With rising raw material prices and lifting of iron ore mining ban in Karnataka, JSW Steel can heave a sigh of relief. The Supreme Court has raised the ceiling from 30 million tonnes to 35 million tonnes for the A and B grade iron ore.
JSW Steel, which has a major presence in Karnataka, has an integrated steel manufacturing facility of 12 million tonnes. It had to rely on other markets because of the low supply of iron ore in Karnataka and paid higher prices for the iron ore available in Karnataka. A few months ago the board also approved a plan to set up a Rs 2100 crore slurry pipeline for the transportation of iron ore. That apart, of the 5 iron ore captive mines it got in Karnataka, only a few of them are utilised to the fullest extent because of the mining cap.
Availability of iron ore in the local market would mean the company will be able to increase its production and at the same time benefit on account of cost savings.
To put it in perspective, with an increase in international iron ore prices and better demand led by the recovery in the domestic steel industry, NMDC took a few price hikes in the recent past. Its prices of iron ore fine (ex-royalty) are hovering around Rs 2300 a tonne as against Rs 1500 a tonne in August 2016. Nevertheless, JSW is also negotiating prices with NMDC which is estimated to charge a premium of about Rs 700-800 a tonne.
Typically, for every tonne of steel around 1.8 tonnes of iron ore is required depending on the quality. This would mean close to about 22 million tonnes of iron ore requirements for the 12 million tonne plant in Karnataka. Even 5-8 percent saving in prices (NMDC premium is almost 25-30 percent) would result in the company saving close to Rs 270-430 crore based on plant capacity and current iron ore prices.
Industry experts suggest that close to 30 percent of JSW Steel’s iron ore requirements are met from other states like Odisha, Jharkhand and Chhattisgarh, which essentially means that once the supply is restored in the state of Karnataka, it will be able to save on huge logistics costs. Moving 10 tonnes of iron ore by road will typically cost around Rs 10000-12000 for a 500 km distance. This effectively works out to a logistic cost of about Rs 1000-1200 per tonne of iron ore. Assuming 10-15 percent of its requirements are localised, the company could save another Rs 211-317 crore in logistic costs taking the local logistic costs to around Rs 200-210 per tonne.
Scope for earnings upgrade
Development in Karnataka mining is positive and the market is expecting supplies to resume further with the expectations of ceiling getting increased in the coming months. Gradually the contribution of captive mines will also start reflecting on the cost. Since this is the major facility and has the largest contribution to revenues it would mean improvement in the margins and profitability in the coming quarters.
As against a net profit of Rs 3500 crore in FY17, the Street is expecting net profit of close to Rs 5000 crore in FY19, which is a growth of 19.5 percent annually. At the current market price of Rs 251 a share, the stock is trading at about 11 times its FY19 estimated earnings and 6.7 times EV/EBIDTA, which is reasonable particularly in the light of the improvement in margins and revival in the domestic steel cycle.