Sanjay Jain (SanjayJain@MotilalOswal.com); +91 22 3982 5412

11 June 2014

Update | Sector: Metals

Jindal Steel & Power CMP: INR327 TP: INR409 Upgrade to Buy

Return ratios start looking up EBITDA to post 20% CAGR; upgrade to Buy

Return on capital employed has hit bottom: Jindal Steel and Power (JSP) has invested heavily in steel, power projects in India and mining assets overseas. Over four years, a total of INR350-400b has been invested in setting up a new 12mtpa steel plant Greenfield site (capacity of 1.5mtpa in phase I) at Angul and Brown field expansion of Jindal Powers capacity by 2,400mw. Further, JSP has invested monies overseas in 2mtpa gas-based steel plant in Oman and coking coal assets of Gujarat NRE in Australia. RoCE (pre-tax) has fallen from a peak of 32.8% in FY09 to 7.9% in FY14 due to long gestation period of these projects. We expect RoCE to start improving now.

EBITDA to post CAGR of 20% over FY14-17E: JSP has recently commissioned 1.5mtpa Angul steel plant with associated facilities during January-May 2014. The 2,400mw (T2) project at Tamnar has already commissioned three units of 600mw each by end-FY14. Oman HBI unit has been forward integrated in billet making recently. Thus, INR300-320b of capex is now put into operation. In spite of uncertainties, we expect consolidated EBITDA to clock a CAGR of 20% over FY14-17E. Uncertainties on sourcing coal, selling power and steel have clouded near term earnings outlook. However, each of these problems is surmountable with time and positive political will. We expect a favorable resolution.

Stock trades at discount to intrinsic value: We review the model and introduced FY17 estimates. We roll over the target price on FY16 estimates. We believe the stock is trading at significant discount to its intrinsic value. We have used three alternative approaches to value the stock: (1) SOTP methodology yields a target price of INR409/share based on FY16E 6.5x EV/EBITDA for steel business and DCF for Jindal Power, (2) P/BV(x) has hit the bottom along with RoE. On factoring moderate re-rating of P/BV(x) and expected growth in book value, the stock should be trading at an average of INR399 during FY16 and (3) the replacement cost yields a target price of INR410/share, not counting the value of mines and opportunity cost.

Upgrading the stock to Buy: JSP is now likely to derive benefit from the INR350b invested over four years. Cash flows will see significant boost on the back of 20% CAGR in EBITDA. With the 12mtpa Greenfield Angul site under its belt, company is now well set to grow steel capacity manifold over next 5-10 years with much lower execution risk. Proximity to the iron ore mining region in Odisha will be a key advantage. We expect that power business too will start growing on de-bottlenecking of transmission infrastructure and reforms in power distribution and coal production. We upgrade JSP to a Buy, with a target price of INR409, 25% upside. Utkal B1 coal mine will drive another ~10% upside.

BSE Sensex S&P CNX 25,474 7,627

Stock Info

Bloomberg JSP IN

Equity Shares (m) 914.9

52-Week Range (INR) 350/182

1, 6, 12 Rel. Per (%) 27/3/11

M.Cap. (INR b) 298.9

M.Cap. (USD b) 5.0

Financial Snapshot (INR Billion) Y/E March 2015E 2016E 2017E Net Sales 248.5 296.8 336.1

EBITDA 76.7 93.5 104.5

Adj PAT 24.7 30.2 35.9

EPS (INR) 26.9 33.0 39.2

Growth (%) 11.5 22.6 18.6

RoE (%) 10.4 11.6 12.3

RoCE (%) 8.7 10.1 10.6

P/E (x) 12.1 9.9 8.3

P/BV (x) 1.2 1.1 1.0

EV/EBITDA (x) 8.7 7.5 6.8

Shareholding pattern (%)

As on Mar-14 Dec-13 Mar-13

Promoter 60.4 59.7 59.1

Domestic Inst 4.1 4.7 6.8

Foreign 23.1 22.8 22.6 Others 12.3 12.8 11.6

Stock Performance (1-year)

Investors are advised to refer through disclosures made at the end of the Research Report.

Jindal Steel & Power

11 June 2014 2

Method 1: Sum-of-the-parts-valuation at INR409/share We expect consolidated EBITDA to post a CAGR of 20% over FY14-17E driven by 15% growth in steel business and 30% growth in Jindal Power. Steel business EBITDA will be driven by 14% steel volume CAGR to 4.3mt driven

by new 1.5mtpa capacity at Angul and modernization of Raigarh facilities. We are a bit conservative on volumes keeping in sight weak demand for plates currently. These facilities have the potential to produce 5mtpa.

