JSW Steel, the largest steel manufacturer in India, is facing a strong demand growth outlook. The company, and the broader steel industry, have lined up a large expansion plan to keep pace with the positive prospects. The commodity price outlook is also expected to stabilise after a volatile last few years.

We recommend that investors accumulate JSW Steel, given the upcoming spurt in output, its execution ability and strong domestic presence. The stock usually trades at a premium, and currently at 10.7 times trailing EV/EBITDA, the valuation is at a 25 per cent premium to historical range. Investors can accumulate the stock on dips for accommodating a margin of error in valuations.  

Rising domestic demand

Indian steel consumption increased to 136 mt (million tonnes) from 120 mt last year, which is a 13 per cent YoY growth. Demand from infrastructure, home, auto, consumer appliances, energy storage and power infrastructure has spelt tailwinds, apart from broader economic growth. The outlook for most of the end-user industries is expected to sustain domestically. The management expects steel demand growth to match 1.5x GDP growth rate in the ‘national building’ phase, which should imply at least 8-10 per cent demand growth per year or in the range of 10-12 mt additional steel demand every year.

The headwind is from imports into India, which increased 37 per cent last year to account for 7 per cent of domestic consumption. China, the largest producer, facing a weak property market domestically, has increased exports by 32 per cent in CY23. As selective stimulus in China and demand recovery globally take shape, imports into India and pricing pressure are expected to subside from the currently high intensity.

Heavy capex outlay

JSW Steel aims to increase capacity at 10 per cent CAGR for the next seven years, with total capex outlay of ₹65,000 crore in the next three years alone. This represents around 30 per cent of the current market cap. The company has guided for 8 per cent YoY volume growth in FY25 sales, which should be viewed as a conservative estimate, given the expansion.

The overall expansion is phased in three broad stages. The first is at commercialisation juncture as construction is completed in Q4FY24. The company had a stated capacity of 28.2 mt till Q3FY24. In the current fiscal it should start commercial production from 5 mt in Vijayanagar and 2 mt in the next phase. The Bhushan Power and Steel (BPSL) acquisition, done in 2021, has been expanded from 3 to 4.5 mt and is expected to ramp up in the year. The BPSL capacity will come online the earliest by Q2FY25, followed by Vijayanagar facility, but the full scope may bear fruit only in FY26.

Beyond this, the company plans to do brownfield expansions in Dolvi, Vijayanagar and Jharsuguda to reach 42 mt by FY28 and further increase it to 51.5 mt by FY31. This includes a 4-mt Green Steel production plant in two phases, which is under proposal for the board. Overall, the expansion is largely brownfield, done at existing locations, which should imply a lower cost.

Investors must note that the top three domestic steel players (Tata Steel, JSW Steel and Jindal Steel and Power) have expansion plans of similar magnitude. The strong demand domestically is expected to absorb such capacities but everyone expanding might be an overhang to take note of.

Commodity prices

JSW Steel saw net realisations decline by 4 per cent in FY24 but with raw material costs, including coal, iron ore and power costs, declining significantly, the spread or EBITDA margins improved 450 bps in FY24 to 15 per cent.

Steel prices are expected to have bottomed out in the last two quarters. Any growth from here is dependent on Chinese and global economic recovery and interest rates taking an accommodative stance. In a likely scenario of that not happening, steel prices may hold fort at the current levels. In any case the spread is unlikely to change. Coking coal, iron ore and power costs have also declined in FY24. The global recovery is likely to impact steel realisations and raw material costs equally with a lag favoring steel prices in the short term, but evenly in the long term.

The other factors impacting JSW Steel’s spread outlook positively (consensus expects 200 bps EBITDA margin improvement in FY25) are operating leverage/efficiency, raw material linkages and value-added product mix. These can only be a soft cushion to the spread in the short term. JSW Steel has acquired a coal mine in Mozambique with access to more than 800 tonnes of premium hard coking coal reserves. The additional iron ores in Karnataka, Odisha and Goa are expected to supplement its backward integration. But the company has a third of iron ore from captive mines and the benefit would be gradual incremental addition to the spread on operationalising the mines.

Valuation and financials

JSW Steel has a net debt to EBITDA of 2.62 times as of March 2024 and a net debt of ₹74,000 crore. The expansion is likely to be financed from internal accruals, while debt reduction may be slower and continue to remain at the current mildly elevated levels.

Compared to last eight-year average of 8.5 times EV/EBITDA, the stock trades at 10.7 times. Considering the tailwinds in demand growth and capacity expansion, tempered by overhang of imports and global economic recovery and scope for margin expansion, we recommend that investors accumulate the stock on dips.

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