 151% and

33%. Also, the markets appear to have penalized Sesa-Sterlite and Hindalco far more

than is warranted, in our opinion.

Implied valuaton of CWIP vs DCF calculation of CWIP (INR b)

Company

Rating

CMP

1-Jan

(INR)

Hindalco

Sesa-Sterlite

JSPL

Tata

SAIL

Total

Buy

Buy

Sell

Sell

Sell

134

199

462

438

93

Shares

CWIP

FY14

(ac)

235

464

134

200

256

1,289

399

416

255

635

275

1,981

Net

Debt

Implied

EV 5xEBITDA

(a)

666

1,006

687

1,061

659

4,079

(b)

509

924

349

795

417

2,994

CWIP Discount

(%)

ic=a-b (1-ic/ac)

158

82

337

266

242

1,085

33

82

-151

-33

5

16

DCF calculations

CapEx

NPV

CWIP Discount

(%)

(d)

(e) dc=d-e (1-dc/dc)

393

522

286

441

721

1,969

-48

345

12

-266

255

51

-114

172

40

-144

297

33

-418

303

58

-942

1,028

48

Source: Company, MOSL

(m)

1,991

2,965

935

971

4,130

Still some downside in Jindal Steel & Power, Tata Steel

Jindal Steel & Power:

The implied valuation of CWIP is at 151% premium. The market

appears to consider projects like Angul as value accretive due to captive coal mine,

Uktal B1, which is at final stages of lease signing, and availability of low cost pellets.

Also, Jindal Power’s 1,000MW commands higher valuations due to low cost of power

generation and freedom to sell at attractive merchant rates. However, we believe

that increasing project cost due to repeated delays, shrinking margins in the power

business, and change in regulations regarding transfer pricing of iron ore in Odisha

have resulted in the NPV of the Angul project turning negative. According to our

calculations the CWIP should attract 40% discount instead.



Tata Steel:

The implied valuation of CWIP is at 33% premium. The Odisha project is

perceived as value accretive because iron ore will be sourced from captive mines.

However, repeated delays have led to an increase in project cost. Phase-1 of the

3mtpa capacity has seen project cost rising to INR250b, implying specific cost of

USD1,500/ton – nearly 50% more expensive than the benchmark or at 60% premium

to the valuation of capacities around the world. According to our calculation, the

CWIP should attract 33% discount instead.

7 January 2013

5

Metals

Sesa-Sterlite and Hindalco could see re-rating

Sesa-Sterlite:

The implied discount is 82% against our calculation of 51% for Sesa-

Sterlite. It is additionally getting de-rated for its group structure. The cash flows of

Hindustan Zinc and Cairn India are not fungible to service the heavily leveraged balance

sheets of other businesses. There lies an opportunity for re-rating if minority stake in

Hindustan Zinc and Balco is bought out from the Government of India (GoI). The GoI is

under pressing need to meet its disinvestment targets and manage budget deficit.

Thus, the probability of the event has increased. Thereafter, the possible merger of

Hindustan Zinc and Balco will facilitate debt servicing and relieve balance sheet stress.



Hindalco:

The implied valuation of CWIP is at 33% discount against our calculation of

12%. Hindalco has the largest lever on CWIP, with CWIP/MCap at 114% and CWIP/EV at

46% because of the USD7.5b investment in the aluminum segment to derive benefits

from the allotted bauxite and coal resources. Though not entirely trouble-free, the

allocation of bauxite and coal mines to Hindalco has largely been non-controversial,

barring Mahan. With MoEF clearance, the Mahan coal block too is out of the woods.

The greenfield projects may not generate significant cash flows at current LME prices

of aluminum and the NPV is a negative INR48b. Utkal Alumina and Mahan are at an

advanced stage of completion. If not Mahan, Utkal is most likely to generate positive

cash flow right from the beginning and has the potential to expand capacity further at

low marginal cost. NPV of the projects is highly sensitive to LME prices and we believe

that LME prices of aluminum are at the bottom of the cycle.

NMDC has no material CWIP

NMDC

has no material CWIP because it has not undertaken asset heavy projects so

far. Therefore, we have kept it outside our study on CWIP. Its balance sheet is debt

free with cash surplus of ~USD4b due to strong cash flows. RoCE is still attractive in

the range of 22-26% despite being diluted by low yielding cash surpluses. The RoIC is

extremely attractive and ranges 200-300% because of its high quality iron ore assets

coupled with low cost operations.



Both volumes and prices will drive earnings at cagr of 16.3% to INR22.4/share over

FY13-15. Volumes will be driven by logistics de-bottlenecking and new 11B &

Kumarsway mines. Indian iron ore pricing is witnessing favorable dynamics due to

growing demand from Indian steel mills and reduced capacities of merchant mines

due to recent investigations/action in illegal and unchecked mining. High export duty

and other surcharges are increasingly becoming irrelevant in curtailing the pricing

power of Indian iron ore mines. The pricing of iron ore fines will inch upwards and

closer to prices of lumps with commissioning of new merchant pellet plants in India

over 1-2 years. This will boost the average iron ore realization for NMDC irrespective

of international market dynamics.

Although the investment of INR155b in setting 3mtpa steel plant has low IRR, the

project will not dent valuations materially because it can be funded purely from the

interest income of surplus cash on balance sheet due to tardy execution. If NMDC is

able to get intended additional iron ore resources, the IRR of project will be attractive.

7 January 2013

6

Metals

The stock trades at attractive EV/EBITDA of 3.6xFY15 and EV/ton of USD5. The dividend

yield is attractive at 4-5%. We value the stock at INR209/share based on 5x FY15 EV/

EBITDA. Maintain

Buy.

Investment cycle to peak in two years

As these projects start generating cash flows over the next two years and capex

intensity peaks, net debt should start coming off. The NPV of almost every project is

eroding due to falling IRR while the WACC is rising. However, there might be an

opportunity for equity value to grow because the investment cycles of most companies

will be peaking within two years for the following reasons:

1. Bearish outlook on metal prices and falling IRR has discouraged companies from

announcing new greenfield projects. Also, they have shelved difficult projects,

where only marginal amounts have been spent. Investments will, however,

continue in projects that are already at advanced stages.

2. Most of the projects that commenced during 2005-2008 have already travelled

the troubled road and are at advanced stages of completion. Therefore, further

execution delays are likely to be limited.

Using alternative approaches to valuation to factor uncertainties

We have adopted two alternative approaches to value projects to factor uncertainties

regarding execution. In both approaches, we have valued core operational assets at

an EV of 5x one-year forward EBITDA and the power business based on DCF.

1. SOTP:

We have valued operational assets as mentioned above. We have adjusted

the CWIP against the NPV of the projects.

2. FY20 valuations discounted for five years:

We arrive at FY20 valuations to factor in

completion of all ongoing projects and the possible delays. We have discounted

these valuations backwards for five years by cost of equity. We believe five years

is a fairly long period to account for unforeseen delays. Most projects will be

completed much before FY20.

Please refer to our Update on the

Steel sector, Downhill Run, dated

29 August 2012

Under each of the two approaches, we have considered two scenarios.

1. Base case scenario:

Iron ore and coking coal prices fall to USD83/ton and USD125/

ton, respectively over 12-16 months due to stagnating demand from the steel

sector and growing supplies from new projects. Aluminum prices are at the bottom

of the cycle from the margin perspective and USD2,000/ton is a good support

level. Zinc and lead prices remain at ~USD2,000/ton.

2. Optimistic scenario:

Iron ore and coking coal prices at USD106/ton and USD170/ton,

respectively. Aluminum prices increase to USD2,500/ton on some recovery in physical

and investment demand. Zinc and lead prices increased to ~USD2,500/ton.

Downgrading Jindal Steel & Power to Sell; our top picks: NMDC, Hindalco,

Sesa-Sterlite

Based on the above exercise, we draw the following conclusions:



Hindalco

has significant upside in 3 of the 4 situations, though the weighted

average IRR of projects is only 6.7%. We

reiterate Buy.



Sesa-Sterlite

has upside in 2 of the 4 situations, though its projects have low IRR.

Maintain Buy.

7 January 2013

7

Metals

Tata Steel

has downside in 3 of the 4 situations.

Maintain Sell.



Jindal Steel & Power and SAIL

have downside in all the 4 situations. We

downgrade

Jindal Steel & Power to Sell.

Also, we

maintain Sell on SAIL.



JSW Steel

does not have significant CWIP due to project delays and is the most

efficient and fastest growing steel company. It is best placed to weather the

volatility in input and steel prices. However, the pricing dynamics of iron ore have

turned adverse due to change in demand-supply equation in Karnataka, which

will progressively eat into margins and equity value. We maintain

Sell.