We expect the steel EBITDA per ton to dilute as share of high margin third party sale of pellets and power in the revenue mix would decline. Further, we assume that large part of iron ore would be sourced at market prices. We estimate the average landed cost of INR2,500/t for iron ore fines and assume pellet realization at INR7,000/t.

Shadeed (Oman) steel plant will start deriving benefits of forward integration. We expect EBITDA to nearly double to INR8-9b.

Wollongong coking coal mines (65% stake) too are expected to turn around.

Income Statement

(INR Million) Y/E March FY12 FY13 FY14 FY15E FY16E FY17E Remarks Net sales 182,086 198,068 200,040 248,477 296,778 336,092 assumed steel prices are stable

Steel segment 151,683 172,971 174,839 205,706 232,960 248,452 CAGR growth of 12% over FY14-17 Standalone 133,340 149,547 145,440 168,829 190,809 203,336

Steel sales (kt) 2,385 2,843 2,935 3,324 3,852 4,328 Angul driving steel volumes at 14%cagr Pellet sales (kt) 1,995 2,112 2,035 3,561 4,095 3,132 Pellet capacity doubled to 9mtpa in FY15

Shadeed 27,961 29,012 34,580 37,740 40,860 40,860 HBI (kt) production 1,200 1,520 1,468 1,500 1,500 1,500 Wollongong (GNM)

2,317 4,471 7,436

Coking coal (kt)

412 1,175 1,720 Others -9,618 -5,588 -5,180 -3,180 -3,180 -3,180 Jindal power 30,404 25,097 25,201 42,771 63,818 87,641 CAGR growth of 52% over FY14-17

Sales (Mkwh) 7,750 7,411 7,984 11,955 16,782 24,603 T2 driving vol. in FY15-17 EBITDA 68,868 65,685 60,764 76,674 93,512 104,478

Steel segment 46,055 50,614 42,943 54,791 61,594 64,962 CAGR growth of 15% over FY14-17 Standalone 42,297 45,126 43,123 47,205 52,268 54,217

EBITDA/t of steel 17,733 15,872 14,690 14,202 13,570 12,526 Margins diluting Shadeed 3,524 4,903 3,790 7,688 8,356 8,301

EBITDA/t of HBI 2,936 3,226 2,581 5,125 5,571 5,534 Margins improving (forward integration) Wollongong (GNM)

1,868 2,940 4,414 GNM to turn around

EBITDA/t of coal

2,503 2,567 Others 235 585 -3,970 -1,970 -1,970 -1,970 Jindal power 22,813 15,071 17,821 21,882 31,919 39,516 CAGR growth of 30% over FY14-17

EBITDA (INR/kwh) 2.9 2.0 2.2 1.8 1.9 1.6 T2 is margin dilutive

Jindal Powers T2 has already signed the PPA for 400mw with Tamil Nadu (TN).

T2 is running only one unit of 600mw at 50-60% PLF. Nearly 150mw of power sales are already flowing to TN on a long term PPA basis. The volumes will increase to 400mw by August 2014 as the transmission bottlenecks are addressed. We believe T2 will be able to sell 4b kwh in FY15, 8.8b kwh in FY16 and 16.6b kwh in FY17. There may be some slips if there are delays in power sector reforms and/or delay in demand pick-up or in rectifying infrastructure bottlenecks. However, NPV of JPL is less sensitive to some delays.

Steel volumes to clock 14% CAGR

If JSP uses zero cost iron ore inventories, there may be

temporary positive aberration to earnings

Jindal Steel & Power

11 June 2014 3

Capital work in Progress (INR billion)

3 11 9 7 2364 71

105 115 103

33 13 927 21 9

15 23

32

77150

70

16 16

2080

140

FY05 FY06 FY07 FY08 FY09 FY10 FY11 FY12 FY13 FY14 FY15E FY16E FY17E

Standalone Jindal power Angul Phase 2

Source: MOSL, Company

At end-FY16, CWIP will largely pertain to Angul phase II capacity expansions by

3mtpa. The expansion will come at lower specific capex as the infrastructure is already built keeping in mind 12mtpa final capacity at this site. The IRR of project is expected to match WACC. Thus, we would value it at cost rather the past practice of discounting.

