Analysis of Steel Sector

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ABSTRACT................................................................................................................................................ 3 INTRODUCTION ....................................................................................................................................... 4 CATEGORIES OF STEEL ........................................................................................................................ 5 ROUTES TO STEEL................................................................................................................................ 6 BASIC OXYGEN STEELMAKING (BOS) .............................................................................................. 6 ELECTRIC ARC FURNACE STEELMAKING (EAF) ................................................................................ 7 PRODUCT MIX ..................................................................................................................................... 9 GLOBAL SCENARIO ................................................................................................................................ 10 US Influence on Global Steel Industry .............................................................................................. 11 Global steel consumption demand led by BRIC nations ................................................................... 13 Flat Steel Prices ................................................................................................................................. 14 Long Steel Prices ............................................................................................................................... 15 CHINA - UNDISPUTED LEADER OF GLOBAL STEEL INDUSTRY ............................................................... 16 INDIAN SCENARIO ................................................................................................................................. 22 PROFITABILITY ACROSS VALUE CHAIN .................................................................................................. 31 COST DRIVERS ....................................................................................................................................... 32 INDUSTRY COST DYNAMICS .................................................................................................................. 35 RESOURCE DEMAND ......................................................................................................................... 36 HOT METAL : COST CURVE ................................................................................................................ 37 Iron-Ore Supply still in the hands of a few.................................................................................... 39 Iron ore prices- to rise with demand–supply mismatch ............................................................... 40 Coking Coal Supply getting Concentrated..................................................................................... 44 COKING COAL-TIGHTNESS AHEAD ................................................................................................ 45 Ferroalloys - Soaring high, to climb higher ................................................................................... 48 Cycles getting shorter ................................................................................................................... 51 PRICING OUTLOOK ................................................................................................................................ 54 COMPANY SECTION.............................................................................................................................. 57 INDIAN STEEL COMPANY POSITIONING............................................................................................ 57 POSITIONING ACROSS VALUE CHAIN ................................................................................................ 58 VALUATIONS OF COMPANIES ........................................................................................................... 59 SAIL ................................................................................................................................................ 59 TATA .............................................................................................................................................. 63

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JINDAL STEEL & POWER Ltd .......................................................................................................... 67 JSW Steel Ltd ................................................................................................................................. 71 SESA GOA ...................................................................................................................................... 75 RISKS...................................................................................................................................................... 79 THE WAY AHEAD ................................................................................................................................... 81

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ABSTRACT
Initiating coverage on the Indian steel sector with an attractive stance based on a bullish outlook for steel demand and prices. Robust steel prices will be sustained as demand momentum remains buoyant, enabling global steel producers to pass on the cost-push inflation from tight raw material and freight markets.

Access to high-quality, low-cost iron ore reserves offers Indian steel companies an edge over regional and global peers. Further, low labor costs and a fast-growing domestic market make India a natural hub for steel production, in our view. Despite these fundamental strengths, valuations remain at about 30% discount to regional peer’s v/s 10% premium over the past two years. Moreover, Indian steel producers are rapidly expanding capacity to gain global size.  Global steel industry:      Resources segment remains in the midst of a sweet spot of a steel cycle Supply squeeze and high supplier concentration to keep resource prices higher Non-integrated steel making companies remain vulnerable from rising input costs Steel prices continue to remain firm but short term fluctuations to remain during inventory adjustment and tactical negotiations with the iron ore/ coal supplier

 Given its captive rich iron ore resource, Indian steel industry is well placed     But increasing cost of coking coal might dampen Indian profits Indian companies are leveraging aggressively While resource intensive companies are getting bigger by acquiring steel making companies Smaller steel making companies are expanding rapidly and integrating backward

 Winners: Players with focus on resources/ high profitability, growth & reasonable financial.

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METHODOLOGY PRIMARY DATA
I interviewed two members of the research team of IFCI financial services and one member of Edelweiss Capital. Visited Hanuman Blast Furnace(Silvassa)

SECONDARY DATA
The project is based on the secondary data collected from the companies websites & the ministry of steel. Various books,magazines, newspapers and articles also provided valuable information.

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INTRODUCTION
GENERAL CHARACTERISTICS  Steel is an alloy of iron and carbon, containing less than 2% carbon, 1% manganese and small amounts of silicon, phosphorus, sulphur and oxygen. Steel is the most important engineering and construction material in the world. It is the most important, multi-functional and most adaptable of materials. Steel production is 20 times higher as compared to production of all non-ferrous metals put together.  Steel compared to other materials of its type has low production costs. The energy required for extracting iron from ore is about 25 % of what is needed for extracting aluminium.  There are altogether about 2000 grades of steel developed of which 1500 grades are high-grade steels. The large number of grades gives steel the characteristic of a basic production material.

CATEGORIES OF STEEL
 Steel market is primarily divided into two main categories - flat and long. A flat carbon steel product is a plate product or a (hot or cold) rolled strip product. Plate products vary in dimensions from 10 mm to 200 mm and thin flat rolled products from 1 mm to 10 mm. Plate products are used for ship building, construction, large diameter welded pipes and boiler applications. Thin flat products find end use applications in automotive body panels, domestic 'white goods' products, 'tin cans' and the whole host of other products from office furniture to heart pacemakers. Plates, HR coils and HR Sheet, CR Sheet and CR coils, GP / GC (galvanized plates and coils) pipes, etc. are included in this category.  A long steel product is a rod or a bar. Typical rod products are the reinforcing rods made from sponge iron for concrete, ingots, billets, engineering products, gears, tools, etc. Wiredrawn products and seamless pipes are also part of the long products group. Bars, rods, structures, railway materials, etc. are included in this category.  Sponge Iron / Direct reduced iron (DRI): This is a high quality product produced by reducing iron ore in a solid state and is primarily used as an iron input in electric arc furnace (EAF) steel making process. This industry is an integral part of the steel sector. India is one of the leading countries in terms of sponge iron production. There is a number of coal-based sponge iron / DRI plants (in the eastern and central region)

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and also three natural gas based plants (in the western part of the country) in the country.

ROUTES TO STEEL
Two methods of making steel are dominant in modern steel industries all over the world:   Basic Oxygen Steelmaking (BOS) Electric Arc Furnace Steelmaking (EAF)

BASIC OXYGEN STEELMAKING (BOS)
The Blast Furnace is large steel structure about 30 metres high. It is lined with refractory firebricks that

can withstand temperatures approaching 2000oC. The furnace gets its name from the method that is used to heat it. Pre-heated air at about 1000oC is blasted into the furnace through nozzles near its base. The hot air blast to the furnace burns the coke and maintains the very high temperatures that are needed to reduce the ore to iron. The reaction between air and the fuel generates carbon monoxide. This gas reduces the iron (III) oxide in the ore to iron.
iron (III) oxide + Fe2O3(s) + carbon monoxide 3 CO(g) iron + carbon dioxide 3 CO2(g)

2 Fe(s) +

Because the furnace temperature is in the region of 1500C, the metal is produced in a molten state and this runs down to the base of the furnace. The furnace temperature is also high enough to decompose limestone into calcium oxide.
calcium carbonate CaCO3(s) calcium oxide + carbon dioxide CaO(s) + CO2(g)

This oxide helps to remove some of the acidic impurities from the ore calcium oxide
CaO(s)

+ silica

calcium silicate

+ SiO2(s)

CaSiO3(l)

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The impurities are removed react with calcium oxide to make a liquid slag that floats on top of the molten iron. The slag is collected after the denser iron has been run out of a tap hole near the bottom of the furnace.

Blast furnace iron + scrap

steel

ELECTRIC ARC FURNACE STEELMAKING (EAF)

The Electric Arc Furnace (EAF) offers an alternative method of bulk steel manufacture. It makes steel from what would otherwise be unsightly and environmentally damaging scrap metals. It also consumes much less energy than the BOS furnace. Every tonne of EAF steel uses about 7.4 GJ of energy compared with about 16.2 GJ for every tonne of BOS steel.

Furnace design
The EAF is a kettle-shaped structure with a removable lid. The three graphite electrodes that heat the furnace pass through this lid, which can be swung back when the furnace is being charged. The hearth of the EAF, where the metal is melted, is lined with a chemically basic and refractory material. The sequence of operations is similar to that in the BOS furnace, except that, after charging, the charge must be melted down.The furnace charge melts when an electric arc passes between the electrodes and the scrap metal. The temperature around the arc rises to 1200oC and a 100 tonnes charge can be melted in about 60 minutes. The four main stages are (roll over the highlighted word to see the pictures 1. Charging with a mixture of metal and lime. 2. Melting the metal and scrap using electric arcs from the graphite electrodes. After this some more lime is added to clear out the oxides in the next step. 3. Blowing with oxygen to oxidise elements such as carbon, silicon and manganese in the scrap metal. As in the BOS furnace, carbon monoxide escapes as a gas. The oxides of the other elements are acidic and combine with the basic lime to make a neutral slag, which is poured off the surface.

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4. Tapping the metal itself by running it out through the furnace spout into a ladle. The liquid in the ladle is now ready for secondary steelmaking and casting. Further treatments of the metal from the EAF take place in much the same way as steel from the BOS plant.

scrap

steel

STEEL MAKING PROCESS

Source: Bloomberg DIFFERENCE BETWEEN BOS & EAF
Blast Furnace iron Fuel Reducing gas Typical furnace temperature State of metallic product Typical furnace height Continuous or batch process? Directly reduced iron Natural gas or crude oil

coke carbon monoxide 1500oC
Liquid

mixture of hydrogen and carbon monoxide 800oC Solid
40 metres Continuous

30 metres Continuous

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PRODUCT MIX
RODUCT WISE
Semis

Applications
  converted into finished products in the company's processing plant sold to rerollers for conversion to finished products.

Blooms, Billets & Slabs

Structurals Crane Rails Bars, Rods & Rebars
Long Products Wire Rods  construction of tanks, railway cars, bicycle frames, ships, engineering and military equip-ment and automobile and truck wheels, frames and body parts  manufacture of bridges, steel structures, ships, large diameter pipes, storage tanks, boilers, railway wagons and pressurevessels; weatherproof steel plates for the construction of railcars
used in mining, the construction of tunnels, factory structures, transmission towers, bridges, ships railways and other infrastructure projects

HR Coils, Sheets & Skelp Plates
Flat Products

CR Coils & Sheets GC Sheets\ GP Sheets and Coils

Pipes Tubular Products Rails Railway Products Wheels, Axles, Wheel Sets

are longitudinally or spirally welded from hot rolled coils for conveying such things as water, oil and gas. used primarily to upgrade and expand the existing railway network in India

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GLOBAL SCENARIO
World Growth rate to moderate but developing nations to maintain momentum
7.0 14.0 World US EU 5.0 10.0 Japan 4.0 8.0 Developing Countries ex. India & China Brazil Russia India China 0.0 2005 2006 2007 2008f 2009f 0.0

6.0

12.0

3.0

6.0

2.0

4.0

1.0

2.0

Source:World Bank World growth eased from 3.9% in 2006 to 3.6% in 2007. The slowdown was led by the US where growth slowed from 2.9% in 2006 to 2.2% in 2007. Much of the decline was direct fallout of the weakening housing market, with residential investment falling rapidly, and tightening credit conditions for both firms and consumers tightening. Among developing countries, growth remained firm at 7.4% in 2007, after an equally strong 7.5% in Z006, underpinned by continued strength in East and South Asia. If China and India are excluded, activity in low-and middle-income countries slipped by 0.2 percentage points to 5.7% in the year. Outlook: In 2008, global growth is expected to moderate further, as the effective cost of capital remains elevated for financial institutions, firms, and households. Weak domestic demand is expected to keep the US GDP growth below 2% in 2008, while growth in Europe and Japan should continue to ease under the additional weight of appreciating currencies. However, on an aggregate, growth in developing countries is expected to be robust in both

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2008 and 2009, remaining at or above 7%, mainly because of strong domestic momentum in most of them.

US Influence on Global Steel Industry
The US influence over the fortunes of the steel industry has been falling drastically over the last few years with consolidation within the steel industry and consistent huge annual jump in China's steel demand and supply. Now US accounts for just 7% of the global steel production and approximately 10% of the global steel consumption. US domestic steel demand decline was significant last year. However, the US steel price levels were reasonably maintained and had little impact on global steel prices, which increased significantly. This was possible due to reduced US steel production, higher exports by steel companies and lower import as the dollar kept depreciating. Shrinking US share in world crude steel production

Source: IISI US steel prices have already shot up 12% during January 2008 (among all the gloom over possible US recession) since the beginning of the year. This is a strong indicator of the shape of things to come in months ahead. Even US steel price levels would remain at elevated levels through most of 2008 and would positively surprise all stakeholders.

