1. business and industrial
2. energy
3. coal

Metals & Mining, Poland
October 15, 2014
Sell
JSW
Transfer of coverage
Price: PLN 31.0
Price target: PLN 24.4
Mind the (funding) gap
Following a change in analyst responsibilities, we adopt a SELL
rating and a PLN 24.4/share price target (PT) on JSW (previously
BUY, PT 109/share, based on an update from 12 December
2012). Slowing Chinese steel production, new Chinese import
duties on coal, the strong dollar and a slowing rate of project
closures all point to a prolonged period of low coking coal prices.
JSW continues to lose money at a rate that makes the banks
unwilling lenders and we have concerns about the possibility of
JSW running out of funding before coal prices recover. The stock
also appears expensive, in our view, pricing in a long-term USD
155/tonne+ HCC price. On 4.6x 2015E EV/EBITDA, it trades at a
discount to its EM coal peers, but not, we believe, a large enough
one given the balance sheet risk and government control.
FCF negative until 2018E: assuming that JSW recovers from its
1H14 production problems, we believe it will still lose PLN
370m in 2015E FCF and will not break even until: a) the new K-S
mine is converted into a coking coal mine and all synergies are
exploited; and b) hard coking coal prices reach sustainable levels
of over USD150/tonne. Of total global coking coal production,
c.40% is now loss-making, so we expect a medium-term
recovery. Without it, JSW will remain an unsustainable lossmaking business.
Funding gap likely without refinancing: if the coal price does not
improve, the clock has started ticking towards a likely funding
shortfall, in our view. The likelihood of this scenario depends on
JSW’s ability to refinance, as its current debt agreements prevent
it from raising over PLN 450m in new debt. On our forecasts, it
should reach that level by early-2016E, based on current capex
guidance, and earlier if production does not recover, prices
stagnate or fall, or JSW’s premium to the benchmark collapses.
Management’s options to delay this outcome are capex cuts,
short-term opex cuts and asset sales, but this would just delay the
funding shortfall, in our view. We believe refinancing will be
possible as JSW’s leverage will only be 1.2x net debt/2015E
EBITDA when it hits the PLN 450m cap. However, the banks
appear to be unwilling lenders and JSW may have to tap the
international bond markets at high cost, although this is not a
formality. With this risk, we cannot recommend buying the stock.
Expected Events
13 November 2014
3Q14 financial results
Key Data
Market Cap
Free Float
Shares Outstanding
Average daily volume
Major Shareholder
USD 1,100m
45%
117.4m
USD 2.1m
Polish Government — 55%
Bloomberg Code
JSW PW
Price Performance
52-w range (PLN)
YTD PLN Performance
29.97-72.51
-42%
JSW: LTM price performance
110
100
90
80
70
60
50
40
Oct-13
Jan-14
Apr-14
JSW
Jul-14
Oct-14
WIG20 Index
Scenario testing: given the lack of clarity from the company
regarding its liquidity, we look at various scenarios in this report
that test JSW’s balance sheet, which shows their vulnerability to
lower coal prices, a rapid fall in the premiums they receive vs.
the benchmark and a repeat of the 1H14 production problems.
JSW’s high sensitivity to coal prices means the stock could see
large moves either way, so we try to demonstrate the financial
implications of such moves.
Sales
EBITDA
Net profit
(USD m)
(USD m)
(USD m)
2017E
9,080
1,765
47
0.40
n.m.
77.6
3.21
0.0%
0.7%
2016E
8,359
1,212
-335
-2.86
n.m.
n.m.
4.58
0.0%
-4.8%
EQUITY
2015E
8,087
1,113
-382
-3.26
n.m.
n.m.
4.55
0.0%
-5.2%
2014E
6,853
597
-616
-5.24
n.m.
n.m.
7.86
0.0%
-7.8%
RESEARCH
2013
7,632
1,403
77
0.66
-92.2%
117.52
5.37
3.3%
0.9%
2012
8,821
1,403
985
8.39
-55.8%
11.15
4.18
5.7%
11.8%
Analyst: Andrew Jones
E-mail: [email protected]
EPS
EPS
P/E
growth
(x)
EV/EBITDA Dividend
(x)
ROE
yield
London: +44 203 530 0629
Website: www.wood.com
Contents
Investment case ....................................................................................................................... 3 The bull case — quick coal price rebound, sustainable premiums, refinancing agreed............... 5 The bear case — refinancing denied, ongoing production issues and collapsing premiums ........ 6 Coking coal prices to recover, but not in the near term ........................................................... 7 Does JSW’s coal continue to deserve a premium to benchmark prices? .................................. 12 Operationally, JSW appears to be moving in the right direction ............................................. 15 FCF negative for years and it could get worse… ..................................................................... 19 What can JSW do in order to reduce the FCF losses? .............................................................. 22 Under what conditions would a rights issue happen?.............................................................. 28 Knurow-Szczyglowice acquisition — was it worth it? ............................................................... 30 Versus consensus .................................................................................................................... 32 Valuation ................................................................................................................................ 34 Appendix — more detail on the development projects ............................................................. 37 Financials ............................................................................................................................... 39 Important disclosures ............................................................................................................. 41 Closing Prices as of 14 October 2014