NMDC

has no material CWIP because it has not undertaken asset heavy projects

so far. Its balance sheet is debt free with cash surplus of ~USD4b due to strong cash

flows. The stock trades at attractive EV/EBITDA of 3.9xFY15 and EV/ton of USD5. It

is our most preferred pick. We maintain

Buy.



Summary of target prices and recommendations

S.N.

1

2

3

4

5

6

7

Company

Hindalco

Sesa-Sterlite

Tata

JSP

SAIL

JSW*

NMDC

CMP

134

199

438

462

93

807

169

Rating

Buy

Buy

Sell

Sell

Sell

Sell

Buy

Target

Price

185

205

230

356

59

478

209

SOTP

Base Optimistic

149

182

182

172

-52

242

331

348

269

-5

FY20 discounted 6yr

Base Optimistic

131

165

412

202

44

193

248

514

279

74

CapEx

(INR b)

393

522

441

286

721

NPV

(INR b)

-48

-266

-144

-114

-480

IRR

(%)

6.7

3.3

9.1

4.3

2.8

Source: Company, MOSL

*Coking coal price is practically pass-through for converters; iron ore costs dynamics are adverse & independent.

There is no significant CapEx delays which is resulting in disproportionate CWIP on balance sheet

#Base case assumptions: Iron ore (USD83/t fob for 63.5% Fe); coking coal (USD125/t fob), al/zn/pb at USD2,000/t

Optimistic assumptions: Iron ore (USD106/t fob); coking coal (USD170/t fob), al(USD2,500/t) zn&pb(USD2,500/t)

Valuations summary

Rating

Tata Steel

SAIL

JSW Steel (Merged)

JSPL

NMDC

Sesa Sterlite

Hindalco

Sell

Sell

Sell

Sell

Buy

Buy

Buy

CMP

P/E (x)

EV/EBITDA (x)

P/B (x)

RoE (%)

(INR) FY13E FY14E FY15E FY13E FY14E FY15E FY13E FY14E FY15E FY13E FY14E FY15E

438

93

812

462

169

199

134

55.3

15.9

21.4

12.4

10.2

5.1

7.0

9.1

11.1

21.5

12.1

9.1

5.9

6.5

8.8

13.6

12.1

10.9

7.5

6.1

5.9

8.5

9.1

7.7

8.9

6.0

5.7

7.6

6.7

7.9

7.8

10.2

5.1

5.4

6.5

6.6

7.9

6.8

9.1

3.9

5.1

5.5

1.7

0.9

1.3

2.2

2.3

0.8

1.3

1.5

0.9

1.3

1.9

2.0

0.7

1.1

1.4

0.8

1.2

1.6

1.7

0.6

1.0

3.0

17.8

5.9

8.1

6.2

6.1

18.6

17.0

26.3

22.8

15.9

12.2

20.6

18.8

Source: Company,

16.3

6.3

10.4

16.1

22.9

11.0

17.4

MOSL

Annexure

Cost of Equity (%)

Tata

A. Risk free rate (91 day T-bill)

B. Beta (adj.) with Sensex (x)

C. Market Premium

K. Cost of Equity (A+BxC)

8.2

1.275

8.0

18.3

SAIL

8.2

1.24

8.0

18.1

JSW

8.2

1.56

8.0

20.6

JSP

HNDL

Sesa-Stlt

8.2

1.24

8.0

18.1

Source:

8.2

8.2

1.35

1.4

8.0

8.0

18.9

19.3

Company, MOSL

7 January 2013

8

Metals

Companies

BSE Sensex: 19,581

Company Name

Hindalco

Jindal Steel & Power

JSW Steel

SAIL

Sesa Sterlite

Tata Steel

S&P CNX: 5,951

Pg.

10

19

26

30

41

53

7 January 2013

7 January 2013

9

7 January 2013

Update | Sector: Metals

Hindalco

BSE SENSEX

S&P CNX

19,581

5,951

CMP: INR134

TP: INR185

Buy

Largest CWIP/MCap turning favorable

Bloomberg

Equity Shares (m)

52-Week Range (INR)

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

M.Cap. (INR b)

M.Cap. (USD b)

HNDL IN

1,990.0

165/100

14/-4/-11

266.7

4.9





Debt to peak soon, with projects turning free cash flow positive; reiterate

Buy



Valuation summary (INR b)

Y/E March

2013E 2014E 2015E



Sales

816.0 854.6 935.8

EBITDA

87.0 101.7 116.8

NP

38.1 41.2 45.3

Adj. EPS (INR) 19.1 20.7 22.7

EPS Gr(%)

12.1

8.2

9.9

BV/Sh. (INR) 100.9 119.9 140.8

RoE (%)

20.6 18.8 17.4

RoCE (%)

7.5

8.2

8.9

Payout (%)

9.2

8.5

7.7

Valuation

P/E (x)

7.0

6.5

5.9

P/BV

1.3

1.1

1.0

EV/EBITDA (x) 7.6

6.5

5.5

Div. Yield (%) 1.1

1.1

1.1

Hindalco Industries (HNDL) has the largest lever on CWIP, with CWIP/MCap of 114%.

Though its investments in the Mahan and Aditya Aluminum projects have low IRR, its

investments in Utkal Alumina and Novelis are value accretive.

We believe the conversion business of Novelis and copper TcRc provide steady cash

flows, resilience and sustainability to HNDL. The primary aluminum business is at the

bottom of the cycle from the perspective of margins.

The implied valuation of CWIP is at a steep 33% discount, which is far more than

warranted. Our two alternative valuation approaches suggest equity value of INR131

and INR149 in the base case, and INR193 and INR242 per share in the optimistic case.

As the capex intensity peaks in 12 months and Utkal Alumina starts generating positive

cash flows, we believe the stock will get re-rated. We maintain Buy.

Hindalco Industries (HNDL) has a profitable business of aluminum and copper

smelting in India. It also owns Novelis’ flat rolled products (FRP) business. As the

conversion business accounts for ~70% of its cash flows, they are relatively less

volatile. Also, HNDL has been able to consistently grow the value of its operating

assets. However, heavy investments and delays in unfinished projects have

resulted in mounting debt on the balance sheet, which in turn, has put pressure

on equity value.

Market cap under pressure due to mounting debt (INR b)

Shareholding pattern (%)

As on

Sep-12

Promoter

32.1

Dom. Inst 14.8

Foreign

37.3

Others

15.9

Jun-12 Sep-11

32.1

32.1

15.2

14.1

36.5

39.4

16.2

14.4

Debt is rising largely due to exponential growth in CWIP

Stock performance (1 year)

(INR b)

(%)

10

Hindalco

Largest CWIP/Mcap lever…

HNDL has undertaken USD6b of capex in India and USD1.5b of capex at Novelis. Indian

projects have suffered execution delays and there have been complications in developing

the bauxite and coal mines. Novelis’ projects are, however, on schedule and within budget.

Currently, HNDL’s CWIP/MCap is 114%, the highest in the Indian Metals sector. Its CWIP/EV

is a whopping 46%, well beyond the tolerable limit of 20-30%.

Despite low weighted average IRR (WAIRR) of 6.7% and negative NPV (-INR48b) at

current LME aluminum prices of USD2,000/ton, HNDL has ventured into investing

USD7.5b largely in India to derive benefits from allotted bauxite and coal resources.

Though not entirely trouble-free, the allocation of bauxite and coal mines to Hindalco

has largely been non-controversial, barring Mahan. With MoEF clearance, the Mahan

coal block too is out of the woods.

If the coal mines do not come through, the WAIRR will decline to 2.6% at LME aluminum

prices of USD2,000/ton but will increase to 7.7% if LME prices move up to USD2,500/

ton. If the coal mines are successfully developed and LME prices too improve to

USD2,500/ton, the WAIRR will increase to 10.6%.

