We recommend our clients to book profit in Bhushan Steel Ltd (BSL) at Rs 431. ‘Fundamental BUY’ call was given at Rs 360 on 09th Feb, 2011 and the stock has almost given 20% return from this level. Higher raw material prices (~35% rise) are likely to hit margins by 300-500bps coupled with uncertain demand prevailing in the industry due to high interest rate environment in Indian economy.

Rationale

High raw material prices would dent the margin: raw material accounts for nearly 60% of sales and 86% of total expenditure. The iron ore prices have escalated by 38% to $183/ton during Jan11 against $132/ton in Oct10. Coking coal prices have also gone up by 33% to $300/ton from the levels of $225/ton on the back of shortage of supply from Australia. Any further hike in raw material prices would dent the margins to the tune of 300-500bps. The blended realization/ton remains flat on sequential basis at Rs 45104/ton against Rs 45013/ton during Q2FY10, while on y-o-y basis it has improved over 7% from Rs 42017/ton.

Uncertain demand will leave little scope for further price hike: steel manufactures have hiked steel prices nearly 21% during the last four months, thereby leaving little scope for further hikes. Adding to that high interest rate scenario is prevailing in the industry. BSL which primarily caters to auto manufactures is likely to be affected by high interest, as the demand for auto grade steel is expected to slow down. A complete pass- through to final steel consumers remains unlikely, that means steel producers may have to bite into their margins for the next two quarters.

High Debt-Equity ratio is a concern: the company poses over Rs 10000cr debt in its book, with debt-equity ratio at 3 which is a cause of concern. With margins likely to remain subdued, high debt would act as a hindrance in further expansions.