US recession worry overdone, steel demand may improve
After three years of less than 2% Fed rates from November 2001 to November 2004, fed rates started rising at a regular interval to reach peak of 5.25% in June 2006 and remained constant there till June 2007. The US consumer, fully leveraged during the low interest rate regime, had to bear higher EMIs as interest rate kept rising. As long as housing prices were rising they were somehow able to finance these larger EMIs against house mortgages. However, when it peaked and started falling even that option was not viable. The increase in income levels was just not good enough to meet the requirements of increased EMIs and default started happening. This, eventually, blew up into the major sub prime crisis.

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The US Fed, though initially late in responding to the crisis, has been aggressively cutting rates since September 2007. It has already brought it down by 225 bps to 3%. Further Fed rate cuts but at a slower pace is expected. What is to be noted here is that though pessimism is high, the real genesis of the problem is being sorted out to a large extent with these aggressive rate cuts (last 125 bps in eight days) and probable tax rate cuts. The bulk of the sub-prime crisis to be resolved in the next two quarters. The bad loans would start turning good and when the reports of that start coming in the media then positive sentiment would be back. The worst is already behind and the steel sector in the US has already seen a domestic demand slowdown since early last year. The domestic steel demand in US is expected to improve from H22008.

US Fed meeting & Fed rates for last decade(%)

Recently it has been further cut by 75 basis points down to 2.25%. The sharp 300 bps Fed rate cut (since Sep 2007) should help to revive the interest sensitive US household construction and automobile sector with some lag effect .

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Global steel consumption demand led by BRIC nations
BRIC (Brazil, Russia, India and China) countries, which accounted for about 41% of global steel demand in 2006, are again expected growth drivers with 12.8% for 2007 and 11.1% for 2008 as per IISI last estimates. Overall, 77% of world growth in 2007 and 71% in 2008 is expected to take place in BRIC. China's apparent steel use is expected to grow 11.4% in 2007 and 11.5% in 2008, accounting for 35% of the world total. For India, forecasts for apparent steel use point to an increase of 13.7% in 2007 and 11.8% in 2008.

Global per-capita steel consumption exceeded 200 kg for the first time in 2006, according to statistics just published by the International Iron & Steel Institute. The institute puts global consumption of crude steel per capita in 2006 at 202.2 kg, up 8% from 187.0 kg the previous year. UAE (1,724 kg), Qatar (1,336 kg), South Korea (1,073 kg) and Taiwan (1,032 kg) top the list. China's per-capita consumption was 291 kg, an 82% increase in five years while India's per-capita consumption was 42 kg per person, greater than 50% over the last five years.

Steel DD-SS
2006 (mn tonnes) World BRIC Production 1227.5 571.2 Consumption Production 1120.9 457.8 40.8 357.4 31.9 43.1 3.8 1343.5 550.0 41.0 489.0 36.4 53.6 4.0 2007 2008E Consumption Consumption 1197.7 516.6 43.1 398.1 33.2 49.0 4.1 1278.6 573.9 44.9 443.8 34.7 54.8 4.3

BRIC(%Share) 46.5 China 423.3

China(%Share) 34.5 India India(%Share) Source:IISI 46.26 3.8

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Flat Steel Prices
US flat steel product prices have been strengthening due to lower inventory levels. Exports activity of coils by many producers has been reducing domestic supply and has been good enough to offset the weakness in domestic end user demand for new residential building and automobiles. Further support has come from continued low imports of flat steel products due to depreciated dollar and high freight rates. North European prices had been flattish for a while now due to higher domestic production coupled with high imports driven by price premium to other markets and strong currency against the dollar. Imports are expected to moderate, going forward, as price premium decline with rise in prices elsewhere leading to firming of prices in Q2/Q308. Elsewhere, globally demand seems to be exceeding supply. Strong Chinese domestic demand and rising raw materials prices has lead to continuing sharp jump in Chinese domestic prices, leading to both reduction in exports and increase in export prices. This, in turn, has helped demand-supply balance at global level and led to improvements witnessed in price levels globally.

Global HRC prices US$/t
900 850 800 750 700 650 600 550 500 450 India domestic Mumbai (incl Excise/Sales/VAT) china export FoB Shangahi china domestic shangahi (incl. 17% vat Turkey Export FOB US domestic FOB Midwest mill N.Europe domestic Ex-Works

Jun-07

May-07

Mar-07

Dec-07

Apr-07

Oct-07

Jan-07

Aug-07

Nov-07

Feb-07

Sep-07

Jan-08

Jul-07

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Source: Steelbb

Long Steel Prices
Long steel prices reflect the mood of the economy at large and are a direct play on the construction sector: infrastructure and real estate. Spectacular price jumps have been seen in BRIC nations and West Asia, where strong economic development is underway. North American prices have started increasing last month while European prices are expected to rise this month. The price rise has been a function of both strong demand and surge in raw material prices. Interestingly, after a sustained rise last year, prices have been softening in some regions of China since the year beginning. More time is needed to attribute this to any slowdown in construction activities in China, as most Olympics projects reach competition stage or to any effect of the latest tax adjustments.
`

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CHINA - UNDISPUTED LEADER OF GLOBAL STEEL INDUSTRY
China's GDP grew 11.4% YoY in 2007. This is the fastest clip since 1994 and the fifth consecutive year it has grown more than 10%. China's steel production in 2007 reached 489 MMT, a 15.7% rise on 2006 and constituting 36.4% of the global crude steel production of 1343.5 MMT for 2007. China's growth enabled the global steel production to grow 7.5%. Excluding it, global steel production grew a mere 3.3% in 2007. China's annual steel production is larger than the aggregate of the next seven largest steel producing nations put together. China also constitutes about one-third of the global steel demand and more than half of the increment demand. There is no doubt the global steel industry fortunes these days are determined most by China. So much so, that Chinese steel production and consumption have grown at a CAGR of 24% and 18%, respectively, over the past five years.

Chinese production & Consumption

Source: China Customs Statistics

Chinese production growth has shown a declining trend. Chinese steel exports and net exports(’000 tonnes)

Source: China Custom Statistics

Chinese net exports have been declining recently.

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As production considerably outpaced its domestic growth rates, China emerged as a net exporter of steel for the first time in 2005. Since then, the possibility of a rapid surge of surplus steel from China and a subsequent slump in steel prices has been hanging like the sword of Damocles’ over the global steel industry. This has been the single largest concern for steel markets and investors globally.

In Action: Curbing production & exports China hikes export taxes on steel, coke & ferroalloys Attempts to curb production and exports of steel

Source:Steel Business Briefing

Chinese government is really serious about curbing growth of energy intensive industries such as steel. Not only has it adopted several macro-tightening measures (going slow on approvals for new projects, encouraging consolidation, closure of small and fragmented capacity), it has also announced several administrative and fiscal measures to control exports and reign in a ballooning trade balance. As seen from the chart above, the initial impact of these measures is evident by the three consecutive month-on-month decline in net exports. Therefore any real threat of large supplies out of China depressing global prices is not forseen. More so, from an Indian

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perspective, China has not been a major source for imported steel (till 2004 it was a net importer). At the margin, even for small quantities that get imported by India annually, a large share is accounted for by the CIS countries (such as Ukraine etc.). China hiked steel export tax spike for 34 finished steel products begining 2008. The changes are as under:       Semis (billets, slabs, ingots) - 25% now from 15% Welded pipes (Tubes) - export tax introduced at 15% from no taxes Narrow strips (all HR/CR/galvanized/coated) - 15% now from 5% Wire rods & bars (long products - rebar) - 15% now from 10% Sections (only cold-formed) - 15% now from 10% Stainless steel (200 series) - 10% now tax from 5%

Export tax not changed for the following:    HRC, HR plate, HDG or CRC H-beams, I-beams, angles, and channels will remain at 10% Some market insiders had feared HRC exports may be slapped with a 15% export tax - up from a current 5%; and that HDG may lose its 5% rebate Steelmaking raw materials    25% export tax for coke and semi-coke, pig iron and DRI from 15%; hike of 10% 20% export tax on ferroalloys from current 10-15%. Includes high carbon ferrochrome, ferro-nickel and ferro-vanadium. Ferroalloys: Manganese alloys and ferrosilicon - no specific mention in the release from China Government. However, traders are expecting them to be included in the 20% slab. Impact China's government has primarily targeted construction steel products, which are the mainstay of their domestic demand growth. Long steel products that too mainly bars and rods (only 5% tax hike) constituted only 15% of the carbon steel imports from China to India, for April-December 2007. This would marginally help producers of long products.

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Almost 30% of Indian steel imports were from China for April-December 2007. Within this, more than 85% were HR coils/strips, CR coils/sheets and plates. These were left untouched in the recent Chinese export tax hikes. This is negative news for Indian players as these excluded product categories would now be relatively more attractive for higher imports from Chinese steelmakers. We recommend caution and careful scanning of steel import data from China for the next few months, for probable negative surprises. China has also targeted raw materials with strong domestic supply like coking coal, coke and ferroalloys, to primarily conserve its resources and substantially increase steel production costs of global peers. This would not only help revive the competitiveness of Chinese steel companies, which have been uncompetitive due to their heavy dependence on import of iron ore whose prices have sky rocketed. Accounting for 40% of world coke trade, China's export negotiations are often carried out one to one. Chinese large coke enterprises were prepared for the tax hike and had prescribed on the previously signed supply contracts to re-fix the price if tax goes up. Coke prices have been revised upwards drastically in the first month of 2008 post the tax hikes from China and are quoting above $450/ t fob. What explains the absence of a slowdown in steel imports from China despite tax hikes? China's steel product exports were back in business in December 2007 with a rise of 16.59% MoM to reach 4.78 MMT. This was down 13.9% YoY, however. Chinese finished steel monthly exports had been consistently drifting lower for the previous few months from 7.1 MMT in April 2007 to 4.1 MMT for November 2007, caused by the previous export tax adjustments by China in June 2007. Rise in December exports can be attributed to expectations of hikes in export taxes from January 1. However, the new export tax policy has turned out to be less harsh than expected, as the Government did not increase export tax on flats and plates, but on low value-added products, whose exports were already cut anyways. The fall in exports earlier was helped by curtailed production by small Chinese mills who were finding it tough to cope up with a sharp jump in cost of production due to sustained rise in raw material prices. This resulted in reduced supply in domestic markets. This, coupled with continuous strong domestic demand and prices, led to diversion of exports to domestic markets. Subsequently, Baosteel raised Q108 steel prices for China, leading to a rise in China's domestic steel prices. This would ease margin pressure. The blast furnaces, which were earlier closed down should soon be back in action, thus increasing supply.
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In addition, massive 10.8 MMT/year of new HRC capacity is going to be on stream in China within just a month, substantially increasing the supply. Following Ningbo Steel's commissioning of its 4 MMT/year HRC mill on Dec 26 2007, central China's Wuhan Steel and north-east China's Beitai Steel will commission their new HRC mills, with respective capacities of 2.8 MMT/year and 4 MMT/year in late January. For FY07, China's steel exports aggregated 69.1 MMT, product exports were 62.68 MMT up 45.8% while semis exports stood at 6.43 MMT down 28.9%. Steel products imports fell to 17.1 MMT. Net exports of steel products in FY08 zoomed 82.3% to 44.57 MMT against 24.44 MMT in FY07. Forecasting steel export from China has always been a contentious issue. China Iron and Steel Association has forecast steel exports would decline by 20 MMT in 2008 to 50 MMT. Jim Jia, Managing Director of mysteel.com, in his recent presentation at the Seventh Asian Steel Conference in Mumbai, gave an aggressive target of China's steel export falling below 30 MMT for 2008. General expectations of a substantial fall in steel exports from China have been building up of late. But total steel exports from China in 2008 to likely sustain the current year levels of close to 70 MMT. Though exports of semis (billets/slabs) and long products should slump further, any slowdown in exports of flats and plates is not seen. These constitute bulk of steel exports and have been left out of the latest steel export tax hikes. China's steel production for 2008 is expected to be 540-550 MMT, 50-60 MMT increment to 2007 figures. IISI predicts FY07 consumption in China would be 398.1 MMT. It will be closer to 420 MMT. IISI has forecast demand growth of 11.5% to 443.8 MMT, an increment of 45. Similar expectations of sub 50 MMT incremental demand, just falling short of the increment in supply are there. Thus, it would make sense for smart Chinese steelmakers to export rather than increase its inventory levels, even if it has to be at some lower margins. Even in the event of a slowdown in steel exports from China, India is unlikely to benefit, as any reduction if any, is likely to be significant for European destinations (similar to trends seen for the US in FY07) where price premiums are coming down. There are risks of EU antidumping duties and freight costs again shooting up. India, given its geographical proximity and benign demand environment, remains a soft target. Also, as stated earlier, HRC, CRC, HR plate, beams and HDG, constituting more than 85% of imports to India, have

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been left out of hike in export taxes. So general expectations of the Indian steel industry getting some relief in slowdown of steel imports from China looks untenable. China monthly steel exports(mt)

Source:SteelBB China steel products-Monthly exports(tonnes)

Source: Bloomberg

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INDIAN SCENARIO
Healthy outlook driven by sustained Indian domestic growth rate The Indian steel industry is standing on a firm footing with accelerated growth in GDP and expansion in physical infrastructure creation. Steel demand is highly dependent on general economic activity, construction and automobiles.