Summary: Projects of Hindalco (INR m)

CapEx

Total O/S as on

Sep2012

Utkal

72,000

28,000

Mahan

107,000

21,000

Aditya

131,950

64,950

Novelis

82,500

35,750

Total

393,450 149,700

CapEx in FY13H2 & FY14

130,215

O/S as on Mar 14

19,485

Project

NPV

8,991

-41,496

-54,024

38,224

-48,305

IRR

(%)

12.2

5.1

3.6

8.8

6.7

Remarks

Captive bauxite FY14 onwards

Coal mine FY16 onwards

Coal mine FY17 onwards

EBITDA/T = USD300

LME (ali) at USD2000/T

WAIRR = 10.6% at ali of USD2500/T

Source: Company, MOSL

Has traveled the troubled path…

Project delays and cost escalations have de-rated the stock. The implied valuation of

CWIP is at heavy discount of 33% and is steeper than a 12% discount according to DCF

calculations. Though not entirely trouble-free, the allocation of bauxite and coal mines

to Hindalco has largely been non-controversial, barring Mahan. With MoEF clearance,

the Mahan coal block too is out of the woods. The greenfield projects may not generate

significant cash flows at current LME prices of aluminum and the NPV is a negative

INR48b. Utkal Alumina and Mahan are at an advanced stage of completion. If not

Mahan, Utkal is most likely to generate positive cash flow right from the beginning

and has the potential to expand capacity further at low marginal cost. NPV of the

projects is highly sensitive to LME prices and we believe that LME prices of aluminum

are at the bottom of the cycle. Its heavy investment in greenfield projects and peaking

capex intensity will be a source of significant upside.

High share of conversion business lends stability to cash flows

HNDL derives ~70% of its cash flows from the conversion business; these are relatively

stable. We believe that the primary aluminum smelting business, which accounts for

the remaining 30% of its cash flows, is at the bottom of the margin cycle.

7 January 2013

11

Hindalco

CWIP/Mcap lever turning favorable as project’s turn free cash flow positive;

Re-iterate Buy

We expect the stock to get re-rated as the capex intensity peaks over next 1 year and

project’s free cash flows turn positive. Applying our two alternative approaches to

valuation, we find that HNDL has significant upside in 3 of the 4 situations. We re-

iterate our

Buy

recommendation.

1. SOTP:

We have valued operational assets at an EV of 5x one-year forward EBITDA.

We have adjusted the CWIP against the NPV of the projects. HNDL’s valuations are

highly sensitive to LME aluminum prices. In the base case scenario, where we

assume LME aluminum prices of USD2,000/ton, we arrive at a value of INR149/

share. In the optimistic scenario, where we assume LME aluminum prices of

USD2,500/ton, we arrive at a value of INR242/share.

2. FY20 valuations discounted for five years:

We arrive at FY20 valuations to factor in

completion of all ongoing projects and the possible delays. We have discounted

these valuations backwards for five years by HNDL’s cost of equity of 18.9%. In the

base case scenario, where we assume LME aluminum prices of USD2,000/ton, we

arrive at a value of INR131/share. In the optimistic scenario, where we assume

LME aluminum prices of USD2,500/ton, we arrive at a value of INR193/share.

Target Price (TP): Base case

SOTP Valuation

FY14 EBITDA

101,717

EV/EBITDA

5

Enterprise Value(1x2) 508,585

add: CWIP

234,879

add: NPV

-48,305

less: Net Debt

399,345

Equity value

295,813

Equity value per share

149

Key assumptions: Captive coal & bauxite; ali at USD2000/t

Target Price (TP): Optimistic scenario

SOTP Valuation

FY14 EBITDA

118,217

EV/EBITDA

5

Enterprise Value(1x2) 591,085

add: CWIP

234,879

add: NPV

55,242

less: Net Debt

399,345

Equity value

481,861

Equity value per share

242

Key assumptions: Captive coal & bauxite; ali at USD2500/t

7 January 2013

12

Hindalco

Target price calculations (INR m)

S.N. Project

1

2

3

4

Utkal

Mahan

Aditya

Novelis

Total equity in projects

add:current Operations@5xEV/EBITDA

Less: Net Debt (incl. projects)

Net Equity value for company

No. of share (m)

TP (INR/share)

TP (discounting back from FY20@Ke)

Current market Cap

Upside (%)

Equity value based on 5xEV/EBTIDA (project cost adjusted in net debt)

FY14

FY15

FY16

FY17

FY18

FY19

FY20

63,861

66,550

66,550

66,550

66,550

66,550

4,003

51,683

54,129

54,642

55,205

55,825

1,060

6,661

52,076

55,303

58,111

59,022

12,375

24,750

37,125

49,500

61,875

61,875

81,299

149,644

209,879

225,994

241,741

243,271

508,585

508,585

508,585

508,585

508,585

508,585

508,585

399,345

377,340

335,110

285,675

234,884

183,356

130,765

109,240

212,543

323,119

432,789

499,694

566,970

621,091

1,990

1,990

1,990

1,990

1,990

1,990

1,990

107

162

217

251

285

312

131

156

185

221

262

312

266,660

266,660

266,660

266,660

266,660

266,660

-2

16

38

65

96

133

Source: Company, MOSL

Utkal Alumina: NPV of INR9b; IRR of 12.2%

HNDL had initiated the Utkal Alumina project in JV with Alcan in 1993. At that time, it

owned 55% stake in the project. The mining lease for the bauxite mine at Baphlimali,

with reserves of 198m tons, was executed between the Odisha government and Orissa

Mining Corporation (OMC) on 17 February 1998. This was transferred to Utkal Alumina

on 10 November 2010.



The project was originally expected to cost INR48b for 1mtpa capacity. Commercial

production was scheduled by March 2009. Subsequently, in 2007, HNDL bought out

Alcan and the scope of the project was revised to 1.5mtpa at slightly higher capex of

INR56b. The project required 6,578 acres of land, which has mostly been acquired.

The timeline for initial production was revised to July 2011. However, the project has

seen further delays and cost escalation. Protests by NGOs regarding rehabilitation

and resettlement (R&R) have contributed to the delays.

The project cost has been revised to INR72b and production is now expected to start

in FY14. Bauxite will initially be transported by a 20km road from the mine to the

refinery. The conveyor is also expected to be ready by the end of FY14. By the end of

September 2012, INR44b were already spent. Since the mine capacity is 8.5mtpa,

HNDL has already obtained MoEF permission to expand capacity to 3mtpa and has

made suitable provisions in the design and layout. We believe that once the teething

problems are behind, this project will be a significant driver for overall earnings

growth.

Free cash flow to firm (INR m)

FY13

a. EBITDA

b. Depreciation

c. NOPLAT=(a-b)*(1-Tax rate)

d. Capex

e. change in Working Capital

FCFF (c+b+d+e)

Present Value (Cumulative)

FY14

8,963

2,828

4,908

-700

-2,172

4,864

82,005

FY15

12,772

2,856

7,933

-707

-923

9,159

86,394

FY16

13,310

2,885

8,340

-714

-130

10,381

86,984

FY17

13,310

2,914

8,317

-721

0

10,509

86,419

FY18

13,310

2,943

8,294

-728

0

10,508

85,661

FY19

13,310

2,972

8,270

-736

0

10,507

84,818

FY20

...FY37

13,310

13,310

3,002

3,555

8,246

6,828

-743

-880

0

0

Terminal

10,505

9,504

value

83,883

53,936

50,141

Source: Company, MOSL

13

-72,000

8,991

7 January 2013

Hindalco

Utkal is one of the few greenfield projects in the Indian Metals space with positive

NPV (INR9b or USD163m) at current LME aluminum prices. With captive bauxite, the

IRR of the project ranges from 4.3% at alumina prices of USD280/ton to 28.1% at alumina

prices of USD560/ton. We have assumed cost of bauxite at USD10/ton. In the absence

of bauxite mine, the IRR and NPV will decline significantly (summarized in the exhibits

below), as the cost of bauxite will increase to USD30-50/ton. The IRR will be

substantially higher when HNDL expands capacity further to 3mtpa at marginally lower

specific capex.

