Steel Authority Expansion Delay to Erode Profit: Corporate India

Steel Authority of India Ltd., the nation’s second-biggest maker of the alloy, may fail to revive profit from an eight-year low as project delays more than double the cost of a planned capacity expansion to $13 billion.

Contractor disputes, holdups and rising equipment prices have inflated the bill for increasing capacity 59 percent to 21.4 million tons, Chairman C.S. Verma said in an interview. The estimate in 2006 was $6.3 billion. The overrun may shrink profit 36 percent to 5.5 rupees a share this year, said Ravindra Deshpande, a Mumbai-based analyst at Elara Securities Ltd.

State-run (SAIL) Steel Authority is counting on higher capacity to compete with Tata Steel Ltd. (TATA) as demand for the alloy is forecast to grow 8 percent in India this fiscal year, driven by public works spending and purchases of cars, homes and appliances. The shares fell 37 percent in the past year, making the company the worst performing steel stock on the BSE Metal Index (BSEMETL), after a 36 percent increase in the number of analysts recommending a sell from a year earlier, according to data compiled by Bloomberg.

“After Steel Authority’s expansion, the return on equity will be low, so the stock is being downgraded,” said Giriraj Daga, a Mumbai-based analyst at Nirmal Bang Securities Ltd., which has kept a sell rating since July last year. “The cost is abnormally high and will only increase from here.”

The shares rose as much as 0.9 percent to 92.85 rupees and traded at 92.30 rupees as of 9:28 a.m. in Mumbai. The benchmark Sensitive Index (SENSEX) gained 0.5 percent.

Plant Cost

Typically, the cost of building a steel mill is about $1 billion per million ton, while Steel Authority will pay $1.6 billion, according to Niraj Shah, an analyst at Mumbai-based Fortune Equity Brokers India Ltd.

Interest costs for New Delhi-based Steel Authority have almost tripled in five years to 6.8 billion rupees ($122 million), while net income dropped to 35.5 billion rupees in the 12 months ended March 31, the least since 2004, according to data compiled by Bloomberg. The stock is rated a hold by 14 of 51 analysts. Nineteen rate it a sell and 18 a buy.

The company’s expansion program, which includes raising steelmaking and iron-ore mining capacities and also refurbishing old equipment to boost efficiency, has been delayed. The first estimate in March 2006 envisaged completion by 2012. The steelmaker will be able to increase its capacity to 18 million tons by the end of the current financial year, Verma said, without giving a timeframe for the full expansion.

“There’ll always be issues with such a huge project,” he said.

Inflated Plan

Steel Authority, which has spent 403.2 billion rupees on its expansion plans, expects to invest 120 billion rupees this financial year. It had 163.2 billion rupees of debt as of March 31, Verma told reporters in New Delhi on May 29.

“The delayed as well as inflated capital-expenditure plan will continue to put pressure on the balance sheet of the company,” Elara’s Deshpande said.

Still, project delays aren’t exclusive to Steel Authority as every company faces these issues, said Anubhav Gupta, an analyst at Kim Eng Securities Pvt. in Mumbai, who rates the stock a buy. ArcelorMittal (MT), the world’s biggest steelmaker, and South Korea’s Posco, the fourth biggest, have been waiting for almost seven years to begin construction of their combined $36 billion projects in eastern India.

“If someone believes in India’s metals consumption story, one could consider buying Steel Authority,” Gupta said.

Coking Coal

A decline in prices of coking coal, a key ingredient in making steel, will help increase profit at Steel Authority, he said. Contract coking coal prices dropped to $206 a ton for the quarter ending June 30, a 36 percent decline from their record a year ago. A spurt in the fuel price last year led to a 29 percent drop in profit in the financial year to March 31.

The benefits of the expansion won’t be seen for at least another two years, said Ritesh Shah, an analyst at Espirito Santo Securities in Mumbai. A proposed mining bill will further erode the company’s earnings, he said.

A planned change in India’s five-decade old mining law will need coal miners to give away an amount equal to the royalty payments for local welfare, while miners of other minerals will have to part with 26 percent of their profit. The bill is being studied by a parliamentary committee.

“We see disappointments on too many fronts in Steel Authority,” said Chirag Shah, a Mumbai-based analyst at Barclays Bank Plc. “We have been negative on the stock and continue to be so.”

To contact the reporter on this story: Rajesh Kumar Singh in New Delhi at rsingh133@bloomberg.net

To contact the editor responsible for this story: Rebecca Keenan at rkeenan5@bloomberg.net

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