Target price calculations

(INR Million)

YEAR FY12 FY13 FY14 FY15E FY16E FY17E Remarks Steel Business

Excluding Jindal Power (JPL)

A. EBITDA 46,055 50,614 42,943 54,791 61,594 64,962 B. Target EV/EBITDA(x)

6.5 6.5 6.5

C. EV (AxB)

356,144 400,361 422,254 Jindal Power (JPL)

D. PV of JPL's FCFF

259,198 264,037 264,084 INR137b for T1 and rest for T2 Consolidated

EBITDA 68,868 65,685 60,764 76,674 93,512 104,478 CAGR growth of 20% over FY14-17 E. Enterprise Value (C+D)

615,342 664,398 686,339

F. Net Debt 169,416 244,180 352,146 371,874 399,607 410,800 G. CWIP 136,520 192,303 252,328 122,771 109,171 165,171 INR120b factored for Angul Phase 2

H. Discount on CWIP (%)

CWIP is valued at book (no discount) Equity Value (E-F+G*(1-H%))

366,239 373,962 440,709

Target price (INR/share) 400 409 482 Target price (INR/share)

445 536 With Utkal B1 coal block

We value the steel business at EV/EBITDA of 6.5x and the power business on PV (present value) of FCFF (future cash flow to firm) discounted at WACC of 10.1% (cost of equity at 15% and pre tax cost of debt at 10%).

Thus, we arrive at a SOTP of INR409/share based on FY16E. If Utkal B1 coal becomes operational by end-FY15, the SOTP will be raised to

INR445/share on FY16 basis and INR536/share on FY17 basis.

Although Angul phase 2 capex is on hold, yet we

believe JSP will put 3mtpa expansion on fast track and spend INR 60b each in FY16

and FY17

Jindal Steel & Power

11 June 2014 4

Method 2: Value at INR399 on re-rating of P/BV due to improving RoE JSP has a strong business positioning in both steel and power. Despite cyclical nature of steel business, company generated high level of returns and never slipped into losses. Thus, it is not vague to look at valuations with respect to book value.

Return ratios have hit bottom

27.231.1

45.742.3

33.7

26.520.2

13.8 12.3 12.1 12.8

16.519.9

32.827.5

21.317.2

12.37.9 8.8 10.1 10.5

FY07 FY08 FY09 FY10 FY11 FY12 FY13 FY14 FY15E FY16E FY17E

RoIC (%) RoCE (%)

Source: MOSL, Company

The P/BV ratio has closely tracked RoE. There has been significant de-rating along with falling RoE. We believe RoE has hit the bottom and is likely to improve gradually as new projects start to generate cash flows.

RoE and P/BV ratio

30.5

25.2

17.7

10.2 10.4 11.612.3

5.1

3.3

2.01.1 1.3 1.4

1.50.0

1.0

2.0

3.0

4.0

5.0

6.0

7.0

0.0

5.0

10.0

15.0

20.0

25.0

30.0

35.0

FY11 FY12 FY13 FY14 FY15E FY16E FY17E

RoE (%), LHS P/BV (x), RHS

Source: Company, MOSL

With a combination of growing book value and modest re-rating of P/BV ratio, we expect the stock to trade at an average price of INR399 during FY16.

Yearly stock price average v/s book value

553

675

563

412

250330

399477

94 131 172 211237 259

285 318

FY10 FY11 FY12 FY13 FY14 FY15E FY16E FY17E

Stock price (INR) - yearly avg. Book value (INR/share)- yearly avg.

Source: Company, MOSL

Although RoCE is expected to improve from 7.9% in

FY14 to 10.5% in FY17E, yet it would have been better

at 11.9% if the INR120b capex for Angul phase II had

not been factored

We expect P/BV ratio to get re-rated as RoE has already

hit the bottom

Expect stock to trade above INR399 in FY16

Jindal Steel & Power

11 June 2014 5

Method 3: Value at INR410/share on replacement cost basis JSP has invested heavily (INR355-400b) over four years. The new projects are now operational but are being valued at discount to cost. Lower profitability largely due to demand side issues and some uncertainties on sourcing raw materials are key reasons for it. There are significant barriers to entry in setting up projects of such size. Further, the cost of recreating such facilities would be significantly higher. These problems too are surmountable. Thus, we believe that IRR of these projects would improve to an extent that valuations would overcome project cost. On replacement cost basis, JSP should be valued at a minimum of INR410/share as explained in following table. This valuation does not capture the advantage of 12mtpa captive coal mines and 2-3mtpa captive iron ore mines. Hence, we believe the stock is undervalued with respect to its intrinsic value. Replacement cost