Utkal Alumina: Net present value (USD million)

160

10

15

20

30

40

50

60

(1,682)

(1,824)

(1,966)

(2,250)

(2,534)

(2,818)

(3,102)

200

(1,309)

(1,451)

(1,593)

(1,877)

(2,161)

(2,445)

(2,729)

240

(936)

(1,078)

(1,220)

(1,504)

(1,788)

(2,072)

(2,356)

Alumina USD/ton

280

320

360

(563)

(190)

183

(705)

(332)

41

(847)

(474)

(101)

(1,131)

(758)

(385)

(1,415) (1,042)

(669)

(1,699) (1,326)

(953)

(1,983) (1,610) (1,237)

400

557

415

272

(12)

(296)

(580)

(864)

440

930

788

646

361

77

(207)

(491)

480

1,303

1,161

1,019

735

451

166

(118)

520

560

1,676

2,049

1,534

1,907

1,392

1,765

1,108

1,481

824

1,197

540

913

255

629

Source: MOSL

Utkal Alumina: Internal rate of return (IRR, %)

160

10

15

20

30

40

50

60

-

-

-

-

-

-

-

200

-

-

-

-

-

-

-

240

(1.1)

(3.9)

-

-

-

-

-

Alumina USD/ton

280

320

360

4.3

2.4

0.4

-

-

-

-

8.5

7.0

5.4

1.7

(3.0)

-

-

12.2

10.8

9.4

6.4

3.0

(1.2)

-

400

15.6

14.4

13.0

10.3

7.4

4.1

0.3

440

18.9

17.7

16.4

13.9

11.2

8.3

5.2

480

22.1

20.9

19.6

17.2

14.7

12.0

9.3

520

560

25.1

28.1

23.9

27.0

22.8

25.8

20.4

23.5

17.9

21.1

15.4

18.7

12.9

16.2

Source: MOSL

Key assumptions

USD/INR =

CPC/LME =

Alumina/LME =

Import duty =

55.0

8%

15%

5%

Cost of equity =

Interest rate =

Debt/Equity =

Tax rate =

19%

10%

70/30

20%

Source: MOSL

Mahan: NPV of –INR41b; IRR of 5.1%

HNDL is setting up a 359ktpa smelter along with 900MW of CPP spread over 3,750

acres of land near Bargawan in Madhya Pradesh at a capex of INR82b. This project has

been allotted the Mahan coal block in JV with the Essar group, which is located near

the project site. The project was expected to commission by the end of July 2011 but

ran into trouble when Mr Jayram Ramesh, then the Minister of Environment and

Forests (MoEF), rejected the forest clearance for the coal mine.



Since captive coal remains at the core of project viability, construction work at the

smelter site has also slowed down, resulting in escalation of project cost to INR107b.

7 January 2013

14

Hindalco

Free cash flow to firm (INR m)

FY13

a. EBITDA

b. Depreciation

c. NOPLAT=(a-b)*(1-T)

d. Capex

e. change in Working Capital

FCFF (c+b+d+e)

Present Value (Cumulative)

FY14

750

4,242

-2,794

-1,050

-1,792

-1,393

60,241

FY15

801

4,284

-2,787

-1,061

-2,201

-1,764

68,432

FY16

10,337

4,327

4,808

-1,071

-226

7,838

77,917

FY17

10,826

4,371

5,164

-1,082

-184

8,269

78,872

FY18

10,928

4,414

5,211

-1,093

-11

8,522

79,502

FY19

11,041

4,458

5,266

-1,104

-12

8,608

79,951

FY20

...FY37

11,165

13,671

4,503

5,333

5,330

6,671

-1,115

-1,320

-14

0

Terminal

8,704

10,684

value

80,364

60,272

56,389

Source: Company, MOSL

-107,000

-41,496

Viability of the project largely depends on availability of coal from the captive mine

in the vicinity. Since the project cost has escalated multiple times due to delays, its

NPV is negative. We have assumed that cost of power will be INR3/kwh (excluding

interest and depreciation) until FY15. Thereafter, coal will be available from the captive

mine, post which the cost of power should drop to INR1/kwh.

Mahan: Net present value (USD million)

1,600

1.0

1.5

2.0

2.5

3.0

3.5

4.0

(1,263)

(1,481)

(1,698)

(1,916)

(2,134)

(2,352)

(2,570)

1,700

(1,136)

(1,353)

(1,571)

(1,789)

(2,007)

(2,225)

(2,443)

1,800

(1,009)

(1,226)

(1,444)

(1,662)

(1,880)

(2,098)

(2,316)

LME USD/ton

1,900

2,000

2,250

(882)

(1,099)

(1,317)

(1,535)

(1,753)

(1,971)

(2,188)

(754)

(972)

(1,190)

(1,408)

(1,626)

(1,844)

(2,061)

2,500

2,700

2,800

2,900

3,000

Power INR/kwh

(Fuel + O&M cost)

(437)

(119)

135

262

(655)

(337)

(83)

44

(872)

(555)

(301)

(174)

(1,090)

(773)

(519)

(391)

(1,308)

(990)

(736)

(609)

(1,526) (1,208)

(954)

(827)

(1,744) (1,426) (1,172) (1,045)

389

516

171

298

(47)

81

(264)

(137)

(482)

(355)

(700)

(573)

(918)

(791)

Source: MOSL

Mahan: Internal rate of return (IRR, %)

1,600

1.0

1.5

2.0

2.5

3.0

3.5

4.0

0.4

(2.5)

-

-

-

-

-

1,700

1.7

(0.8)

-

-

-

-

-

1,800

2.9

0.7

(2.2)

-

-

-

-

LME USD/ton

1,900

2,000

2,250

4.1

2.0

(0.5)

-

-

-

-

5.1

3.2

0.9

(1.9)

-

-

-

7.6

5.9

4.0

1.8

(0.8)

-

-

2,500

9.8

8.2

6.6

4.8

2.7

0.2

(2.9)

2,700

11.4

10.0

8.5

6.8

5.0

2.9

0.5

2,800

12.2

10.8

9.4

7.8

6.1

4.1

1.9

2,900

3,000

Power INR/kwh

(Fuel + O&M cost)

13.0

13.7

11.6

12.4

10.2

11.1

8.7

9.6

7.1

8.0

5.2

6.3

3.2

4.4

Source: MOSL

Aditya Aluminum: NPV of –INR54b; IRR of 3.6%

HNDL is setting up a 359ktpa smelter along with 900MW of CPP spread over 3,328

acres at Lapanga in Odisha at a capex of INR132b. The project was originally expected

to be completed at a capex of INR82b by October 2011. Until September 2012, INR67b

had already been spent. We expect the project to commence production in FY15 and

ramp up during FY16. 3mtpa of coal is expected to be available from the Odisha captive

mine in JV with Mahanadi Coalfields and Nevyeli Lignite.



7 January 2013

15

Hindalco

Free cash flow to firm (INR m)

FY13

a. EBITDA

b. Depreciation

c. NOPLAT=(a-b)*(1-T)

d. Capex

e. change in Working Capital

FCFF (c+b+d+e)

Present Value (Cumulative)

FY14

FY15

212

5,278

-4,053

0

-507

718

64,205

FY16

1,332

5,331

-3,199

-1,320

-2,677

-1,865

70,731

FY17

10,415

5,384

4,025

-1,333

-882

7,195

80,577

FY18

11,061

5,438

4,498

-1,346

-233

8,357

82,475

FY19

11,622

5,492

4,904

-1,359

-192

8,845

83,424

FY20

...FY37

11,804

13,671

5,547

6,570

5,006

5,681

-1,373

-1,626

Terminal

-20

0

Value

9,160

10,625

56,079

83,992

59,940

56,079

Source: Company, MOSL

-131,950

-54,024 -60,876

As in the case of Mahan, viability of Aditya Aluminum hinges upon availability of

captive coal at low cost – production cost increases by ~USD500/ton if coal is purchased.

Even with captive mine, the IRR of project is only 3.6% at LME aluminum price of

USD2,000/ton. At higher LME prices, the IRR and NPV improve significantly.

Aditya Aluminum: Net present value (USD million)

1,600

1.0

1.5

2.0

2.5

3.0

3.5

4.0

(1,416)

(1,609)

(1,802)

(1,995)

(2,188)

(2,381)

(2,574)

1,700

(1,308)

(1,501)

(1,694)

(1,887)

(2,080)

(2,273)

(2,466)

1,800

(1,199)

(1,392)

(1,585)

(1,778)

(1,971)

(2,164)

(2,357)

LME USD/ton

1,900

2,000

2,250

(1,091)

(1,284)

(1,477)

(1,670)

(1,863)

(2,056)

(2,249)

(982)

(1,175)

(1,368)

(1,561)

(1,754)

(1,947)

(2,141)

(711)

(904)

(1,097)

(1,290)

(1,483)

(1,676)

(1,869)

2,500

2,700

2,800

2,900

3,000

Power INR/kwh

(Fuel + O&M cost)

(440)

(223)

(115)

(6)

102

(633)

(416)

(308)

(200)

(91)

(826)

(609)

(501)

(393)

(284)

(1,019)

(802)

(694)

(586)

(477)

(1,212)

(996)

(887)

(779)

(670)

(1,405) (1,189) (1,080)

(972)

(863)

(1,598) (1,382) (1,273) (1,165) (1,056)

Source: MOSL

Aditya Aluminum: Internal rate of return (IRR, %)

1,600

1.0

1.5

2.0

2.5

3.0

3.5

4.0

(0.7)

(3.4)