Steel Business Briefing

Strong demand momentum driven by infrastructure creation, rising consumption Empirical evidence suggests that for developing economies such as India, steel consumption correlates highly with GDP/IP growth. The Indian economy has been growing at a robust 3year average of 8.6%. Sustainability of this trend will necessitate massive infrastructure creation. India’s Planning Commission estimates the total investment needs for infrastructure—including roads, ports, power, airports, and railways— at about US$320 bn over the next five years. Moreover, India is on the cusp of a massive increase in city population driven by rapid urbanization—this in turn will drive the need to build adequate urban infrastructure. The steel sector—a basic building block for construction—will clearly be a direct beneficiary of this infrastructure spend and rising urbanization trend. Simultaneously, higher purchasing power of a rising middle-class (estimated at 355 mn people, about 32% of the population) and easy availability of credit with benign interest rates is resulting in a consumption boom, driving strong incremental demand for automobiles and consumer durables. Steel demand in India is primarily driven by construction, capital goods and automobile segments—all of which have robust underlying momentum. As a result, steel demand in India is expected to grow at a healthy rate of 9% over the next three years.

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Population living in urban areas and as a proportion of overall population

Source: CEIC

India’s growing urbanization trend to drive consumption and demand in the long term. India’s GDP, IP and consumption yoy growth

Source: CEIC

Medium term outlook for GDP and industrial production should drive steel consumption. This is also consistent with the empirical top-down evidence that for developing countries such as India, elasticity of steel demand to GDP growth is in the range of 1.1x-1.3x. So, if the GDP growth trend has to be sustained at 7%-8% range, steel consumption should grow at about 9%. Based on the Planning Commission's estimate of the most likely level of infrastructure investment, total GCF in infrastructure during the Eleventh Plan (2007-08 to 2011- 12) is expected to be Rs.20017.76 bn (at 2006-07 prices) or US$ 500 bn (at exchange rate of Rs.40 per US dollar) against Rs.8805.15 bn anticipated from the Tenth Plan (2002-03 to 2007-08) at a CAGR of 7.5%. This is expected to give a fill up to the demand for long products.

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Infrastructure boom just getting larger and larger

Source :GOI

Expected annual infrastructure Investments in India

Source: GOI

Growth(yoy) in fixed asset investment, infrastructure index

Source: CEIC

Encouraging trends in the near term.

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Change (yoy) in cement despatches(construction) and automobile sales

Source: CEIC

Tata Nano, the world's cheapest car, a quantum leap into the future The Tata Nano, recently unveiled in the Auto Expo 2008, has received high appreciation from both consumers and experts. Its entry would lead to the emergence of a new consumer segment and serve as a major growth engine of domestic auto steel demand. Flat steel is a direct play on car volumes, which would see a sustained jump with the success of the Nano and the response expected from other auto players. Production capacity can be the only constraint as demand in this new segment is expected to outstrip any supply. Beyond the boost for the Indian automotive sector in a few years, India is likely to emerge as a global small car development and manufacturing hub giving a big boost to domestic steel demand. Also, there has been a lot of debate with regards to the stress it would put on road and infrastructure, which is not adequately developed. The solution for this lies is better infrastructure, which would only improve steel intensity and consumption. "Hamara" Bajaj follows suits unveiling prototypes for mass cars and Lite trucks Just 48 hours before the Tata 'people's car' made its debut, another ultra low-cost car, this time from the Bajaj stable, made its appearance. The prototype vehicle will serve as the basic platform for the Renault-Nissan-Bajaj ultra low-cost (priced at around $3,000 or Rs.125,000) car. Bajaj may invest around Rs.7 bn in the venture. Bajaj is pushing to expand the relationship with Renault-Nissan to 'Lite' trucks as well. The company showcased two Lite trucks alongside the car prototype on auto expo. This is just the beginning and this new

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market segment with bring in humongous incremental demand for the steel industry mainly flat products. Indian passenger car market

Source: SIAM

Indian steel demand robust but inventories are up; India to turn net importer of steel for FY07-08 for first time in a decade Indian steel consumption is growing at a record rate of 12.6%. This is almost twice the 6.6% growth in supply to 38.05 MMT by domestic players during April-December 2007. For FY08, Indian finished steel production is expected to be 55.5 MMT, which lands it into top five steel producing nations in the world.

Imports have jumped 68.9% YoY from 2.93 MMT to 4.96 MMT during April-December 2007. In contrast, export growth merely moved 9.1% to 3.85 MMT. This trend is likely to continue and India is likely to emerge as a net importer of steel for FY07-08. Rupee appreciation and high freight charges have affected export attractiveness. The Indian steel industry has also failed to leverage the domestic consumption growth facing pressure from a spurt in steel imports from China, leading to higher inventories, which are up 17.8% to 0.45 MMT.

HRC, plates and CRC constitute bulk of the imports. This is because they are exempt from latest export tax hike from China. For April-December 2007 steel imports from China stood

Page 26

at 1.47 MMT (almost 30% share) with flats and plates constituting more than 85%. So, any slowdown in imports from China is not forseen. India’s net exports of steel

Source: JPC

Witnessing a Decline in the recent past

Capacity, Production & Consumption of steel in India

Source: SBB

Steel consumption continues to sustain rapid growth Supply-side response: Not massive despite announced plans India stacks up as the sixth largest steel producing nation in the world. The Indian steel industry has been operating at average capacity utilization levels of 90% over the past three

Page 27

years. Of this, the major producers comprising large integrated players (the organized sector) have been operating near peak utilization levels. Therefore, incremental growth in production, in our view, will be driven by ramp-up of recently built capacity, and/or commissioning of new brownfield/greenfield capacity. There has been a flood of new capacity expansion plans announced over the past three years, both by existing players and potential new entrants. This has been mainly in the form of signing MoUs (Memorandum of Understanding) with governments of states which are endowed with iron ore/coal deposits. If these MoUs were to materialize, it would lead to a massive trebling of existing capacity—from about 50 mn tpa currently to about 150 mn tpa by 2012—outstripping the forecast demand trends. India will then have to turn into a major exporter of steel to support the incremental output growth. This would, however, be negative for steel pricing trends (as is being witnessed in China currently—with massive increase in output, in excess of domestic consumption growth rate, domestic prices are lower than international prices). However, the translation of a majority of these MoUs on paper into actual facilities on the ground may be hindered because of persisting roadblocks, which include: • land acquisition for greenfield projects has encountered policy hurdles and is taking longer than anticipated. No clear roadmap/guideline in place as various players experiment with different models with varying rates of success; • • no consensus on an adequate relief and rehabilitation policy (including skill development for employment, etc.) for the displaced families to win them over; every single MoU is hinged upon the respective state governments allocating suitable deposits of iron ore for the steel project. There are multiple applicants for each iron ore block and there is no uniform objective criteria to hasten this process; • • • securing environmental and forest clearances have become a long-winded procedure, accentuated by a proactive civil society movement lead-times for equipment suppliers (mining as well as engineering) have considerably increased due to a surge in order books over the past few years; with increasing attraction for white collar jobs, there is a shortage of skilled labor.

Therefore it is not expected that India’s production, and net exporter status would change over the medium term.

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CAPEX Massive investments ahead: Production capacity targets for 2012 & 2020 jump further The Indian steel sector is likely to see investment of Rs.2750 bn by 2012 based on estimation of Rs.40 bn investment per MMT of additional capacity. According to the Steel Ministry, in the most likely scenario the steel production capacity in the country is expected to touch 124 MMT by 2012. Brownfield expansion plans over the next five years are expected to add 40.5 MMT capacity to the existing capacity of 56.84 MMT while greenfield projects are expected to add 28.72 MMT. Supply jump is supported by buoyant demand growth expected to remain above 10% for the next five years according to the Steel Ministry. Furthermore, taking into consideration the intentions expressed by various steel investors including multinationals, domestic steel majors and FDI, the likely capacity achievable by 2019-20 will be around 275 MMT.

Page 29

‘Building steel castles in the air’—Steel projects in India are easier to plan, but difficult to execute Summary of announced steel projects

Source:SteelBB

Page 30

PROFITABILITY ACROSS VALUE CHAIN
RESOURCES
Pure Iron & Steel Making

Processing

RESOURCE PRICES
140 (USD/Tonne) 50 60

600 (USD/Tonne) 500 600 700

CR Coil Steel Prices 250 USD/Tonne) 200

120

400 100 40 80 30 60 20 40 10 100 200 300

500 400 300 200 50 100 150

100

20

0 1995 1997 1999 2001 2003 2005 2007 0 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 CR-HR Spread CIS CR Spot Price 0

0 1992 1994 1996 1998 2000 2002 2004 2006 2008

0

Met coal(LHS)

Iron ore (RHS)

HR Coil Steel Price

Profitability Trend

4-5x rise

2x rise

Flat

(USD/Tonne) 140

50 45 (USD/Tonne)

600 (USD/Tonne) Hot Rolled Coil 400

700 (USD/Tonne) 600 Cold Rolled Coil 500 1x
2X

COAL
120 100 5x 80 60 40 20 0 2003 Op. Cost Profit 2005 Freight

40 35 30 25 20 15 10 5 0

500

IRONORE

400 300 200 100

4x 300

200

100 0 0 2003 Op. Cost 2005 Profit 2003 Op. Cost 2005 Profit Op. Cost Profit 2003 2005

Capital Intensity

Low

High

Medium

Control over resources remain key to profitability

Page 31

COST DRIVERS

Source:Bloomberg

EAF: Production cost(USD/Tonne)
Without Captive inputs Scrap(100%) Other inputs RM Cost Conversion+ overhead TOTAL Price(USD) 330 Input/Tonne Output 1.08 Cost(USD) 356 80 436 40 476

BF+ Other: Production cost(USD/Tonne)
Without Captive inputs Price(USD) Input/Tonne Output Cost(USD)

Iron ore contract price(cif) Met-Coal Contract price cif Other inputs+ overheads TOTAL(Liquid Steel) Casting+ rolling TOTAL Hot Rolled Operataing Cost

84 138 -

1.8 1 -

151 138 100 389 60 449 449

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Steel prices to rise atleast 15% during 2008: Price rise to come in stages. Very bullish for 1H1CY08, Cautious for H2CY08. Indian steel majors have hiked prices by firm $40/t-$60/t after initiating 2008 with a modest hike of US$15/t-30/t. The price rise is in line with sharp rise in global steel price levels. Further price rises in Q2CY08 to aggregate at least 15% during 2008is expected. The price rise would vary across product categories and would be higher for long steel products compared to flat steel products. Most of the price rise is expected due to sustained raw material cost pressures.



Cost of production to shoot up by US$120/t of crude steel. Long term contract prices for 2008-09 of key raw materials namely iron ore (up 57% to US$80.8/t), coking coal (up 66.7% to US$160/t), coke (>60%), ferroalloys (>60%), scrap, energy costs via thermal coal(>50%) and freight charges(>25%) are all expected to shoot up sharply. These will aggregate up to US$120/t for non-integrated steel companies.



Raw material cost pressures to sustain at least for medium term. The cost push in raw material prices is due to the inability of suppliers (mine development takes minimum two to three years on average) to match fast increase in demand driven by China, other BRIC nations and West Asia. Aggressive sustained consolidation in the already highly consolidated raw material industry (further in line is BHP-Rio, CVRD-Xstrata), increasing new mine development cost and appreciating local currencies against the dollar are adding further pressure. Other factors explained later in the report.



Steel industry business model to change in 2008. Steel product price rises are increasingly turning out to be just a pass through of the cost push from raw materials. Though demand is good enough to pass on the bulk of the cost increment, it is not robust enough for steelmakers to cream a buffer over highly significant cost increments. The situation is similar globally, regions and production processes.



Backward integration key to success - coking coal, ferroalloy-ores, iron ore plays best placed.The existing mining operations have not seen any significant jump in production cost. So mineral, steel and ferroalloy companies with captive ownership of key raw materials (ironore, coal, coking coal & ferroalloy ores) would gain enormously as any increment in revenues will flow almost entirely to net profits!

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Weakness over US recession a good time to buy - Big jump in US domestic HRC prices, shock to the system! According to latest industry reports, US domestic hot rolled coil (HRC) prices have shot up $73/t during Jan 2008 (up 12%), putting fob mill price at $699/t. HRC prices are now 24% higher than the 12-month low of $564/t in July 2007. This surprise rapidfire price rise dispels the apprehensions of global steel prices softening in the face of a US recession. If there is no impact in the US' own dockyard, one can discount the impact on global steel price levels.

Biggest Gainers
  Miners owning coking coal, ferroalloy ores & iron-ore. Vertically integrated steel & ferroalloy companies.

Gainers
  Steel companies with high ownership of key steelmaking raw materials. Steel companies with visible concrete steps in this direction.

Losers
 Low ownership of iron-ore, coking coal & maintaining status quo.