Process

Value

Specific Value Sub total per share

Capacity cost (USD m) (USD m) (INR b) (INR) A. Steel (mtpa) (USD/t)

5,500 330 361

Raigarh 3.0 1,000 3,000 Angul Steel 1.5 1,000 1,500 Oman 2 500 1,000 B. Power (MW) (U$m/MW)

4,210 253 276

Tamnar -1 1,000 1.0 1,000 Tamnar -2 2,400 1.0 2,400 CPP 810 1.0 810 C. Overseas mining

700 700 42 46

D. Capital work in progress

123 134 E. Total Asset Value (A+B++D)

747 817

F. Net Debt

372 406 G. Net Asset Value (NAV) 375 410

Risk factors Jindal Power has yet to find buyers (PPA) for 2,000mw and coal supply (FSA) for

1,200mw for Tamnar-II. We have assumed PLF of 25% in FY15E, 45% in FY16E and 85% in FY17E. In the absence of PPA and/or FSA, Jindal Power may resort to merchant sales of power and purchase of e-auction coal. Margins in such a situation will be volatile.

For Angul steel plant, we assume that thermal coal will be available in e-auction in the range of INR1,800-2,100/t. In case of delay in developing coal block or delay in production growth at Coal India, there may be significant impact on e-auction coal prices in view of large quantities required.

Margins in steel business are exposed to steel and iron ore prices. We expect iron ore supply in Odisha will ease. If there are delays to restart the closed iron ore mines, supply may be tighter and the cost of iron ore may be higher than our estimates. However, JSP can use zero cost inventories of iron ore fines to keep its overall cost low for one or two years.

There are significant barriers to entry in setting

up projects of such size

The replacement cost of projects is INR410/share.

Replacement cost does not include valuation of (1)

12mtpa captive coal mines, (2) 2-3mtpa captive iron ore

mines in India and (3) loss of opportunity

Jindal Steel & Power

11 June 2014 6

Financials and valuation Income statement (INR Billion) Y/E March 2012 2013 2014 2015E 2016E 2017E Net Sales 182.1 198.1 200.0 248.5 296.8 336.1 Change (%) 38.9 8.8 1.0 24.2 19.4 13.2 EBITDA 68.9 65.7 60.8 76.7 93.5 104.5 EBITDA Margin (%) 37.8 33.2 30.4 30.9 31.5 31.1 Depreciation 13.9 15.4 18.3 24.2 27.4 30.4 EBIT 55.0 50.3 42.5 52.5 66.1 74.1 Interest 3.6 7.6 15.0 23.4 28.6 30.3 Other Income 1.4 1.4 0.7 2.9 3.2 4.8 Extraordinary items -0.9 -5.7 -3.0 0.0 0.0 0.0 PBT 51.9 38.3 25.1 32.0 40.7 48.5 Tax 11.9 9.2 6.2 8.2 10.9 12.6 Tax Rate (%) 22.9 24.0 24.6 25.6 26.9 26.0 Reported PAT 40.0 29.1 18.9 23.8 29.8 35.9 Adjusted PAT 41.0 34.9 21.9 23.8 29.8 35.9 Change (%) 7.7 -14.9 -37.1 8.6 25.0 20.7 Min. Int. & Assoc. Share -0.4 0.0 0.2 0.8 0.5 -0.1 Adj Cons PAT 40.6 34.8 22.1 24.7 30.2 35.9

Balance sheet (INR Billion) Y/E March 2012 2013 2014 2015E 2016E 2017E Share Capital 0.9 0.9 0.9 0.9 0.9 0.9 Reserves 180.2 211.6 225.2 246.6 273.6 306.2 Net Worth 181.1 212.5 226.1 247.5 274.5 307.1 Debt 170.9 246.2 362.3 379.8 419.8 454.8 Deferred Tax 11.9 13.4 14.7 15.6 16.6 17.7 Total Capital Employed 367.0 477.6 613.9 653.2 721.1 790.2 Gross Fixed Assets 223.3 267.0 356.2 544.0 629.2 639.9 Less: Acc Depreciation 58.4 74.3 86.5 108.1 132.9 160.7 Net Fixed Assets 164.9 192.7 269.7 435.9 496.3 479.2 Capital WIP 136.5 192.3 252.3 122.8 109.2 165.2 Investments 3.8 8.1 3.4 3.4 3.4 3.4 Current Assets 143.9 176.0 209.3 215.4 241.3 275.3 Inventory 35.8 45.2 48.8 52.4 59.6 64.5 Debtors 13.1 19.5 17.7 22.5 28.9 34.2 Cash & Bank 1.5 2.0 10.2 7.9 20.2 44.0 Loans & Adv, Others 93.6 109.3 132.6 132.6 132.6 132.6 Curr Liabs & Provns 83.1 93.1 126.8 130.2 135.0 138.8 Curr. Liabilities 29.1 31.4 27.5 31.0 35.7 39.5 Provisions 54.0 61.7 99.3 99.3 99.3 99.3 Net Current Assets 60.9 83.0 82.5 85.2 106.3 136.5 Total Assets 367.0 477.6 613.9 653.2 721.1 790.2