-

-

-

-

-

1,700

0.5

(1.9)

-

-

-

-

-

1,800

1.6

(0.5)

(3.2)

-

-

-

-

LME USD/ton

1,900

2,000

2,250

2.6

0.7

(1.7)

-

-

-

-

3.6

1.8

(0.3)

(3.0)

-

-

-

5.8

4.2

2.5

0.5

(2.0)

-

-

2,500

7.7

6.3

4.8

3.1

1.2

(1.0)

(3.9)

2,700

9.1

7.8

6.5

5.0

3.3

1.4

(0.8)

2,800

9.8

8.5

7.2

5.8

4.2

2.5

0.4

2,900

3,000

Power INR/kwh

(Fuel + O&M cost)

10.4

11.1

9.2

9.9

8.0

8.7

6.6

7.4

5.1

6.0

3.5

4.4

1.6

2.7

Source: MOSL

Hindalco: Target price calculation (INR m, FY15E)

EBITDA

EV/EBTIDAx

Target EV

Net Debt

Equity Value

A. (INR/share)

CWIP

B. (INR/share)

C. CWIP discount factor (%)

Target Price A+B*C (INR/share)

7 January 2013

116,844

5.0

584,219

371,119

213,099

107

177,158

89

12

185

Source: MOSL

16

Hindalco

Financials and Valuation

Income Statement (Consolidated)

Y/E March

Net sales

Change (%)

Total Expenses

EBITDA

% of Net Sales

Depn. & Amortization

EBIT

Net Interest

Other income

PBT before EO

EO income

PBT after EO

Current tax

Deffered tax

Tax

Rate (%)

Reported PAT

Minority interests

Share of asso.

Adjusted PAT

Change (%)

2011

720,779

18.7

634,910

85,868

11.9

27,500

58,368

14,411

4,309

48,266

-9,834

38,432

9,739

-100

9,638

25.1

28,793

3,659

29

34,998

279.5

2012

808,214

12.1

726,316

81,897

10.1

28,699

53,199

17,579

7,831

43,450

43,450

7,862

7,862

18.1

35,587

2,113

496

33,970

-2.9

2013E

816,015

1.0

729,054

86,961

10.7

25,156

61,805

17,446

7,435

51,794

-2,727

49,068

8,616

3,985

12,601

25.7

36,467

1,144

29

38,079

12.1

2014E

854,565

4.7

752,848

101,717

11.9

28,909

72,808

22,677

4,905

55,036

55,036

9,155

3,618

12,773

23.2

42,263

1,089

29

41,203

8.2

(INR Million)

2015E

935,793

9.5

818,949

116,844

12.5

33,460

83,384

28,782

5,792

60,394

60,394

9,406

4,659

14,065

23.3

46,329

1,089

29

45,269

9.9

Balance Sheet

Y/E March

Share Capital

Reserves

Net Worth

Minority Interest

Total Loans

Deferred Tax Liability

Capital Employed

Gross Block

Less: Accum. Deprn.

Net Fixed Assets

Goodwill on consolidation

Capital WIP

Investments

Curr. Assets

Inventory

Account Receivables

Cash and Bank Balance

Others

Curr. Liability & Prov.

Account Payables

Provisions & Others

Net Current Assets

Appl. of Funds

E: MOSL Estimates

2011

1,990

288,243

290,233

22,169

294,602

37,596

644,601

392,654

158,014

234,640

123,940

92,518

18,742

378,856

137,420

75,411

80,680

85,346

204,095

104,334

99,761

174,761

644,601

2012

1,991

317,123

319,113

17,091

410,419

36,050

782,673

428,945

186,608

242,338

150,097

227,981

17,483

376,124

132,460

80,172

81,556

81,937

231,350

110,522

120,828

144,775

782,673

2013E

1,991

348,981

350,972

18,235

450,419

40,035

859,660

480,162

211,763

268,399

150,097

304,287

17,483

353,479

134,480

82,682

54,380

81,937

234,083

113,255

120,828

119,395

859,660

(INR Million)

2014E

1,991

386,690

388,681

19,324

460,419

43,653

912,077

619,062

240,672

378,390

150,097

234,879

17,483

370,873

141,542

86,320

61,074

81,937

239,645

118,817

120,828

131,228

912,077

2015E

1,991

428,466

430,456

20,414

470,421

48,312

969,603

719,162

274,132

445,030

150,097

177,158

17,483

430,787

155,042

94,507

99,302

81,937

250,952

130,124

120,828

179,835

969,603

7 January 2013

17

Hindalco

Financials and Valuation

Ratios (Consolidated)

Y/E March

Basic (INR)

EPS

Cash EPS

BV/Share (adj.)

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)

Working Capital Ratios

Fixed Asset Turnover (x)

Asset Turnover (x)

Debtor (Days)

Inventory (Days)

Leverage Ratio (x)

Current Ratio

Interest Cover Ratio

Debt/Equity

2011

17.6

28.3

83.6

1.5

10.0

2012

17.1

32.3

84.9

1.5

10.3

2013E

19.1

31.0

100.9

1.5

9.2

2014E

20.7

35.8

119.9

1.5

8.5

2015E

22.7

40.1

140.8

1.5

7.7

7.9

4.1

1.6

0.7

7.3

1.1

7.0

4.3

1.3

0.8

7.6

1.1

6.5

3.7

1.1

0.8

6.5

1.1

5.9

3.3

1.0

0.7

5.5

1.1

23.1

10.1

14.5

20.3

7.5

11.7

20.6

7.5

13.2

18.8

8.2

13.5

17.4

8.9

13.1

1.8

1.1

38.2

69.6

1.9

1.0

36.2

59.8

1.7

0.9

37.0

60.2

1.4

0.9

36.9

60.5

1.3

1.0

36.9

60.5

1.9

4.1

1.3

1.6

3.0

1.9

1.5

3.5

2.0

1.5

3.2

1.7

1.7

2.9

1.3

Cash Flow Statement

Y/E March

EBITDA

Non - cash expense

tax paid

Change in working Capital

CF from Op. Activity

2011

85,868

-3,393

-13,131

-7,084

62,260

2012

81,897

14,415

-10,901

-9,322

76,090

-124,007

-13,277

-5,660

-142,945

10,861

89,511

-28,531

-4,110

67,731

876

80,680

81,556

2013E

86,961

-2727

-8,616

-1,797

73,822

-127,523

7,464

-120,059

2014E

101,717

(INR Million)

2015E

116,844

-9,406

-10,380

97,059

-42,379

5,821

-36,557

-9,155

-5,138

87,424

-69,493

4,933

-64,559

(Inc)/Dec in FA + CWIP

-77,598

(Pur)/Sale of Invest. & yield thereon 1,847

Others

4,945

CF from Inv. Activity

-70,806

Equity raised/(repaid)

Debt raised/(repaid)

Interest

Dividend (incl. tax)

CF from Fin. Activity

(Inc)/Dec in Cash

Add: Opening Balance

Closing Balance

E: MOSL Estimates

7 January 2013

99

37,384

-25,410

-3,838

8,236

-310

80,990

80,680

40,000

-17,446

-3,494

19,061

-27,176

81,556

54,380

10,000

-22,677

-3,494

-16,170

6,694

54,380

61,074

10,002

-28,782

-3,494

-22,273

38,228

61,074

99,302

18

7 January 2013

Update | Sector: Metals

Jindal Steel & Power

BSE SENSEX

S&P CNX

19,581

5,951

CMP: INR462

TP: INR356

Sell

Implied valuation of CWIP at 151% premium

Earnings declining; downgrading to Sell

Bloomberg

Equity Shares (m)

52-Week Range (INR)

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

M.Cap. (INR b)

M.Cap. (USD b)

JSP IN

934.8

663/321

14/-10/-25

431.9

7.9







Valuation summary (INR b)

Y/E March

2013E 2014E 2015E

Sales

202.9 214.6 265.4

EBITDA

65.0 75.1 94.3

Adj. PAT

35.0 35.8 39.5

Adj. EPS (INR) 37.4 38.3 42.2

EPS Gr(%)

-11.8

2.6 10.3

BV/Sh. (INR) 207.7 242.3 280.9

RoE (%)

18.6 17.0 16.1

RoCE (%)

13.0 12.0 11.9

Payout (%)

5.5

5.4

4.9

Valuation

P/E (x)

12.4 12.1 10.9

P/BV

2.2

1.9

1.6

EV/EBITDA (x) 10.2

9.1

7.7

Div. Yield (%) 0.4

0.4

0.4



Jindal Steel & Power (JSP) delivered 46% earnings CAGR over FY00-11 due to focus on

investment in high RoI / short payback projects and benefit of captive iron ore and coal

mines. Given its equally strong pipeline of projects, the stock got re-rated to factor growth.