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INDUSTRY COST DYNAMICS
There has been a fundamental shift in the cost structure for steel production over the past few years. Cost inflation has impacted all key components—energy prices, key inputs such as iron ore and coking coal, freight charges and labor costs. Not only has this inflated operating costs, but the capital costs have also increased over the past several years.

As the mining industry failed to keep pace with incremental demand growth from a rapid surge in steel production in China, prices of two major inputs—iron ore and coking coal— increased 2.6x and 2.7x, respectively over the past five years.

Iron ore contract prices is expected to rise further by 30% in FY2009E . The analysis indicates that over the past three years there has been a close correlation between six month trailing average premium (prior to the date of contract settlement) and the actual contract settlement. If this relationship holds for the FY2009E negotiations it may be realistic to assume a 30% rise for contract prices.

A surge in sea-borne trade for these bulk commodities has also impacted the freight markets, where freight rates have on an average increased by 180% (Baltic Dry Index) over the past four years.

A majority of the increase in these cost elements is more structural (and therefore more sticky) in nature than cyclical (which is largely largely reversible). As marginal projects need to deliver on the expected ROIC (to cover the cost of capital), a high-cost structure will act as a floor for steel prices and support a high-price regime in the medium term.

India enjoys certain natural advantages which lends ia a sustainable competitive edge to emerge as a hub for steel production and consumption: • • • • Acess to high quality iron ore reserves Competitive labour cost (despite poor productivity) Skilled labour force with mining and steel making experience High domestic demand gowth

Page 35

RESOURCE DEMAND

900

RESOURCE DEMAND TO RISE FURTHER
Steel Demand Rising: BF Output Rising EAF output Rising

40

WorldWorld Ceude Steel Production (mn Tonne)

800 700 600 500

SLowdown Share of EAF rising

Rising Demand /Output Share of EAF falling

35

30

25

20 400 15 300 200 100 0 10

5

0

1988

1970

1972

1974

1976

1978

1980

1982

1984

1986

1990

1992

1994

1996

1998

2000

2002

Blast Furnace
EFFICIENCY AGE : 1978-1988
  

EAF

% of EAF

Incremental steel demand/supply from the western world/ matured economies EAF : Scrap preferred inputs Iron ore and coal took back stage

IRON AGE:1988-TILL DATE  Iron ore and coal taking centre-stage  Incremental steel demand largely

Page 36

2004

HOT METAL : COST CURVE
Hot Metal/ Cost Curve
400

US$/t
350 300 Others 250 Iron ore 200 Coking coal 150 Labour 100 50 0
Russia India Brazil China USA South Korea Japan Germany France

Tight Iron-Ore situation Company Country Tight Coal Situation Company Country

 

 

 

 

 

 

 





 

 

 

 

Russia is best placed. India and Brazil have iron-ore advantage. China enjoys coal advantage
If we take the case of South Korea onwards where there is tightness in irone-ore as well as coking coal HRC price will be: HRC Cost @$450/t= Hot metal cost @$320/t+ Processing Cost @$130/t.

Page 37

Best Case Greenfield Capital Cost (USD/ ton) Operating cost EBIT @ 16% ROCE Depreciation @ 5% EBITDA Cost of Production Selling Price of saleable steel

(USD/ Tonne) 1200 450 192 60 252 450 702

Base Case Brownfield Capital Cost (USD/ ton) Operating cost EBIT @ 16% ROCE Depreciation @ 5% EBITDA Cost of Production Selling Price of saleable steel

(USD/ Tonne) 900 450 144 45 189 450 639

Page 38

Iron-Ore Supply still in the hands of a few(refer to hot metal cost curve)

Iron-Ore:Global Demand(mn tonnes)
Countries Steel outpu t 349 220 128 113 45 112 48 38 116 1132 BF Iron Ore Source/Availability requirement 548 230 101 171 52 151 48 38 1138 Local Local Local Local Local Net Import Net Import Net Import Net Import Net Import Imports

China Europe North America Russia+CIS Latin America Japan Korea India Others World

87% 58% 44% 84% 64% 74% 56% 55% 68%

275 154 132 42 131 734

Local

Iron Ore: Global Supply concentrated in few hands Countries (mn Key Players tonnes) Australia 238 Rio ˜62% BHP Billiton of the Latin America 240 CVRD total India 80 India(fragmented) Others(CIS/Africa/Canada) 176 Others 198 Total 734 734

137 101 218 80

Local iron ore situation Countries China Status Fragmented Structure Largely govt. owned and village ownership Poor quality, high cost High quality, low cost -

India North America Russia+ CIS Latin America

Fragmented Consolidated Consolidated Consolidated

Supply concentration and tight coal situation remain the key factors

Page 39

Iron ore prices- to rise with demand–supply mismatch

Next year contract prices likely to go up significantly, high level of spot prices

Source: World Steel (IISI) Incremental Supply BHP Billiton Rio Tinto CVRD Kumba India Others Total (mn tonnes) 35 60 130 15 15 30 285

Mn tonnes Steel Ouput %growth Pig iron +DRI Iron ore % Pig iron +DRI Incremental Demand (over 07)

Realistic case 05 06 1139 1240 7 9 850 930 1315 1439 75 75 -

07 1352 9 1014 1568 75 -

08E 1446 7 1085 1678 75 -

09E 1533 6 1150 1779 75 -

10E 1610 5 1207 1868 75 299

Iron-ore long-term contract prices hike likely to beat best of estimates
Page 40

The iron ore industry is highly consolidated with more than 70% of the sea-borne trade being controlled by three private players namely CVRD, Rio Tinto and BHPBilliton. Add to this the fact that visible action for merger between BHP and Rio has begun and CVRD is also in advanced merger talks with another mining giant Xstrata. Iron ore is consumed in crude steel production through blast furnace (65% share) and DRI processes with total consumption being approximately 1.65 times of global steel consumption through these processes. Blast furnace process accounts for more than 85% of China's steel production, which has been growing at a staggering pace of 50-60 MMT each year resulting in an incremental iron ore demand of almost 80 MMT each year. It is increasing accepted that China steelmakers would remain dependent on iron ore imports for many years to come. Iron ore spot prices correlate highly with contract markets

Source: CRU

Page 41

India is endowed with abundant deposits of high quality iron ore reserves. Of its 24 bn tonnes of estimated iron ore reserves ,(6% of total global iron ore reserves), about 70% is high-grade haematile with an iron(Fe) content of more than its requirement. As a result, India is also a large exporter of iron ore (accounting for 8% of global sea-borne iron ore trade in 2006), and a key supplier to China. Thus, a rise in contract iron ore prices in FY2009E are likely to be a big positive for Indian steel producers with access to captive high quality iron ore reserves. Any pass-through of higher iron ore prices by global steel producers may lead to higher realizations for Indian companies as well, but without a corresponding increase in raw material costs. While the industry is currently divided over iron ore exports, till the time the Indian steel industry builds enough beneficiation / sintering / pelletization facilities (which consume fines), exports of iron ore will continue. Triggers for iron ore prices settling above market expectations CVRD has cancelled about 5 MMT of iron ore shipments to China in the first quarter, supporting spot iron ore prices as talks over term prices continue Rio-Tinto has already announced selling 15 MMT of iron ore in spot markets for FY08 against 4 MMT in FY07. Rio, in the past, has been accused of being soft in long-term contract prices for iron ore. However, with BHP's hostile bid looming, it is expected to bargain tough to bolster its claim of higher valuation for its stock. Entering big time in spot sales in FY08 is a step in this direction and is likely to weigh heavy on price negotiations. BHP Billiton has already announced its intention of settling FY08 iron ore prices on CFR basis unlike earlier practice of fob basis with CVRD. Given the prevailing high dry bulk freight charges, it wants to leverage Australia's proximity to China and boost its net profits. In January 2007, freight charges for 160,000t cargo for Western Australia-China were around $16/t and Brazil-China was $37/t. Prevailing prices have now shot up to $35.50/t and $82.50/t, respectively. This implies that freight cost advantage for China to import from Australia as opposed to Brazil has increased from $21/t to $47/t, that is, a gain of $26/t, which itself is 50% of the long-term price of iron ore for last year. What is interesting to note here is China snubbing BHP's proposal comes a week before BHP's announcement of a likely takeover bid for Rio-Tinto!

Page 42

Rail freight of iron ore hiked from January 7 2008 to burden Indian steel companies by more than 6% while iron ore companies are required to pay further 60% congestion surcharge on the basic freight. New hikes are in addition to the usual busy season surcharge of 7% apart from 2% development surcharge. Indian iron ore leader NMDC has already raised their long-term prices by 47.5% to Rs.1783/t from Rs.1209/t effective retrospectively from October 1 2007. These rates are still well below the international long-term market rates. NDMC is likely to further raise prices once longterm price negotiations for FY08 are settled. Domestic giants seem to be more active now. This means there is no respite for Indian steel players in FY08. 10-15% ad valorem (or by value) duty on export prices of iron ore has been proposed by the Indian Steel Ministry in the new pre-Budget (expected on February 29) recommendations sent to the Finance Ministry. The proposed duty to curb exports would be based on current fob prices for exports, replacing a system of fixing specific rates on every tonne shipped out of the country. The current duties have had no impact as iron ore exports continue to grow with rising prices. The tax payable under the new duty structure will change with fluctuating prices. China's move of increasing export duty on coke by 10% may lead to acceptance of the proposal in some form. Forecast: Conditions are just ripe for iron ore long-term prices for 2008-09 to jump 57% to US$80.8/t ahead of increased market expectations of 30-50%. Extremely sharp upwards movement being witnessed in scrap prices across markets in last month is a good indicator of its high probability. However, price negotiations to linger for the next few months. They are unlikely to settle sometime soon like last year when the process was completed by Christmas.

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Coking Coal Supply getting Concentrated (refer to hot metal cost curve) Global coking coal demand (mn tonnes) Countries China Europe North America Russia+CIS Latin America Japan Korea India Others World Steel Output 349 220 128 113 45 112 48 38 116 1132 BF 87 58 44 84 64 74 56 55 68 Coking coal requirement 304 128 56 95 29 84 27 21 744 Source/Availability Local Net import Local Local Net import Net import Net import Net import Net import Import 60 0 0 29 84 27 18 10 228

Supply: Concentrated in few hands Countries Australia (mn tonnes) Key Players 125 BHP Billiton/Mitsubushi 45 Anglo/Mitsui 12 Rio Tinto 10 26 Elk Vally 20 X strata 10 26 ~50% of the total 19 ~70% of hard coking coal 12 20 Others 131 228 Total 228

Canada USA Indonesia Russia Others Total

Local Situation Countries China Status Fragmented Structure Large state owned State owned local Town & Village Nos 119 2,000 32,000 %of output 47 16 37

North America Russia+CIS

Consolidated Consolidated

Coking coal supply concentration is rising

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COKING COAL-TIGHTNESS AHEAD

Coal prices are likely to rise, again on rising imports from China/Asia and slower additional supply

Mn tonnes Steel Ouput %growth Pig iron Coking Coal % Pig iron share Incremental Demand (over 07)

Realistic case 05 06 1139 1240 7 9 795 871 731 801 70 70 -

07 1352 9 946 870 70 -

08E 1446 7 1012 931 70 -

09E 1533 6 1150 1779 70 -

10E 1610 5 1127 1037 70 166

Incremental Net Supply China Australia Canada Russia Africa/Others Total

(mn tonnes) 105 25 15 10 10 165

Coking coal tightness to resurface; Prices to go up

Page 45

Coking coal/coke - short supply in India, supply squeezing grips China as well Coking coal international trade dynamics are quite unlike other steelmaking raw materials with China constituting just 5.7% of the total global imports while India's 10.6% share is a little more significant. Going forward, with maximum demand growth coming from China and India, the supply-demand balance would undergo major change. Indian steel production capacity targets for 2012 and 2020 have been revised upwards sharply to 124 MMT and 275 MMT, respectively. China growing @50MMT plus for years now likely to continue similarly. For 2008, India is likely to witness the highest growth rate in coking coal import @ 20.8% to 29 MMT, twice the 14 MMT import expected from China, against the global average growth rate of 2.2%. India currently imports almost entirely from Australia, which has been plagued by port congestion for most of 2007. Coking Coal imports-Key importing nations

Source:Steelguru

On the coke front, India mainly imports from China and partially from the US. China has recently increased the export taxes on coke by 10-25%. This has sent raw materials prices spiraling mercilessly. China has also recently released a new list of 146 coke companies constituting 12.6 MMT of coking coal capacity. These were slated to close by end of 2007. This list is additional to the first list, involving 20 MMT/year of coking capacity released in October 2007 with the same closing deadline for end of 2007. These targets when implemented even with some delay would substantially curtail supply. Luo Bingsheng, Executive Vice Chairman, China Iron & Steel Association, recently announced that inventories of coking coal in some steelworks are less than 10 days. There is some scare buying in the coking coal market. Indeed, the supply of coal is traditionally short before the Chinese New Year because most coal mines stop the production for holidays.