E: MOSL Estimates

Jindal Steel & Power

11 June 2014 7

Financials and valuation

Ratios Y/E March 2012 2013 2014 2015E 2016E 2017E Basic (INR) EPS 43.4 37.3 24.2 26.9 33.0 39.2 Cash EPS 58.2 53.7 44.2 53.4 63.0 72.4 Book Value 193.7 227.3 247.1 270.5 300.1 335.7 DPS 1.6 1.6 1.6 1.6 1.6 1.6 Payout (incl. Div. Tax.) 3.8 4.4 7.7 6.9 5.7 4.8 Valuation(x) P/E 7.5 8.8 13.5 12.1 9.9 8.3 Cash P/E 5.6 6.1 7.4 6.1 5.2 4.5 Price / Book Value 1.7 1.4 1.3 1.2 1.1 1.0 EV/Sales 2.6 2.8 3.3 2.7 2.4 2.1 EV/EBITDA 6.9 8.4 10.7 8.7 7.5 6.8 Dividend Yield (%) 0.5 0.5 0.5 0.5 0.5 0.5 Profitability Ratios (%) RoE 25.2 17.7 10.1 10.4 11.6 12.3 RoCE 17.3 12.4 7.9 8.7 10.1 10.6 Turnover Ratios (%) Asset Turnover (x) 0.5 0.4 0.3 0.4 0.4 0.4 Debtors (No. of Days) 26.2 36.0 32.3 33.1 35.5 37.2 Inventory (No. of Days) 71.8 83.4 89.1 76.9 73.3 70.0 Creditors (No. of Days) 93.8 86.5 72.1 65.8 64.1 62.3 Leverage Ratios (%) Net Debt/Equity (x) 0.9 1.2 1.6 1.5 1.5 1.4

Cash flow statement (INR Billion) Y/E March 2012 2013 2014 2015E 2016E 2017E OP/(Loss) before Tax 51.9 38.3 25.1 32.0 40.7 48.5 Depreciation 13.9 15.4 18.3 24.2 27.4 30.4 Others -1.4 -1.4 -0.7 -2.9 -3.2 -4.8 Interest 3.6 7.6 15.0 23.4 28.6 30.3 Direct Taxes Paid -10.0 -7.8 -4.9 -7.3 -9.9 -11.5 (Inc)/Dec in Wkg Cap -17.0 -21.6 8.6 -4.9 -8.9 -6.4 CF from Op. Activity 43.4 36.8 57.7 60.7 70.9 82.8 (Inc)/Dec in FA & CWIP -73.3 -99.5 -107.4 -58.2 -71.6 -66.7 (Pur)/Sale of Invt -0.8 -4.3 -37.2 0.0 0.0 0.0 Others 0.0 0.0 0.0 0.0 0.0 0.0 CF from Inv. Activity -74.1 -103.8 -144.6 -58.2 -71.6 -66.7 Inc/(Dec) in Net Worth 0.0 0.0 -5.0 0.0 0.0 0.0 Inc / (Dec) in Debt 31.2 75.3 116.1 17.5 40.0 35.0 Interest Paid -3.6 -7.6 -15.0 -23.4 -28.6 -30.3 Divd Paid (incl Tax) -1.5 -1.5 -1.7 -1.7 -1.7 -1.7 CF from Fin. Activity 27.5 67.5 95.0 -4.7 12.9 7.8 Inc/(Dec) in Cash -3.2 0.5 8.2 -2.2 12.3 23.8 Add: Opening Balance 4.6 1.5 2.0 10.2 7.9 20.2 Closing Balance 1.5 2.0 10.2 7.9 20.2 44.0

E: MOSL Estimates

Jindal Steel & Power

11 June 2014 8

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Disclosure of Interest Statement JINDAL STEEL & POWER LTD 1. Analyst ownership of the stock No 2. Group/Directors ownership of the stock No 3. Broking relationship with company covered No 4. Investment Banking relationship with company covered No

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