However, over FY12-14, JSP's earnings have been declining at a compounded rate of 5%

due to margin compression and project delays. Gains on account of use of zero cost iron ore

inventories are clouding the shrinkage in the underlying steel business earnings. Non-

disclosure of such inventories is a regulatory risk.

With the shift in focus from asset-light growth to capex-intensive growth and hurdles in

execution, the CWIP/MCap and CWIP/EV ratios have started mounting. However, the

implied valuation of CWIP is at a 151% premium to our DCF-based valuation.

Our two alternative valuation approaches suggest equity value of INR172/share and INR202/

share in the base case, and INR269/share and INR279/share in the optimistic case. We

downgrade the stock to Sell.

After massive re-rating over FY08-10…

JSP’s steel business benefitted from 10x increase in iron ore prices and 6x increase

in coking coal prices over the last 10-12 years. Similarly, its power business

benefitted from high merchant power rates. Captive thermal coal and iron ore

mines helped to keep the cost of production of steel and power under check.

Further, JSP kept its balance sheet light by investing in only high RoI businesses

rather than pursuing large ambitions in the asset-heavy steel or power businesses.

The cost of the completed projects has already been fully recovered (see exhibit,

CWIP catching up with net debt). High growth in earnings and absence of dilution

led to massive re-rating of the stock during FY08-10; low earnings volatility reduced

the cost of equity. The basis of valuation shifted from EV/EBITDA to P/E to capture

the high growth and strong pipeline of projects.

CWIP at significant premium (INR b)

Shareholding pattern (%)

As on

Sep-12

Promoter

59.0

Dom. Inst

6.5

Foreign

23.2

Others

11.4

Jun-12 Sep-11

59.0

58.6

7.3

7.5

21.9

22.9

11.8

11.1

Stock performance (1 year)

Source: Company, MOSL

…the stock got de-rated due to corporate governance issues

Towards the end of 2009, JSP filed a DRHP for the listing of its power business. The

DRHP revealed that 3.57% of Jindal Power’s equity has been allotted to related

parties at throw-away prices in comparison to the intrinsic value and/or the target

19

Jindal Steel & Power

valuation for listing. Further, certain assets like overseas oil & gas investments were

stripped off. Though Jindal Power did not get listed, JSP got de-rated due to concerns

relating to corporate governance.

Also, there has been a shift from asset-light model

With rising market cap and cash flows, JSP switched its strategy from asset light growth

to asset heavy growth. It drew plans to invest USD31b to raise steel capacity to 32mtpa

and power capacity to 13GW over 10 years. Most of its projects are held up or are

progressing slowly due to multiple issues. In FY12, EBITDA yield of the gross block was

29% (GB/EBITDA of 3.5x) for the operating steel business. However, new projects

have significantly lower yields, e.g. 8.6% (GB/EBITDA of 11.6x) for the Angul project,

despite captive coal mines. The cost of the Angul greenfield project has seen inflation

of 50-70% due to delays and problems from local inhabitants near the site. Also, the

envisaged cost of iron ore and thermal coal has seen high inflation due to decline or

stagnation in mine production because of clamp-down on illegal iron ore mining and

environmental issues.

Ratios had started rising

CWIP catching up with net debt

Source: Company, MOSL

Summary: Active projects (INR m)

Project

CapEx

Total O/S post

FY14

50,000

136,000

41,487

150,000

336,000

286,000

NPV

165,131

-13,315

-100,492

51,324

41,487 -113,807

IRR

(%)

8.9

0.1

Remarks

Project cost is fully recovered

Assumed power is sold at

CERC guideline

cost of gas at USD7.5/mmbtu

using captive coal

Although JSP is investing in various

projects, but there is no

clear visibility on time line

Source: Company, MOSL

Tamnar 1

Tamnar 2

Angul

Total

Projects*

4.3

*no contribution in earnings until FY14

In addition to two active projects, i.e. Tamnar-2 and Angul, JSP has committed

investments in a number of coal mining projects in African countries, Indonesia,

Australia and Mongolia. These projects are in initial stages of development and will

require large capital commitment for rail and port infrastructure. Therefore, we believe

that these projects will be a drag on JSP’s equity value in the initial 5-10 years.

7 January 2013

20

Jindal Steel & Power

Sum of the part valuations

Equity Valuation

Iron & Steel

Shadeed

Business

Segment

As at the end of FY13, JSP will have CWIP of ~INR223b outstanding of the INR286b

capex, which will have an NPV of –INR114b. The CWIP/MCap ratio, though not as bad

as in FY02, has risen sharply to 52%. The CWIP/EV ratio has increased to 34%. Cash

flows from high yield operating assets are now being deployed in low yield projects.

This will drive further de-rating of the stock, in our view. Our SOTP value has gradually

declined from INR728/share (as per our report dated 18 July 2011) to INR356/share

because of the following reasons:



The value of the steel and CPP business has declined from INR342/share to INR186/

share due to delays in the 1.5mtpa steel and 810MW CPP project at Angul, and the

540MW CPP project at Raigarh. The profitability of 1,350MW has been far lower

than expected due to higher than expected fuel cost and inability to sell power in

the merchant market due to regulatory hurdles.



The value of Jindal Power has declined from INR337/share to INR145/share due to

repeated delays in initiating power projects of 1,980MW at Goda and Dumka in

Jharkhand because of uncertainty regarding coal blocks and tardy land acquisition.

Tamnar-2 has been delayed due to temporary suspension of ToR (terms of

reference) for the project.



The Bolivia project was closed with losses of ~INR5b (INR5/share) instead of value

of INR21/share in our SOTP.

Method

Valuation

multiple

10.0

10.0

Value Rationale

(INR m) (INR/sh)

172,080

24,472

2,046

112,721

21,869

333,188

184

26

2

121

23

356

This is equal to FY14 EV/EBITDA of 5.8x

1.5mtpa DRI plant, Attractive 22 year gas

supply contract

Coal tenaments in Australia

1000MW Capacity for Tamnar 1

2400MW capacity for Tamnar 2

Steel, Power FY14E PER (x)

Steel

FY14E PER (x)

Mkt Cap

DCF (to equity)

DCF (to equity)

Rockland & GNM Coal

Jindal Power

Power

Tamnar II

Power

SOTP

Our concerns on the business have increased

Over the last 12 months, our concerns on the business have increased.



The high margin Tamnar-1 (1,000MW) plant may be forced to sell power on long-

term power purchase agreement by the regulator. This could result in significant

reduction in earnings.



The steel business may not be able to source iron ore from Sarda Mines at low

prices. The Odisha government will be implementing e-auction from 1 April 2013.

This will lead to significantly higher transfer price. Although the transfer pricing

between Sarda Mines and JSP has already changed significantly, it has not reflected

in the recent quarterly margins and earnings, as the decline in recurring earnings

has been offset by gains on zero cost iron ore inventory.



The steel business has benefitted from high coking coal and iron ore prices. We

believe that the prices of both iron ore and coking coal will decline over the next

12-16 months due to stagnation in demand from the steel sector and growing

supply from new raw material projects. We have highlighted this view in our

recent Sector Update, Downhill Run, dated 29 August 2012. Recurrent earnings/

margins could be squeezed significantly.



Zero cost iron ore inventories are not disclosed on the balance sheet. Also, JSP

does not share this information publically. In the absence of clarity, this remains

a source of regulatory risk.

7 January 2013

21

Jindal Steel & Power

Downgrading stock recommendation to Sell

Applying our two alternative approaches to valuation, we find that JSP has downside

in all of the four situations. We downgrade our stock recommendation from Neutral

to Sell.

1. SOTP:

We have valued operational assets at an EV of 5x one-year forward EBITDA.

We have adjusted the CWIP against the NPV of the projects to capture their intrinsic

value. JSP’s valuations are highly sensitive to steel/iron ore prices. In the base

case scenario, where we assume iron ore prices of USD83/ton and coking coal

prices of USD125/ton, we arrive at a value of INR172/share. In the optimistic

scenario, where we assume iron ore prices of USD106/ton and coking coal prices

of USD170/ton, we arrive at a value of INR269/share.

2. FY20 valuations discounted for five years:

We arrive at FY20 valuations to factor in

completion of all ongoing projects and the possible delays. We have discounted

these valuations backwards for five years by JSP’s cost of equity of 18.1%. In the

base case scenario, we arrive at a value of INR202/share. In the optimistic scenario,

we arrive at a value of INR279/share.