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However, the short supply is extremely serious this year. Recently in northern China there has been increased inspection of truck load limit of 55 MMT, which has become a logistic problem. Further, a majority of Indian steel companies are sitting on very low coking coal/coke inventories. In the latest developments, there have been floods in the Queensland region in Australia, which severely hampered the coking coal mining operations. A curtailed supply in 2008 from the main supplying nation is expected. Coking coal imports,consumption and production (mn MT)

Source: Ministry of Coal

India relies heavily on imports to satisfy its demand for coking coal India does not enjoy the same advantage in coking coal. As per estimates of the Geological Survey of India (GSI), India has about 245 bn tonnes of coal reserves—however, coking coal deposits comprise only 13% (32 bn tonnes) of it. Therefore, the Indian steel industry has to largely rely on imported coal (mainly from Australia). Despite the coking coal handicap, captive iron ore and low labour costs make Indian steel producers among the lowest cost producers (such as Tata Steel’s Indian operations and JSPL). Forecast: Latest coking coal spot prices are reported to be above US$200/t against last year's contract prices of US$96/t. Market conditions are getting extremely tight each passing week. Contract prices for FY08-09 to settle at record levels of US$160/t, up 66.7% YoY. Spot prices of coking coal and coke to significantly rise further even from these levels.

Page 47

Ferroalloys - Soaring high, to climb higher
China with a huge jump of more than 50 MMT in steel production year after year has been leading the demand for ferroalloys. With supply failing to catch up this has led to huge jump in prices of ferroalloy ores. Now, the Indian steel production capacity looks set to zoom during the next decade. The Indian Steel Ministry has upgraded the target for 2012 and 2020 to 124 MMT and 275 MMT, respectively. The fortunes of ferroalloy producers (though mainly integrated ones) is going to be in an upswing for years to come. This is likely to be among the hottest sectors, going forward.

Ferrochrome demand in China climbed last year with a huge jump in production of stainless steel and steelmakers substituting the alloy for nickel, which rose to a record US$51,800/t on the LME in May 2007. China, the world's largest ferrochrome user, probably imported three times more ferrochrome last year than in 2006. China imported 1.24 MMT in the first 11 months as compared with 449,385 ton during the previous year. It also increased imports of chrome bearing rock by 40% to more than 6 MMT. Ferrochrome prices in the EU have shot up to US$ 1.21 a pound, up 55% from the 2007 average of US$0.78. With rising demand from China, increasing costs, low stocks and the absence of new production capacity, prices may top US$1.5 this year.

China had exported 2.93 MMT of ferroalloy in January-November 2007, up almost 50%. Japan was China's main export destination with 1 MMT of ferroalloy or 34.6% share followed by South Korea with 0.33 MMT or 11.4% share. With increase in export tax increasing to 20% from earlier 10-15%, exports are expected to come down while prices are likely to rise further. Earlier in October 2007, the Chinese government had canceled the preferential electricity rates for Chinese ferroalloy plants forcing the producers to increase prices. China has recently announced a second batch of closure of 45 ferroalloy plants with 91 outdated production units with a total capacity of 120,000 ton, located in the inner Mongolia region. In October, China had announced the first batch of 204 ferroalloy plants with a total of 302 outdated production units and 1.17 MMT/ year of ferroalloy capacity, which were to shut down production by the end of 2007.

Back in India, Tata Steel, which was the biggest supplier of chrome ore, has stopped selling to outside parties. They are selling their ore only on toll conversion basis to those who have agreements with them. All these are pointers to the huge shortage of the alloy and the present price increases can not only sustain but also maintain upward momentum for few years to come.

Page 48

Ferroalloys prices (US$/lb)

Source: Bloomberg

Freight rates cost pressures shaping up trading dynamics
Dry bulk freight rates at end-2007 were more than double the end-2006 levels. Thus, Asian peers are finding nearby countries like India relatively attractive. China, along with Malaysia and Thailand, accounted for almost two-third of steel imports during the period.

Ocean freight rates are substantially below the all-time high, reached in November. This has been due to a combination of factors like seasonal slowdown, easing traffic at Australian ports, short-term stoppage of exports from CVRD in Brazil, flooding in Australia and South Africa resulting in coal exports slowdown etc. The underlying tone remains strong and with fuel costs persisting at high levels,dry bulk freight charges would bounce up again from these levels in the coming months.

Page 49

Freight charges will be back in action soon

Source:Bloomberg

Aggregate Cost Increment Forecasts
Hike in resource prices 200809E(%) ~Increase in steel prod.costs US$/t

Iron ore Coking Coal Coke Thermal Coal Ferro Alloys Freight Charges Total

57 66.70 >60 >50 >60 >25

50 48 3 7 120 120

To sum up, the cost of production can shoot up to $120/t for blast furnace steel producers without vertical integration. With captive ownership of various resources, proportionate cost increase can be prevented. EAF players using scrap are worse off as sharper price jumps are being witnessed in global scrap prices. Turkey prices for America scrap have reached CFR US$460/t, a massive 31% jump from US$350/t levels in early November 2007.

Page 50

Cycles getting shorter
• • • Supply-side shocks are causing steel spot prices to contract, with the average cycle now lasting only a year in Asia This is expected to continue till 2009 or at least while China remains a major net exporter of steel to the region Ironically, shorter spot price cycles lead to flatter, or more stable, contract price cycles(see graphs below) which means the average selling prices of steel products do not change much year to year (see graph) in a short cycle if the entire cycle plays out in a year

• Stable contract prices should lead to stable margins and returns. Lower volatility of
earnings and returns should, in our view, be rewarded by markets with higher valuations.

Normal steel cycles

Shortened steel cycles

Contract prices generally follow the same peaks and valleys in a normal, longer, spot price cycle. But shorter spot cycles, however, can flatten the contract price cycles.

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Shorter Cycles: Normalized price through the cycle

Source: Goldman Sachs

In a flatter contract price cycle, ASPs do not change much year to year. In a more consolidated steel universe, the more tangible benefits of consolidation, such as structurally higher steel prices, in an industry as global as steel can be enjoyed by all. Therefore expect prices, profits and returns to be structurally higher—which should result in higher valuations.

High prices to be sustained Indian steel prices are linked to East Asian steel prices, adjusted for import tariffs, exchange rate fluctuations, freight rates, etc. Domestic steel prices are generally pegged at a certain discount to the landed cost of imported steel to discourage domestic buyers from resorting to imports. In the past five years, domestic HRC steel price has been at a discount of 5% to landed cost of imported metal. Domestic discount/premium to landed cost

Page 52

Demand- supply and other conditions dictate premium/discount of domestic prices to landed cost. bull run in steel prices will be sustained over the medium term, and prices are not likely to retrace to historical long-term average levels. With raw material and freight markets showing no signs of easing off, risks remain on the upside.

On the raw material side, iron ore and hard coking coal prices are likely to increase by 30% and 20% respectively, for FY2009E.

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PRICING OUTLOOK
Indian steel makers hike steel prices beginning Feb 2008 by firm US$40/t-US60/t after modest hike of US$15/t – US30/t last month. Steel Authority of India Ltd has raised prices by Rs.1500/t- 2500/t after raising Rs.600-700/t for long products, cuts rebates by same amount for flats last month. RINL has raised prices by Rs.3000/t- 3500/t after raising Rs.800/t for round steel products, Rs.1000/t for TMT bars, Rs.1200/t for semis and Rs.1200-1500/t for structural products last month. Tata Steel has raised prices by Rs.2000/t- 2500/t after raising by Rs.800-900/t last month and Ispat Industries has raised prices by Rs.2000/t, after raising it by Rs.600-800/t last month. Other private players have hiked prices similarly.

Domestic price hike in line with global price trends
World leader ArcelorMittal and China majors like Baosteel and Anshan had already declared significant price hikes beginning Q1CY08 and have continued the trend for coming months. Turkish producers are contracting rebar at $720-725/t fob for March deliveries. This is up from $635-645/t last month and $555-560/t in October 2007, a 30% jump in just three months! In Dubai Gold & Commodities Exchange (DGCX), rebar futures prices are going up rapidly. The DGCX rebar price, which started December at $653.6/t for February contracts has now shot up to $803.4/t, so it has put on incredible $150/t or 22.9% in just one and a half months. Prices for March and April contract stood at $836.2/t and $845.2/t, respectively. Even though DGCX is new in the rebar market, it has fast become a barometers of price movements in the physical market and future expectations. Price hikes to come in stages Recent price hikes are just a beginning. More hikes by the next quarter is expected. Globally, strong consumption trends in Brazil, Russia, India, China and the West Asia are offsetting weakness in the US. Even in the US, prices are rising despite a fall in end user demand, driven by demand from steel service centers where inventory levels are low, as also a fall in imports and jump in exports.

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Raw material cost pressures for iron ore, coking coal, coke and scrap; higher energy costs and freight charges have substantially increased the average cash costs of steel industry and price rises are necessary to sustain margins. The dollar has been depreciating sharply over the last year and this trend is expected to continue this year as well. So offset for currency exchange losses arising out of this there is upward pressure on all commodities and similarly on steel products. How the product price hikes will offset this cost push varies with product categories. It is higher for semis and long products and lower for flats (HRC, CRC) and plates. However, even for HRC huge 17% (approximately) price rise would only help to sustain margins. The ongoing supply tightness in the Indian steel industry to enable steel producers to pass on the bulk of the cost increment is expected. However, it looks unlikely that they would be able to cream a buffer. We forecast steel product prices will rise atleast 15% during the year. With varying demand inelasticity and supply pressures across product categories, percentage price push from steelmakers would also vary significantly. Long steel products fueled by booming infrastructure and real estate is likely to lead to price growth this year. Flat steel products price growth is likely to be comparatively weaker given import pressure from China.

Gainers & Losers
Vertically integrated blast furnace producers stand to cash windfall as they benefit from price hikes of steel products without facing significant raw material cost pressures. Mineral companies (though few in India) owning these resources are best placed. Potentially, their net profit growth can surpass the best of expectations. Those with a high degree of self-sufficiency of key raw materials like iron ore and coking coal also stand to gain and so would be one's taking visible concrete movements in that direction. Those with limited or no captive resources would struggle to maintain their operating margins. Given that the industry, at present, is in a comfort zone of record margins levels, even some compressed operating margins are bearable. However, the problem lied in the radical shoot up of valuation of steel companies with little discrimination and with the likelihood of many among these delivering performance below expectations, this would likely be corrected, going forward.

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Snakes and ladders Biggest Gainers + Miners owning coking coal/Iron-ore & Ferroalloy Ores + Vertically Integrated Steel & Ferroalloy Companies Gainers Losers + Steel Companies with high ownership of key steelmaking raw materials + Steel Companies with visible concrete steps in this direction - Low ownership of iron-ore, coking coal & maintaining status quo

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COMPANY SECTION

INDIAN STEEL COMPANY POSITIONING
OLIGOPOLY
FRAGEMENTED

Industry Surface

Differentiation Uttam Bhushan Jindal Steel Mukund
Generic Strategy Different iation Success Factors -Niches

Cost Leadership

Kalyani

Alliances -Services

Generic Strategy -Cost Leadership Success Factor -Long term access to high quality -Economy of Scale

Visa Steel Monnet JSPL Steel

JSW Steel Sail Tata Steel

Denote Future Strateg y Shift

VALUE CHAIN

Iron Ore, Coal, Thermal ore, Alloy Ore

Sponge Iron, Coke, Power

Iron & Steel

Semi Fabrication

Fabrication

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POSITIONING ACROSS VALUE CHAIN

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VALUATIONS OF COMPANIES
SAIL
SAIL: volumes to almost double in 6 yrs

SAIL is best placed on the India growth story   Sizable presence and domestic leadership Captive resources, scalable and integrated

Growing dominance: Backed by cash flows and resources    Capacity: To rise from 12mn to 24+mn tonnes in FY11 through internal growth and acquisitions Cost competitiveness: Captive resources (iron ore, coal) and modernization Rich product mix: Higher value-added sales

Globally cost competitive player in steel    Vertically integrated and one of the lowest cost producers (HRC)at ~USD325

Enrichment of Product Mix

Sizable iron ore resource (~2bn tonnes new mines) already allotted Hedge against cyclical downturn

Steady growth and attractive valuations   We forecast an EPS of Rs 18.4 for FY08 and Rs 21.2 for FY09 At CMP Rs 201, SAIL trades at 5.0x FY09E EV/EBITDA – maintain sector Outperformer rating

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Profit model (Rs mn) Total revenue Cost of goods sold SG&A R&D Other operating profit/(expense) EBITDA Depreciation & amortization EBIT Interest income Interest expense Income/(loss) from uncons. subs. Others Pretax profits Income tax Minorities Net income pre-preferred dividends Preferred dividends Net income (pre-exceptionals) Post-tax exceptionals Net income EPS (basic, pre-except) (Rs) EPS (basic, post-except) (Rs) EPS (diluted, post-except) (Rs) DPS (Rs) Dividend payout ratio (%) Free cash flow yield (%)

3/07 3/08E 3/09E 3/10E 339231.20 373877.70 401842.50 428261.60 (201795.10) (196094.90) (212799.70) (234752.80) (57794.60) (62098.70) (66728.50) (71709.00) 0.00 0.00 0.00 0.00 10380.00 (15476.50) (15811.40) (16570.30) 102136.30 114030.90 124068.10 128394.60 (12114.80) (13823.30) (17565.10) (23165.10) 90021.50 100207.50 106503.00 105229.50 7526.00 3843.90 4041.10 2043.20 (3321.30) (2564.60) (1992.90) (2307.90) 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00 94226.20 101486.80 108551.20 104964.80 (32203.30) (33490.70) (35821.90) (34638.40) 0.00 0.00 0.00 0.00 62022.90 0.00 62022.90 0.00 62022.90 -15.02 15.02 3.10 20.60 14.90 67996.20 0.00 67996.20 0.00 67996.20 -16.46 16.46 3.29 20.00 4.60 72729.30 0.00 72729.30 0.00 72729.30 -17.61 17.61 3.52 20.00 (3.70) 70326.40 0.00 70326.40 0.00 70326.40 -17.03 17.03 3.41 20.00 (5.80)

Growth & margins (%) Sales growth EBITDA growth EBIT growth Net income growth EPS growth Gross margin EBITDA margin EBIT margin

3/07 21.90 47.60 57.60 54.60 54.60 40.50 30.10 26.50

3/08E 10.20 11.60 11.30 9.60 9.60 47.60 30.50 26.80

3/09E 7.50 8.80 6.30 7.00 7.00 47.00 30.90 26.50

3/10E 6.60 3.50 (1.20) (3.30) (3.30) 45.20 30.00 24.60

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Balance sheet (Rs mn) Cash & equivalents Accounts receivable Inventory Other current assets Total current assets Net PP&E Net intangibles Total investments Other long-term assets Total assets Accounts payable Short-term debt Other current liabilities Total current liabilities Long-term debt Other long-term liabilities Total long-term liabilities Total liabilities

3/07 96098.30 23147.50 66514.70 18025.70 203786.20 128337.50 1291.50 5137.90 0.00 338553.10

3/08E 3/09E 3/10E 101028.60 51080.00 9476.50 30729.70 33028.20 35199.60 78438.00 85119.90 78250.90 18025.70 18025.70 18025.70 228221.90 187253.70 140952.70 144514.20 236949.10 353784.00 1291.50 1291.50 1291.50 5137.90 5137.90 5137.90 0.00 0.00 0.00 379165.50 430632.20 501166.10

21833.10 20486.40 22018.80 23466.40 6572.10 6572.10 6572.10 6572.10 87656.70 87656.70 87656.70 87656.70 116061.90 114715.20 116247.60 117695.20 35233.10 24897.90 18897.90 33897.90 14126.60 14126.60 14126.60 14126.60 49359.70 39024.50 33024.50 48024.50 165421.60 153739.70 149272.10 165719.70

Common stock & premium 41304.00 41304.00 41304.00 41304.00 Other common equity 131827.50 184121.70 240056.10 294142.40 173131.50 225425.70 281360.10 335446.40 Total common equity 0.00 0.00 0.00 0.00 Minority interest Total liabilities & equity BVPS (Rs) 338553.10 379165.50 430632.20 501166.10 41.31 53.90 67.37 80.37

Ratios ROE (%) ROA (%) ROACE (%) Inventory days Receivables days Payable days Net debt/equity (%) Interest cover - EBIT (X)

3/07 41.50 19.70 52.40 116.30 22.60 38.80 (31.40) NM

3/08E 34.10 18.90 48.90 134.90 26.30 39.40 (30.90) NM

3/09E 28.70 18.00 34.70 140.30 29.00 36.50 (9.10) NM

3/10E 22.80 15.10 22.70 127.00 29.10 35.40 9.20 397.50

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Valuation P/E (analyst) (X) P/B (X) EV/EBITDA (X) Dividend yield (%)

3/07 11.20 4.10 2.90 1.80

3/08E 10.20 3.10 5.50 2.00

3/09E 9.50 2.50 5.40 2.10

3/10E 9.90 2.10 5.70 2.00

Cash flow statement (Rs mn) Net income pre-preferred dividends D&A add-back Minorities interests add-back Net inc/(dec) working capital Other operating cash flow Cash flow from operations Capital expenditures Acquisitions Divestitures Others Cash flow from investments Dividends paid (common & pref) Inc/(dec) in debt Common stock issuance (repurchase) Other financing cash flows Cash flow from financing Total cash flow

3/07 3/08E 62022.90 67996.20 12114.80 13823.30 0.00 0.00 (5411.20) (20852.10) (6122.90) 0.00 61031.80 60967.40

3/09E 72729.30 17565.10 0.00 (7448.00) 0.00 82846.40

3/10E 70326.40 23165.10 0.00 6145.10 0.00 99636.60

(10908.40) (30000.00) (110000.00) (140000.00) 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00 (1822.10) 0.00 0.00 0.00 (12730.50) (30000.00) (110000.00) (140000.00) (11067.70) (15702.00) (1114.90) (10335.20) 0.00 0.00 (1746.80) 0.00 (13929.40) (26037.20) 34371.90 4930.30 (16795.00) (6000.00) 0.00 0.00 (22795.00) (49948.60) (16240.10) 15000.00 0.00 0.00 (1240.10) (41603.40)

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TATA
Milestones in the offing…  Equity raising and capacity expansion are the key to future success of Tata Steel
FY 09: 2 mnt. BRownfield Capacity addition FY 10: Synergies gain & 3mnt. Brownfield expansion FY 11: Green field expansion

…but not without short-term financial challenges:  

Higher interest costs on bridge debt financing

FY 08: Equity Raising

Tax inefficiencies for one of the SPVs (Tata Steel Asia)

Thus, sustainable success hinges on:   Improving margin by enhancing integrated operations in India Corus synergy gains/ reducing the high operating leverage

SPV
SPV Structure Additional Interest Tax efficiency of borrowing

Tata Steel (India)

3bn equity yet to be raised

High

Tata Steel Asia Holdings Pte Ltd

Low

Tata Steel UK Ltd High Corus Group Plc

Risks:  Increased financial leverage  Drag on operating margin with acquisition of Corus

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Profit model (Rs mn) Total revenue Cost of goods sold SG&A R&D Other operating profit/(expense) EBITDA Depreciation & amortization EBIT Interest income Interest expense Income/(loss) from uncons. subs. Others Pretax profits Income tax Minorities Net income pre-preferred dividends Preferred dividends Net income (pre-exceptionals) Post-tax exceptionals Net income EPS (basic, pre-except) (Rs) EPS (basic, post-except) (Rs) EPS (diluted, post-except) (Rs) DPS (Rs) Dividend payout ratio (%) Free cash flow yield (%)

3/07 3/08E 3/09E 3/10E 251177.80 1160944.90 1229115.00 1201185.10 (171272.50) (809058.40) (862425.90) (825921.00) (19049.60) (202862.20) (214750.00) (227192.40) 0.00 0.00 0.00 0.00 5179.80 9829.10 10937.30 11124.60 76145.30 192540.20 201573.60 203389.00 (10109.80) (33686.80) (38697.20) (44192.80) 66035.50 158853.40 162876.40 159196.20 0.00 2582.70 913.70 1802.10 (4111.90) (26609.70) (36754.40) (38196.30) 791.80 356.50 356.50 356.50 0.00 0.00 0.00 0.00 62715.40 135182.90 127392.20 123158.50 (21474.10) (32814.20) (31769.20) (31542.80) (675.20) (520.90) (876.70) (1414.30) 40566.10 0.00 40566.10 0.00 40566.10 -70.95 70.95 16.51 23.30 6.60 101847.80 0.00 101847.80 0.00 101847.80 -126.29 111.24 10.78 8.50 (0.30) -117.48 103.48 11.14 9.50 (4.50) 94746.30 0.00 94746.30 0.00 94746.30 -98.52 98.52 10.31 10.50 (8.00) 90201.40 0.00 90201.40 0.00 90201.40

Growth & margins (%) Sales growth EBITDA growth EBIT growth Net income growth EPS growth Gross margin EBITDA margin EBIT margin

3/07 24.10 18.20 18.30 11.30 7.50 31.80 30.30 26.30

3/08E 362.20 152.90 140.60 151.10 78.00 30.30 16.60 13.70

3/09E 5.90 4.70 2.50 (7.00) (7.00) 29.80 16.40 13.30

3/10E (2.30) 0.90 (2.30) (4.80) (16.10) 31.20 16.90 13.30

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Balance sheet (Rs mn) Cash & equivalents Accounts receivable Inventory Other current assets Total current assets Net PP&E Net intangibles Total investments Other long-term assets Total assets Accounts payable Short-term debt Other current liabilities Total current liabilities Long-term debt Other long-term liabilities Total long-term liabilities Total liabilities

3/07 3/08E 3/09E 3/10E 108879.60 53657.90 48893.00 52835.30 16865.30 170757.70 178677.60 170184.40 38881.30 213319.80 234772.80 270835.10 19815.00 33500.60 33500.60 33500.60 184441.20 471236.00 495844.00 527355.40 142205.30 401613.60 472730.60 547271.70 4294.30 159733.70 159733.70 159733.70 164975.00 147969.60 148326.10 148682.50 0.00 0.00 0.00 0.00 495915.80 1180552.90 1276634.40 1383043.30 17915.90 13901.50 57321.70 89139.10 235353.80 19217.00 254570.80 343709.90 199978.40 22078.90 59133.40 281190.70 471545.00 65944.50 537489.60 818680.30 9618.10 341959.50 355510.20 6362.50 208997.10 24028.90 59133.40 292159.50 471545.00 65944.50 537489.60 829649.00 9618.10 426487.60 439161.60 7823.80 198338.80 60528.90 59133.40 318001.10 471545.00 65944.50 537489.60 855490.70 9618.10 506470.20 517729.90 9822.70

7270.60 Common stock & premium 138951.40 Other common equity 146222.00 Total common equity 5983.90 Minority interest Total liabilities & equity BVPS (Rs)

495915.80 1180552.90 1276634.40 1383043.30 255.75 388.29 479.66 565.47

Ratios ROE (%) ROA (%) ROACE (%) Inventory days Receivables days Payable days Net debt/equity (%) Interest cover - EBIT (X)

3/07 32.60 11.60 20.80 71.00 21.10 51.30 92.20 16.10

3/08E 40.60 12.20 22.00 56.90 29.50 49.20 121.60 6.60

3/09E 23.80 7.70 14.50 94.80 51.90 86.50 99.90 4.50

3/10E 18.90 6.80 12.50 111.70 53.00 90.00 90.80 4.40

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Valuation P/E (analyst) (X) P/B (X) EV/EBITDA (X) Dividend yield (%)

3/07 9.70 2.70 5.60 2.40

3/08E 6.20 1.80 5.20 1.60

3/09E 6.60 1.40 5.00 1.60

3/10E 7.00 1.20 5.50 1.50

Cash flow statement (Rs mn) Net income pre-preferred dividends D&A add-back Minorities interests add-back Net inc/(dec) working capital Other operating cash flow Cash flow from operations Capital expenditures Acquisitions Divestitures Others Cash flow from investments Dividends paid (common & pref) Inc/(dec) in debt Common stock issuance (repurchase) Other financing cash flows Cash flow from financing Total cash flow

3/07 40566.10 10109.80 0.00 2538.70 (2208.30) 50946.80 (29270.80) (11.10) 0.00 (131481.30) (160763.20)

3/08E 101847.80 31998.00 0.00 (26995.60) 0.00 107014.70

3/09E 94746.30 36856.90 0.00 (20354.20) 0.00 111769.10

3/10E 90201.40 42263.70 0.00 (38227.40) 0.00 95295.60

(90378.00) (109814.20) (118733.80) 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00 (90378.00) (109814.20) (118733.80) (10510.20) 1950.00 0.00 1840.30 (6719.90) (4765.00) (11048.50) 36500.00 0.00 1929.00 27380.50 3942.30

(7116.60) (10172.60) 201692.70 239169.50 15458.50 (339438.90) 893.90 38583.60 210928.50 (71858.30) 101112.10 (55221.70)

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JINDAL STEEL & POWER Ltd
Resource advantage:  Sizable iron ore & thermal coal reserves used in steel Sponge iron & teel business: Cost competitive (~25%) compared to BF producers  Profitable and rapidly growing business (75% of FY07 EBIT)  Steel expansion: 2.5 mtpa steel capacity already in place; volumes to nearly triple in two years from current level  Optimizing captive resources for further value addition ( flat products - steel plates)  EAF+ BF ( captive iron ore + imported coking coal)