Target Price (TP): Optimistic Scenario

SOTP Valuation

FY13 EBITDA

(excl. JPL-T1 & Angul) 19,016

EV/EBITDA (x)

5

EV (excl JPL-T1) (1x2) 95,081

JPL-T1 valuation

165,131

Angul valuation

33,863

Total EV (3+4+5)

294,074

add: CWIP

134,272

add: NPV

-13,315

less: Net Debt

254,687

Equity value

160,344

Equity value per share

172

Key assumption: iron ore at USD106/t; coking coal at USD170/t

Target Price (TP): Base case

SOTP Valuation

FY13 EBITDA

(excl. JPL-T1 & Angul) 31,147

EV/EBITDA (x)

5

EV (excl JPL-T1) (1x2) 155,735

JPL-T1 valuation

165,131

Angul valuation

64,532

Total EV (3+4+5)

385,397

add: CWIP

134,272

add: NPV

-13,315

less: Net Debt

254,687

Equity value

251,667

Equity value per share

269

Key assumption: iron ore at USD106/t; coking coal at USD170/t

7 January 2013

22

Jindal Steel & Power

Target price calculations

S.N.

1

2

3

4

5

Tamnar 2 (FCFF-DCF based)

Angul (5xEV/EBITDA)

Tamnar 1 (FCFF-DCF based)

Raigarh (3mtpa steel & 893MW of CPP)

Other mining business

Total EV for company

Less: Net Debt (incl. projects)

Net Equity value for company

No. of share (m)

TP (INR/share)

TP (discounting back from FY20@Ke)

Current market Cap

Upside (%) w.r.t. CMP

ProjectEquity value based on 5xEV/EBTIDA (project cost adjusted in net debt)

FY14

FY15

FY16

FY17

FY18

FY19

FY20

143,797

33,863

166,156

151,171

-1,589

493,398

266,325

227,073

935

243

202

431,878

-56

141,554

33,863

167,688

151,171

-1,589

492,687

233,357

259,329

935

277

239

431,878

-48

138,348

33,863

169,113

151,171

-1,589

490,905

190,206

300,699

935

322

282

431,878

-39

136,021

33,863

170,337

151,171

-1,589

489,803

144,716

345,087

935

369

333

431,878

-28

133,529

130,804

33,863

33,863

171,326

172,514

151,171

151,171

-1,589

-1,589

488,300

486,762

99,211

52,847

389,088

433,916

935

935

416

464

393

464

431,878

431,878

-15

0

Source: Company, MOSL

165,131

151,171

-1,589

314,713

254,687

60,026

Key assumptions

USD/INR =

Iron ore prices =

Coking coal =

HRC =

55.0

83

125

443

Cost of equity =

Interest rate =

Debt/project cost =

Tax rate =

18.3%

10%

50%

20%

Source: MOSL

7 January 2013

23

Jindal Steel & Power

Financials and Valuation

Income Statement (Consolidated)

Y/E March

Net sales

Change (%)

Total Expenses

EBITDA

% of Net Sales

Depn. & Amortization

EBIT

Net Interest

Other income

PBT before EO

EO income

PBT after EO

Tax

Rate (%)

Reported PAT

Minority interests

Share of Associates

Adjusted PAT

Change (%)

2011

131,122

18.2

67,960

63,162

48.2

11,510

51,652

2,596

815

49,871

49,871

11,830

23.7

38,040

659

158

37,539

4.7

2012

182,086

38.9

114,154

67,932

37.3

13,865

54,067

3,600

1,419

51,886

51,886

11,863

22.9

40,023

574

200

39,649

5.6

2013E

202,876

11.4

137,882

64,994

32.0

14,263

50,731

6,854

1,388

45,264

-5,741

39,523

10,175

25.7

29,347

447

310

34,952

-11.8

2014E

214,563

5.8

139,482

75,081

35.0

18,239

56,842

10,785

1,548

47,605

0

47,605

11,433

24.0

36,173

527

200

35,846

2.6

(INR Million)

2015E

265,444

23.7

171,154

94,290

35.5

25,297

68,992

17,124

259

52,127

0

52,127

11,991

23.0

40,136

812

200

39,525

10.3

Balance Sheet (Consolidated)

Y/E March

Share Capital

Reserves

Net Worth

Minority Interest

Total Loans

Deferred Tax Liability

Capital Employed

Gross Block

Less: Accum. Deprn.

Net Fixed Assets

Capital WIP

Good will

Investments

Curr. Assets

Inventory

Account Receivables

Cash and Bank Balance

loans & advances and others

Curr. Liability & Prov.

Account Payables

Provisions & Others

Net Current Assets

Appl. of Funds

E: MOSL Estimates

2011

934

140,169

141,103

2,335

139,728

10,055

293,221

192,756

44,321

148,435

93,809

1,018

2,979

114,648

27,734

11,537

4,640

70,737

67,668

22,736

44,933

46,980

293,221

2012

935

180,176

181,111

3,071

170,908

11,920

367,010

223,301

58,360

164,940

136,520

918

3,776

143,922

35,795

13,068

1,492

93,567

83,066

29,110

53,956

60,856

367,010

2013E

935

193,247

194,182

3,477

230,455

13,281

441,395

224,002

73,066

150,936

222,536

1,018

5,001

152,478

35,693

18,238

1,151

97,396

90,572

36,110

54,462

61,905

441,395

(INR Million)

2014E

935

225,595

226,530

4,061

290,955

14,724

536,269

389,168

91,306

297,862

134,272

1,018

5,001

191,173

38,057

19,453

36,268

97,396

93,056

38,594

54,462

98,117

536,270

2015E

935

261,621

262,556

4,929

344,955

15,886

628,326

457,660

116,603

341,057

165,988

1,018

5,001

212,382

40,424

22,095

52,467

97,396

97,119

42,657

54,462

115,263

628,326

7 January 2013

24

Jindal Steel & Power

Financials and Valuation

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)

Working Capital Ratios

Fixed Asset Turnover (x)

Asset Turnover (x)

Debtor (Days)

Inventory (Days)

Leverage Ratio (x)

Interest Cover Ratio

Debt/Equity

2011

40.1

53.0

151.0

1.5

3.8

2012

42.4

57.6

193.7

1.6

3.9

2013E

37.4

46.7

207.7

2.0

5.5

2014E

38.3

58.2

242.3

2.0

5.4

2015E

42.2

70.0

280.9

2.0

4.9

10.9

8.0

2.4

3.3

8.9

0.3

12.4

9.9

2.2

3.3

10.2

0.4

12.1

7.9

1.9

3.2

9.1

0.4

10.9

6.6

1.6

2.7

7.7

0.4

30.5

21.3

33.7

24.6

16.9

26.1

18.6

13.0

23.3

17.0

12.0

19.9

16.1

11.9

18.1

0.7

0.4

32.1

21.2

0.8

0.5

26.2

19.7

0.9

0.5

32.8

17.6

0.6

0.4

33.1

17.7

0.6

0.4

30.4

15.2

19.9

1.0

15.0

0.9

7.4

1.2

5.3

1.1

4.0

1.1

Cash Flow Statement (Consolidated)

Y/E March

Pre-tax profit

Depreciation

(Inc)/Dec in Wkg. Cap.