Power: Offsetting steel cyclicality  Hugely profitable business – (25% of FY07 EBIT)  Power capacity to increase nearly four times from current 340 MW through subsidiary; setting up 1,000 MW mega thermal power project using captive coal  High ROE business (~30% ROE) ,merchant power plant outside the purview of regulated returns Valuations  At CMP of Rs 5,099 the stock trades at 6.7x FY09E consolidated EV/EBITDA  Sector Neutral rating

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V/EBITDA for Steel Business
Profit model (Rs mn) Total revenue Cost of goods sold SG&A R&D Other operating profit/(expense) EBITDA Depreciation & amortization EBIT Interest income Interest expense Income/(loss) from uncons. subs. Others Pretax profits Income tax Minorities Net income pre-preferred dividends Preferred dividends Net income (pre-exceptionals) Post-tax exceptionals Net income EPS (basic, pre-except) (Rs) EPS (basic, post-except) (Rs) EPS (diluted, post-except) (Rs) DPS (Rs) Dividend payout ratio (%) Free cash flow yield (%) -229.26 226.15 18.00 7.90 (38.40) 3/07 3/08E 3/09E 3/10E 35198.10 51645.90 78339.30 90999.20 (19465.50) (29605.90) (36603.40) (41418.00) (5106.50) (6297.80) (7843.30) (8833.60) 0.00 0.00 0.00 0.00 287.20 395.90 493.70 556.30 14278.80 22205.20 41633.60 49520.90 (3365.50) (6067.20) (7247.30) (8217.00) 10913.30 16138.00 34386.30 41303.90 0.00 21.20 26.20 63.30 (1504.30) (2453.60) (4933.50) (4873.60) 61.80 0.00 0.00 0.00 0.00 0.00 0.00 0.00 9470.80 13705.60 29479.00 36493.60 (2418.50) (3597.30) (4770.90) (5466.60) 7.20 0.60 (19.50) (27.20) 7059.50 0.00 7059.50 0.00 7059.50 10108.90 0.00 10108.90 0.00 10108.90 -328.30 323.83 27.17 8.30 (18.60) 24688.50 0.00 24688.50 0.00 24688.50 -801.78 790.88 36.03 4.50 6.40 30999.80 0.00 30999.80 0.00 30999.80 -1006.75 993.06 41.28 4.10 16.00

Growth & margins (%) Sales growth EBITDA growth EBIT growth Net income growth EPS growth Gross margin EBITDA margin EBIT margin

3/07 3/08E 3/09E 3/10E 35.9 46.7 51.7 16.2 38.1 55.5 87.5 18.9 33.9 47.9 113.1 20.1 21.1 43.2 144.2 25.6 21.1 43.2 144.2 25.6 44.7 42.7 53.3 54.5 40.6 43 53.1 54.4 31 31.2 43.9 45.4

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Balance sheet (Rs mn) Cash & equivalents Accounts receivable Inventory Other current assets Total current assets Net PP&E Net intangibles Total investments Other long-term assets Total assets Accounts payable Short-term debt Other current liabilities Total current liabilities Long-term debt Other long-term liabilities Total long-term liabilities Total liabilities Common stock & premium Other common equity Total common equity Minority interest Total liabilities & equity BVPS (Rs)

3/07 3/08E 3/09E 3/10E 986.10 1763.50 13931.20 26035.90 3203.10 5869.00 8477.50 9778.60 6424.40 11053.80 13564.20 15346.10 9314.90 7859.40 7859.40 7859.40 19928.50 26545.70 43832.30 59020.00 79058.00 103114.20 113211.10 119255.70 89.70 32.40 32.40 32.40 1087.30 590.70 590.70 590.70 0.00 0.00 0.00 0.00 100163.50 130283.00 157666.50 178898.80 9903.40 22101.00 6105.10 38109.50 32259.20 4150.40 36409.60 74519.10 164.00 25426.50 25590.50 53.90 9050.20 11946.80 6067.50 27064.50 62902.40 4150.40 67052.80 94117.30 164.00 34565.00 36150.90 14.80 11352.60 11946.80 6067.50 29366.90 64562.40 4150.40 68712.80 98079.70 164.00 57966.60 59552.50 34.30 12816.50 11946.80 6067.50 30830.80 54778.40 4150.40 58928.80 89759.60 164.00 87491.80 89077.70 61.60

100163.50 130283.00 157666.50 178898.80 831.07 1174.02 1934.01 2892.86

Ratios ROE (%) ROA (%) ROACE (%) Inventory days Receivables days Payable days Net debt/equity (%) Interest cover - EBIT (X)

3/07 3/08E 3/09E 3/10E 31.6 32.7 51.6 41.7 8.5 8.8 17.1 18.4 12.5 12.6 24.9 27.9 113.5 107.7 122.7 127.4 32.1 32.1 33.4 36.6 159.3 116.8 101.7 106.5 208.1 202.1 105 45.6 7.3 6.6 7 8.6

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Valuation P/E (analyst) (X) P/B (X) EV/EBITDA (X) Dividend yield (%)

3/07 3/08E 3/09E 3/10E 17.3 12.1 4.9 3.9 4.7 3.3 2 1.4 7.8 8.7 4.4 3.3 0.5 0.7 0.9 1.1

Cash flow statement (Rs mn) Net income pre-preferred dividends D&A add-back Minorities interests add-back Net inc/(dec) working capital Other operating cash flow Cash flow from operations Capital expenditures Acquisitions Divestitures Others Cash flow from investments Dividends paid (common & pref) Inc/(dec) in debt Common stock issuance (repurchase) Other financing cash flows Cash flow from financing Total cash flow

3/07 3/08E 3/09E 3/10E 7059.50 10108.90 24688.50 30999.80 3365.50 6067.20 7247.30 8217.00 0.00 0.00 0.00 0.00 2880.40 (8148.40) (2816.60) (1619.10) 130.80 1417.90 0.00 0.00 14871.00 9444.90 29138.70 37625.00 (35885.80) (30123.40) (17344.10) (14261.70) 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00 245.50 0.00 0.00 0.00 (35640.30) (30123.40) (17344.10) (14261.70) 0.00 21071.30 0.00 (317.70) 20753.60 (15.70) (970.40) 20489.00 0.00 1937.30 21455.90 777.40 (1287.00) (1474.60) 1660.00 (9784.00) 0.00 0.00 0.00 0.00 373.00 (11258.60) 12167.70 12104.70

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JSW Steel Ltd

Robust volume growth with enrichment in product mix: To grow ~3x in 4 years  Set to grow from 3.8 mtpa to 10 mtpa by FY11  Diversified product mix: Long products capacity & acquisition of plate mill in USA Cost competitive expansion supported by healthy cash flows

JSW:Capacity Buildup Schedule

 Capacity expansion at capital cost of ~ USD 540/ tonne  Total project cost – Rs 171 bn  Timely commissioning of facilities holds the key Recent acquisition of US Steel facilities  To further enrich product mix  Signs of capital misallocation  Increased financial risk with rising leverage Risk factors  Increased financial leverage
FY 09: Margin expansion of US operations FY 08: 1mtpa CR mill commissioning FY 10: 6.8mtpa Brownfield expansion FY 11: 10mtpa Brownfield expansion

 Input cost pressure (especially increase in coal & coke costs) Valuations  Financial risks, arising out of leverage would offset valuation upside, until project execution milestones are reached  Valuations capture near term upsides. Sector Neutral rating with a target price of Rs 660

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Profit model (Rs mn) Total revenue Cost of goods sold SG&A R&D Other operating profit/(expense) EBITDA Depreciation & amortization EBIT Interest income Interest expense Income/(loss) from uncons. subs. Others Pretax profits Income tax Minorities Net income pre-preferred dividends Preferred dividends Net income (pre-exceptionals) Post-tax exceptionals Net income EPS (basic, pre-except) (Rs) EPS (basic, post-except) (Rs) EPS (diluted, post-except) (Rs) DPS (Rs) Dividend payout ratio (%) Free cash flow yield (%)

3/07 3/08E 3/09E 3/10E 85944.40 120881.80 170737.70 226233.70 (54442.20) (77119.50) (109948.20) (139039.10) (6819.90) (13595.40) (24930.30) (29358.00) ----(1106.30) (54.40) (318.00) (217.80) 28558.30 38161.60 46080.40 70238.00 (4982.30) (8049.10) (10539.10) (12619.10) 23576.00 30112.50 35541.20 57618.80 ----(4313.50) (6619.00) (7933.20) (9070.90) 0.00 0.00 0.00 0.00 (428.80) 0.00 0.00 0.00 18833.70 23493.50 27608.00 48547.90 (6231.80) (9117.70) (8006.30) (14078.90) 0.00 7.00 (233.50) (368.40) 12601.90 0.00 12601.90 0.00 12601.90 -80.16 78.93 13.04 16.30 (2.60) 14382.90 0.00 14382.90 0.00 14382.90 -83.63 77.44 12.31 14.70 (68.30) 19368.20 0.00 19368.20 0.00 19368.20 -112.62 104.28 16.58 14.70 (35.40) 34100.60 0.00 34100.60 0.00 34100.60 -198.28 183.60 29.19 14.70 (12.80)

Growth & margins (%) Sales growth EBITDA growth EBIT growth Net income growth EPS growth Gross margin EBITDA margin EBIT margin

3/07 38.30 59.70 70.50 47.70 39.50 36.70 33.20 27.40

3/08E 40.70 33.60 27.70 14.10 4.30 36.20 31.60 24.90

3/09E 41.20 20.80 18.00 34.70 34.70 35.60 27.00 20.80

3/10E 32.50 52.40 62.10 76.10 76.10 38.50 31.00 25.50

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Balance sheet (Rs mn) Cash & equivalents Accounts receivable Inventory Other current assets Total current assets Net PP&E Net intangibles Total investments Other long-term assets Total assets Accounts payable Short-term debt Other current liabilities Total current liabilities Long-term debt Other long-term liabilities Total long-term liabilities Total liabilities Common stock & premium Other common equity Total common equity Minority interest Total liabilities & equity BVPS (Rs)

3/07 3/08E 3/09E 3/10E 3378.00 1186.10 1565.80 3069.90 2451.60 3448.20 4870.40 6453.40 10113.50 15423.90 21989.60 27807.80 8913.20 8913.20 8913.20 8913.20 24856.30 28971.40 37339.00 46244.40 101920.30 189972.20 241683.00 281063.90 1948.70 7421.70 7421.70 7421.70 1929.40 1929.40 1929.40 1929.40 0.00 0.00 0.00 0.00 130654.70 228294.70 288373.20 336659.40 5094.10 7164.90 10120.00 13409.30 1415.50 1415.50 1415.50 1415.50 17763.20 17763.20 17763.20 17763.20 24272.80 26343.60 29298.70 32588.00 43105.10 104951.90 145723.60 161973.60 10126.60 10126.60 10126.60 10126.60 53231.70 115078.50 155850.20 172100.20 77504.50 141422.10 185148.90 204688.30 1639.80 51510.40 53150.20 0.00 1719.80 1719.80 1719.80 85159.80 101277.90 129656.40 86879.60 102997.70 131376.20 (7.00) 226.50 594.90

130654.70 228294.70 288373.20 336659.40 324.13 505.17 598.89 763.90

Ratios ROE (%) ROA (%) ROACE (%) Inventory days Receivables days Payable days Net debt/equity (%) Interest cover - EBIT (X)

3/07 26.80 10.30 17.40 64.90 10.30 37.60 77.40 5.50

3/08E 20.50 8.00 13.30 60.40 8.90 29.00 121.10 4.50

3/09E 20.40 7.50 11.40 62.10 8.90 28.70 141.00 4.50

3/10E 29.10 10.90 15.10 65.40 9.10 30.90 121.50 6.40

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Valuation P/E (analyst) (X) P/B (X) EV/EBITDA (X) Dividend yield (%)

3/07 8.90 2.20 3.30 1.90

3/08E 9.10 1.40 5.90 1.80

3/09E 6.70 1.20 5.80 2.40

3/10E 3.80 0.90 4.00 4.20

Cash flow statement (Rs mn) Net income pre-preferred dividends D&A add-back Minorities interests add-back Net inc/(dec) working capital Other operating cash flow Cash flow from operations Capital expenditures Acquisitions Divestitures Others Cash flow from investments Dividends paid (common & pref) Inc/(dec) in debt Common stock issuance (repurchase) Other financing cash flows Cash flow from financing Total cash flow

3/07 12601.90 4982.30 0.00 3133.90 (621.40) 24997.00

3/08E 14382.90 8049.10 0.00 (4236.20) 0.00 16219.10

3/09E 19368.20 10539.10 0.00 (5032.80) 0.00 19955.40

3/10E 34100.60 12619.10 0.00 (4111.90) 0.00 37823.70

(23465.20) (94131.30) (57097.40) (46847.40) 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00 983.70 (5473.00) 0.00 0.00 (22481.50) (99604.30) (57097.40) (46847.40) (4087.30) 1383.10 2121.90 456.10 (126.20) 2389.30 (2413.50) 61846.80 21760.00 0.00 81193.30 (2191.90) (3250.00) 40771.70 0.00 0.00 37521.70 379.70 (5722.20) 16250.00 0.00 0.00 10527.80 1504.10

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SESA GOA

Pure play on iron ore prices    Sesa Goa is India’s largest miner and exporter of iron ore in the private sector access to over 200 mn tonnes (mt) of iron ore reserves in Goa, Karnataka and Orissa and its current mining output is ~10 mt annually. With sustained tightness in the iron ore market, it will be a direct beneficiary of higher iron ore prices Sound Financials…   High margins, attractive returns- direct play on iron ore prices debt-free balance sheet, strong free cash flow generation and cash pile of Rs220 per share are added positives Challenges  Lack of progress in securing additional mining blocks

Catalysts   Reining in logistics costs will remain a key focus area potential announcements on strategic use of the cash pile or expansion plans post completion of the open offer by Vedanta Resources could provide potential upside triggers

Valuations  At 2.8x one-year forward EV/EBITDA—which is at a 50% discount to global mining companies— the stock is attractively valued. Risks    Weaker-than-expected iron ore prices on the back of a slowdown in steel production in China; slower-than-expected ramp-up of volumes through debottlenecking; regulatory and administrative measures to curb iron ore exports (similar to imposing a tax on high-grade iron ore exports this year).