Tax paid

Other operating activities

CF from Op. Activity

(Inc)/Dec in FA + CWIP

(Pur)/Sale of Investments

CF from Inv. Activity

Equity raised/(repaid)

Debt raised/(repaid)

Dividend (incl. tax)

Other financing activities

CF from Fin. Activity

(Inc)/Dec in Cash

Add: Opening Balance

Closing Balance

E: MOSL Estimates

2011

49,871

11,510

-25,857

-10,230

1,235

26,528

-75,471

206

-75,265

3

53,685

-1,439

52,249

3,512

1,128

4,640

2012

51,886

13,865

-17,024

-9,999

840

39,568

-73,254

-797

-74,052

1

31,180

-1,536

1,663

31,307

-3,177

4,640

1,492

2013E

39,523

14,263

-1,390

-8,140

-14,281

29,974

-86,718

-1,225

-87,942

0

59,547

-1,920

57,627

-341

1,492

1,151

(INR Million)

2014E

47,605

18,239

-1,095

-9,995

-1,316

53,439

-76,902

0

-76,902

0

60,500

-1,920

58,580

35,117

1,151

36,268

2015E

52,127

25,297

-947

-10,835

-1,316

64,327

-100,208

0

-100,208

0

54,000

-1,920

52,080

16,199

36,268

52,467

7 January 2013

25

7 January 2013

Update | Sector: Metals

JSW Steel

BSE SENSEX

S&P CNX

19,581

5,951

CMP: INR831

TP: INR478

Sell

No pile-up of CWIP, but balance sheet leveraged

Margins to come under pressure; Sell

Bloomberg

Equity Shares (m)

52-Week Range (INR)

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

M.Cap. (INR b)

M.Cap. (USD b)

JSTL IN

223.1

885/503

11/7/37

185.4

3.4







Valuation summary (INR b)*

Y/E March

2013E 2014E 2015E

Sales

476.2 465.0 500.7

EBITDA

70.8 72.5 83.1

Adj. PAT

9.4

9.3 16.6

Adj. EPS (INR) 38.9 38.6 68.5

EPS Gr(%)

-41.6

-0.6 77.2

BV/Sh. (INR) 628.2 633.9 676.9

RoE (%)

6.2

6.1 10.4

RoCE (%)

8.7

8.5

9.8

Payout (%)

22.6 22.7 12.8

Valuation

P/E (x)

21.4 21.5 12.1

P/BV

1.3

1.3

1.2

EV/EBITDA (x) 7.7

7.8

6.8

Div. Yield (%) 0.9

0.9

0.9

*Post merger JSW-ISPAT



JSW Steel (JSTL) has been the best executor of projects among Indian metal companies,

and has avoided piling up CWIP on its balance sheet.

However, its balance sheet has got leveraged due to expensive investments in overseas

plate & pipe mill, and iron ore / coking coal mines in the Americas. It also acquired the

debt-laden Ispat industries, recently.

We continue to admire JSTL’s operating efficiencies and execution skills, but are

concerned about continued availability of attractively priced iron ore fines. We expect

the prices of iron ore fines to move up to bridge the gap vis-à-vis the prices of pellets

and/or lumps.

As the availability of attractively priced iron ore fines gets constrained, JSTL’s margins

will come under pressure. We reiterate Sell.

Superior execution skills have helped to avoid pile-up of CWIP

JSW Steel (JSTL) has been the best executor of projects among Indian metal

companies, with very comfortable CWIP/MCap and CWIP/EV ratios. There was,

however, one exception in its history – JSTL’s CWIP/MCap had spiked immediately

after the financial crisis of 2008 due to the double whammy of (1) CWIP on account

of its new ~3mtpa blast furnace, whose commissioning was delayed due to demand

collapse, and (2) pressure on market cap due to debt burden. However, the

recovery was equally swift, once the banking system normalized.

CWIP at comfortable levels (INR b)

Shareholding pattern (%)

As on

Sep-12

Promoter

38.6

Dom. Inst

4.7

Foreign

41.8

Others

14.9

Jun-12 Sep-11

38.6

38.3

4.7

4.6

41.3

42.8

15.3

14.4

Stock performance (1 year)

Ratios at much lower levels than industry

(%)

Expensive investment led to high debt level

(INR b)

26

JSW Steel

Profitable business in India, but overseas investments prove expensive

JSTL has a profitable steel business in India and has been the fastest growing steel

company in the world. In the last five years, it has invested USD900m in US plate &

pipe mill, USD250m in Chile iron ore mines, and USD100m in US coking coal mine.

None of its overseas acquisitions have been profitable and there is no visibility of

turnaround, given the global economic slowdown, high cost structure, and strategic /

technological disadvantage. We believe it is fair to treat them as sunk investments.

Acquisition of debt-laden Ispat Industries to provide growth opportunity…

The recent acquisition of Ispat Industries (Dolvi) will provide growth opportunity to

the JSW Steel group, especially given that growing through brownfield expansion in

Karnataka and greenfield projects in eastern states like West Bengal is challenging.

The Supreme Court imposed a cap on total iron ore production in Karnataka, limiting

the opportunity to grow steel production in the state. Similarly, the IRR of its steel

project in West Bengal has taken a hit due to delays in developing its coal mine due to

regulatory and political confusion. Further, iron ore availability has become difficult

for non-integrated steel plants due to drop in India’s iron ore production post the

Shah Commission investigation.

…but adds to balance sheet leverage

Post merger, the Dovi plant will be the key driver for future expansions. Dolvi (near

Mumbai) has the advantage of an in-plant jetty to receive coal and iron ore from the

sea route and proximity to re-rollers in western India. JSTL is pursuing projects to set

up coke-oven batteries, pellet plants and captive power plants at Dolvi, which will

have high IRR because of productivity gains and internal utilization of waste energy.

Similarly, it is investing in CAPL (downstream facility) at Vijay Nagar to cater to the

auto industry and improve its product mix. In the absence of publically available

information to accurately calculate the profitability of these projects, we value them

at project cost.

Margins to come under pressure; maintain Sell

We expect margins of USD125/ton and volumes of 9.4m tons in FY14 from the erstwhile

JSTL operations. We remain concerned that margins will come under pressure due to

changed iron ore pricing dynamics in India, which has (perhaps temporarily) turned

net importer of iron ore. Our target price for JSTL is INR478/share (EV of 5x FY14E

EBITDA), which implies 42% downside. We maintain

Sell.

Target price calculations (INR m)

Year

EBITDA

Target EBITDA multiple

Target EV

less: Net Debt (INR m)

add: CWIP

Residual equity value

No. of shares

Target price (INR)

2015E

83,086

5.0

415,430

366,179

66,335

115,586

242

478

Source: Company, MOSL

27

7 January 2013

JSW Steel

Financials and Valuation

Income Statement (Consolidated, JSW-Ispat merged from FY13)

Y/E March

Net sales

Change (%)

Total Expenses

EBITDA

% of Net Sales

Depn. & Amortization

EBIT

Net Interest

Other income

PBT before EO

EO income

PBT after EO

Tax

Rate (%)

Reported PAT

Minority interests

Share of Associates

Preference dividend

Adj. PAT (after MI & Asso)

Change (%)

2011

241,059

27.2

192,380

48,679

20.2

15,597

33,082

10,603

1,900

24,379

24,379

7,785

31.9

16,594

-239

707

279

16,783

40.4

2012

343,681

42.6

282,662

61,019

17.8

19,332

41,687

14,273

769

28,183

-15,353

12,830

5,002

39.0

7,828

189

-2,262

279

14,844

-11.6

2013E

476,228

7.0

405,424

70,805

16.9

28,530

42,275

28,343

3,170

17,102

-1,645

15,457

9,040

42.5

6,416

-384

828

9,393

-39.6

2014E

465,014

-1.7

392,528

72,485

17.4

29,069

43,417

31,132

1,495

13,779

13,779

4,134

30.0

6,395

-524

828

9,341

-14.9

(INR Million)

2015E

500,731

9.9

417,645

83,086

17.0

29,069

54,017

31,132

1,545

24,430

24,430

7,573

31.0

13,677

-524

828

16,552

68.0

Balance Sheet

Y/E March

Share Capital

Reserves

Net Worth

Minority Interest

Total Loans

Deferred Tax Liability

Capital Employed

Gross Block

Less: Accum. Deprn.

Net Fixed Assets

Capital WIP

Investments

Curr. Assets

Inventory

Account Receivables

Cash and Bank Balance

Others

Curr. Liability & Prov.

Account Payables

Provisions & Others

Net Current Assets

Appl. of Funds

E: MOSL Estimates

2011

2,231

163,062

165,293

2,219

211,203

20,494

399,209

337,771

68,732

269,039

65,078

26,437

98,329

44,097

9,334

23,170

21,729

59,674

29,622

30,052

38,655

399,209

2012

2,231

165,265

167,496

2,177

274,301

27,250

471,223

426,895

88,775

338,121

35,703

18,856

146,453

57,893

15,394

32,653

40,514

67,910

41,039

26,871

78,543

471,223

2013E

2,417

149,430

151,847

1,793

359,941

10,849

524,430

596,378

185,364

411,014

56,335

4,441

166,884

84,222

22,540

14,193

45,930

114,245

86,916

27,329

52,639

524,430

(INR Million)

2014E

2,417

150,819

153,236

1,270

379,941

15,037

549,483

627,878

214,433

413,446

76,335

4,441

166,873

82,115

21,947

16,881

45,930

111,612

84,283

27,329

55,261

549,483

2015E

2,417

161,219

163,636

746

399,941

25,908

590,231

687,878

243,501

444,377

66,335

4,441

191,093

87,986

23,415

33,762

45,930

116,015

88,686

27,329

75,078

590,231

7 January 2013

28