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Profit model (Rs mn) Total revenue Cost of goods sold SG&A R&D Other operating profit/(expense) EBITDA Depreciation & amortization EBIT Interest income Interest expense Income/(loss) from uncons. subs. Others Pretax profits Income tax Minorities Net income pre-preferred dividends Preferred dividends Net income (pre-exceptionals) Post-tax exceptionals Net income EPS (basic, pre-except) (Rs) EPS (basic, post-except) (Rs) EPS (diluted, post-except) (Rs) DPS (Rs) Dividend payout ratio (%) Free cash flow yield (%)

3/07 22179.30 (6632.80) (4544.80) 0.00 (1341.10) 10053.10 (392.50) 9660.60 0.00 (3.40) 0.00 0.00 9657.10 (3147.00) (48.90) 6461.20 0.00 6461.20 0.00 6461.20 -164.15 164.15 30.93 18.80 9.80

3/08E 29265.40 (7221.70) (5996.90) 0.00 (1861.40) 14602.40 (417.00) 14185.40 346.00 0.00 0.00 0.00 14531.40 (4735.40) (48.90) 9747.10 0.00 9747.10 0.00 9747.10 -247.63 247.63 46.65 18.80 12.10

3/09E 37785.70 (9269.20) (7742.80) 0.00 (2409.30) 18805.90 (441.50) 18364.40 627.60 0.00 0.00 0.00 18992.00 (6189.00) (48.90) 12754.10 0.00 12754.10 0.00 12754.10 -324.02 324.02 61.05 18.80 15.30

3/10E 37367.70 (8894.50) (7657.10) 0.00 (2380.90) 18901.10 (466.00) 18435.20 973.40 0.00 0.00 0.00 19408.50 (6324.70) (48.90) 13034.90 0.00 13034.90 0.00 13034.90 -331.16 331.16 62.39 18.80 18.00

Growth & margins (%) Sales growth EBITDA growth EBIT growth Net income growth EPS growth Gross margin EBITDA margin EBIT margin

3/07 3/08E 3/09E 3/10E 20.20 31.90 29.10 (1.10) 12.70 45.30 28.80 0.50 12.00 46.80 29.50 0.40 13.10 50.90 30.90 2.20 13.10 50.90 30.90 2.20 70.10 75.30 75.50 76.20 45.30 49.90 49.80 50.60 43.60 48.50 48.60 49.30

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Balance sheet (Rs mn) Cash & equivalents Accounts receivable Inventory Other current assets Total current assets Net PP&E Net intangibles Total investments Other long-term assets Total assets Accounts payable Short-term debt Other current liabilities Total current liabilities Long-term debt Other long-term liabilities Total long-term liabilities Total liabilities Common stock & premium Other common equity Total common equity Minority interest Total liabilities & equity BVPS (Rs)

3/07 3/08E 3/09E 3/10E 8,649.80 15,689.10 24,334.80 34,786.60 3,004.00 3,963.80 5,117.80 5,061.20 3,277.30 3,568.30 4,580.00 4,394.80 333.4 333.4 333.4 333.4 15,264.60 23,554.60 34,366.00 44,576.00 5,889.60 5,972.60 6,031.10 6,065.10 0 0 0 0 58.4 58.4 58.4 58.4 0 0 0 0 21,212.60 29,585.60 40,455.50 50,699.50 2,100.10 98.3 1,669.10 3,867.50 0.00 604 604 4,471.50 2,771.10 98.3 1,669.10 4,538.50 0.00 604 604 5,142.50 3,577.80 98.3 1,669.10 5,345.20 0.00 604 604 5,949.20 3,538.30 98.3 1,669.10 5,305.70 0.00 604 604 5,909.70

393.6 393.6 393.6 393.6 16154.40 23807.60 33821.80 44056.50 16,548.00 24,201.20 34,215.40 44,450.10 193.1 242 290.9 339.8 21,212.60 29,585.60 40,455.50 50,699.50 420.41 614.84 869.25 1,129.26

Ratios ROE (%) ROA (%) ROACE (%) Inventory days Receivables days Payable days Net debt/equity (%) Interest cover - EBIT (X)

3/07 3/08E 3/09E 3/10E 46.10 47.80 43.70 33.10 35.40 38.40 36.40 28.60 66.70 112.20 129.50 122.00 181.50 173.00 160.40 184.10 45.10 43.50 43.90 49.70 94.20 123.10 125.00 146.00 (51.10) (63.80) (70.20) (77.40) NM NM NM NM

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Valuation P/E (analyst) (X) P/B (X) EV/EBITDA (X) Dividend yield (%)

3/07 3/08E 3/09E 3/10E 11.9 7.9 6.1 5.9 4.7 3.2 2.3 1.7 4.2 4.2 2.8 2.2 1.6 2.4 3.1 3.2

Cash flow statement (Rs mn) Net income pre-preferred dividends D&A add-back Minorities interests add-back Net inc/(dec) working capital Other operating cash flow Cash flow from operations Capital expenditures Acquisitions Divestitures Others Cash flow from investments Dividends paid (common & pref) Inc/(dec) in debt Common stock issuance (repurchase) Other financing cash flows Cash flow from financing Total cash flow

3/07 3/08E 3/09E 3/10E 6461.20 9747.10 12754.10 13034.90 392.50 417.00 441.50 466.00 0.00 0.00 0.00 0.00 288.50 (579.80) (1358.90) 202.20 0.00 0.00 0.00 0.00 7191.20 9633.20 11885.60 13752.00 (2210.00) 0.00 0.00 4684.00 2474.00 (500.00) 0.00 0.00 0.00 (500.00) (500.00) 0.00 0.00 0.00 (500.00) (500.00) 0.00 0.00 0.00 (500.00)

(1388.00) (2093.90) (2739.90) (2800.20) 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00 (1388.00) (2093.90) (2739.90) (2800.20) 8277.20 7039.30 8645.70 10451.70

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RISKS
Any steel demand slowdown in China post Olympics can be catastrophic China's steel demand is driven by infrastructure growth, boosted by preparation for Olympic Games which begin in August 2008. How steel demand holds up in China post Olympics, would settle the future of the boom in global steel markets. Dr SK Gupta, a noted steel veteran, cautioned in the recent Seventh Asian Steel Conference that in the past several economies had gone through good steel demand growth for few years preOlympics, followed by stagnant demand for almost five years post Olympics. Analysts, steel experts and associations seem to differ on this and forecast China will sustain steel demand growth even beyond Olympics. Both views have merit, so one should exercise caution and would review in depth every data emerging from China, closer to the event. EU antidumping duties on steel imports from China If the European Union imposes anti-dumping duties on steel imports from China after the ongoing investigations then Chinese exports to EU, which are currently significantly high, would be diverted to other locations preferably Asia. There are fair chances of this happening. This may affect global steel prices. European steel prices may move up and there may be price pressure in Asia including India. Indian Government intervention in steel pricing The Indian Government has in the past played spoilsport and put pressure on the industry to exercise restraint while effecting price increases. Though it seems it would understand that the price increases this year are more to offset the increase in raw material prices, one never knows as it has happened with oil and to some extent in the cement sector. Risks exist given that significant steel price rise is possible a few times during the year and with an eye on general elections ahead. Dollar appreciation, though unlikely, would badly hurt ongoing commodity boom Experts are worried about a US recession. However, what is amusing is that if there is any surprise significant upturn in US economy or for any other unforeseen reason dollar reverses the ongoing depreciation trend, it would badly impact the ongoing commodity boom. Offsetting the appreciation of local currencies of exporting nations against the dollar, has been an upward push

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driver of price hikes currently witnessed in commodities and steel so any change in that is likely to break the present momentum. Steel substitution by aluminum - particularly in automobiles Aluminum prices may be three times that of flat steel products but it weighs just a third of steel and density adjusted, aluminum costs are almost similar to present steel prices. Steel prices are set to rise sharply but aluminum prices may just lag behind and this would make aluminum a possible substitute, particularly in the automobile sector. This may cap price upside for flat steel products. US economy running into deep recession We are hopeful that with aggressive Fed rate cuts, the possibility of recession in the US should subside. However, if the US economy shrinks during the year, the strength in steel prices would be lower than anticipated. However, I do not see prices collapsing even in the event of a minor recession. As stated earlier, dollar appreciation is a bigger concern.

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THE WAY AHEAD
Lifting raw material self-sufficiency to be buzzword in 2008 A spurt in execution of international mining acquisitions is almost sure shot. It has already kickstarted with Tata Steel and JSW's initiatives for interest in coking coal at Mozambique and iron ore at Ivory Coast and Latin America, respectively, with further scouting on in other territories. Similarly, JSPL has taken up gigantic iron ore reserves at Bolivia. The tempo would gain momentum during the year.Many companies are likely to seal several such deals, which would keep the sector in the limelight and also improve company fundamentals and valuations. The latter half of 2008 may see this frenzy beginning to spread to domestic M&As wherein lot of smaller steel and mining companies may be taken over by larger domestic players. If the New National Mineral Policy sees daylight even by H208, the fortunes of mineral companies and captive resource companies would undergo everlasting jump in fortunes.

Securing coking coal mines - negligence no more affordable; action has begun SAIL and Tata Steel has formed a JV to identify, acquire and develop coking coal deposits in India. A total of Rs.120 bn would be invested in four mines with reserves of 500- 600 MMT of medium coking coal in Jharkhand. Coal Ventures International Ltd (CVIL), an SPV by SAIL, NTPC, RINL, Coal India and NMDC was formed and given mega PSU status with a fund accumulation of over Rs.100 bn for acquisitions for coking and thermal coal assets abroad mainly in countries like Australia, Canada, the US, Indonesia, Mozambique, Zimbabwe and South Africa. CVIL has powers that are more than that of a Navratna company as it can clear investment proposals of up to Rs.15 bn at the board level itself. Mozambique is a strategically located destination for Indian coking coal needs. Freight from the African country is less than half of what is paid to ship the mineral from Australia. It is fast catching the fancy of Indian companies. JSW started this with a license to conduct due diligence on a 6,900 hectare site with estimated 200 MMT reserves that could be later mined for coal. It got positive results from studies conducted for the first license and later purchased two more licenses.

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Tata Steel has formed an SPV with Australian Riversdale Mining Ltd to develop a hard coking and thermal coal project at key coal exploration tenements held by Riversdale in Mozambique. Tata Steel will take 35% stake for AU$100 mn and would get assured 40% share of the offtake for coking coal, whose reserves are estimated to be good 1.225 bn MMT. Gremach Infrastructure Equipments & Projects has acquired 75% controlling stake in 11 coalmine licenses from Osho Mozambique Coal Mining Ltd in Mozambique over an area of 13,520 hectares and reserves of more than 200 MMT. Prospecting of the area is to be completed by mid 2008. These 11 licenses are very close to existing CVRD mines with few of them having common boundary with CVRD licenses where hard prime coking coal has already been found. Coal ministry allocation of long-term linkages is just a minor relief - 236 sponge iron units with 14.5 MMT of total production capacity have been recently allotted 19 MMT/annum long-term linkages of coal mines. About 194 units are already in production and another 42 with capacity of 4.12 MMT are in process of commission. A total of 84 units are located in Orissa, 48 in Chhattisgarh, 36 in West Bengal, 27 in Jharkhand, 15 In Andhra Pradesh and eight each in Karnataka and Maharashtra. In addition to this, several captive power plants of steel companies have been allotted similar coal linkages. With coal on track to becoming another scarce resource, the criticality of this act would be visible in the coming times. These linkages have an assured supply from Coal India. However, the catch lies in the fact that the prices, which have recently started being determined by eauction, are responsive to prevailing benchmark spot prices, already hovering above 90$/t. They are likely to surpass $100/t during 2008. This means the issue of availability, though assured, price benefit would largely be saved in freight costs.

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