© 2014 by WOOD & Company Financial Services, a.s.
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without written permission from WOOD & Company Financial Services, a.s.
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WOOD & Company Financial Services a.s.
Palladium, Namesti Republiky 1079/1a,
110 00 Prague 1 — Czech Republic
tel.: +420 222 096 111
fax: +420 222 096 222
http//: www.wood.com
JSW
2
WOOD & COMPANY
Investment case
In our view, there are too many risks that could push JSW towards a funding shortfall.
While JSW has options for delaying this shortfall, such as short-term capex cuts, falling
prices, premiums or production could easily offset these measures. In the end, it comes
down to whether it is able to refinance the debt and that remains the major uncertainty.
In the meantime, we expect continued weakness in the coal price to negatively affect the
stock, negative FCF and no dividends until 2018E, and growing balance sheet stress. The
stock is not cheap enough to compensate for these risks, in our view. Following a change
in analyst responsibilities, we adopt a SELL rating, with a price target (PT) of PLN
24.4/share.
High cost producer: the company is FCF loss-making at current price levels due to 2Q14
cash costs of USD 141/tonne, leaving JSW at around the 90% percentile of the global cost
curve. These costs will drop to close to USD 100/tonne once the production issues are
resolved. However, in addition, JSW spends roughly USD 20/tonne on maintenance
capex, a much higher figure than its regional peers, which should leave the all-in costs
close to USD 120/tonne. This compares to spot hard coking coal (HCC) prices at c.USD
114/tonne and our average JSW realised price forecast for 2H14 of USD 100/tonne
(blending HCC, semi-soft coking coal and thermal coal). JSW needs a price rally to remain
a viable entity, in our view.
JSW is highly leveraged to coal prices. As a result of high costs, a 5% change in our price
forecasts would move our DCF valuation (one component of our PT in conjunction with
EV/EBITDA) from negative to over 50% upside. As a result, deriving a PT for JSW is a
difficult exercise.
Sensitivity of our JSW DCF valuation to WACC and realised prices
Benchmark coal/coke price, $/t
WACC
19
7.4%
8.4%
9.4%
10.4%
11.4%
12.4%
-10%
-46
-44
-43
-42
-41
-40
-5%
3
-4
-8
-11
-14
-16
0%
51
37
26
19
13
9
5%
100
77
61
49
40
33
10%
148
117
96
79
67
57
20%
245
198
165
140
121
105
Source: Wood Research
Not cheap enough given the current risks: we believe the stock currently prices in more
than a 30% rally in current hard coking coal benchmark prices from the current levels.
Also, at 4.6x 2015/16E EV/EBITDA, it trades at a 15% premium to its long-term average
one-year forward EV/EBITDA ratio, based on the Bloomberg consensus. The stock is not
cheap, in our view. It certainly does not price in the risk of a potential rights issue, which
some investors expect given the weak coal price environment.
We see limited prospects for a rally in coking coal prices in the near future. Chinese steel
production continues to decelerate, dollar strength will affect demand negatively, and the
pace of mine closures is slowing, which all means that the surplus in the coking coal
market is not likely to return to balance in the near term. On top of this, China has levied
import duties on coal, aimed at keeping the loss-making mines open, which will
inevitably lower imports, in our view. Given JSW’s high sensitivity to coal prices and the
market’s expectations of a coal price rally, continued low coal prices will, we believe,
result in further downside pressure on the stock.
Refinancing remains the main uncertainty: according to management during the 2Q14
conference call, the company’s current debt agreements only allow it to raise another PLN
450m in new debt. At current coal prices and based on the 2015E capex guidance, JSW
could violate this cap in early-2016E, earlier if certain scenarios occur. Further capex cuts
and efficiency savings could slow the rate of cash bleed and delay this scenario but,
without a rally in prices, this just delays the time for it to reach the debt cap. For this
reason, some investors have concerns about the potential for JSW to perform a rights
issue. Net debt/EBITDA will only be 1.6x on our base case at year-end 2014E, and 2.4x if
the debt cap is breached based on 2014E EBITDA (which is the trough EBITDA on our
base case due to the 1H14 production problems). Based on 2015E EBITDA, this level of
JSW
3
WOOD & COMPANY
net debt would only be 1.2x, hardly a level that usually results in debt restrictions. As a
result, we expect JSW to find refinancing despite the reluctance of the Polish banks.
However, in the absence of clarity over the funding situation, some investors are likely to
continue to speculate on a rights issue scenario.
Several company-specific risks threaten to accelerate the rate of cash flow losses,
especially:

Premiums to benchmark pricing: JSW received a 15% premium to benchmark
coking coal prices in 2Q14. However, since the IPO, its average premium has
averaged zero, so it is reasonable to assume that prices may return to benchmark
levels soon. We model this premium declining gradually to zero by 2017E,
meaning that JSW’s realised prices rise slower than market prices. However, if
premiums fall faster, cash losses would increase, potentially triggering the funding
limit. Without the contribution of the premium we model in 2015E, our EBITDA
forecast would fall 59% to PLN 455m.

Reoccurring production problems: JSW generated negative EBITDA in 2Q14
despite the high premiums following a 25% yoy fall in production. 80% of the
cost base is fixed, so unit mining costs rose to PLN 428/tonne, +20% yoy. The
production data from September show production annualising at 13.4mtpa, close
to the 13.6mtpa 2013 level, so these problems appear to be temporary rather than
a trend. However, the lack of management communication on the subject and the
fact that it came as a surprise (JSW had guided for 13.8mt this year vs. our current
forecast of 12.3mt) suggest to us that this remains a tangible risk that could move
the company closer to a rights issue scenario.
Integration of the Knurow-Szczyglowice (K-S) mine is crucial for unlocking value and
generating positive FCF: we believe that JSW overpaid for K-S as the mine is currently
losing money at the EBITDA level as a predominantly thermal coal mine. JSW is planning
to mine deeper, convert it largely into a coking coal mine and reduce costs through
synergies with its adjacent Budryk mine. However, it should have been valued as the lossmaking thermal coal mine that it is rather than JSW paying PLN 1.5bn for an asset that we
value at PLN 1.95bn if applying the same WACC that we use for the group (i.e., applying
no risk discount), assuming all planned synergies and improvements are executed and
assuming that coking coal prices recover nearly 30% by 2017E. There was little prospect
of the mine turning a profit in its current form under previous management, so to pay a
price reflecting the majority of the upside should be seen as value-destructive, in our view.
Given JSW’s current financing issues, there is financing risk, as well as execution risk, that
should be accounted for when considering how quickly JSW can invest the capex needed
to turn the mine around. We generously model the best-case scenario and, even in this
case, there is limited value to be unlocked; if there are delays to this turnaround, the mine
could continue to bleed cash for longer than we expect and further stress the balance
sheet for JSW.
JSW
4
WOOD & COMPANY
The bull case — quick coal price rebound, sustainable
premiums, refinancing agreed
While the funding risk and the fact that the stock already prices in a recovery that is far
from guaranteed both make us sellers, there is a bull case for JSW. The share price is
highly sensitivity to the choice of long-term coal prices, so a small change in coal prices
could allow us to find upside in our PT.
The bull case for JSW would be based on the following factors:

Benchmark HCC prices have bottomed and need to recover in the medium term
given that over 40% of seaborne production is currently loss-making.

Production appears to have normalised and we believe it should recover to 2013
levels in 2015E after a weak 1H14. This would also drive down unit costs as 80%
of the cost base is fixed.

The PLN/USD rate has weakened 8.5% in the past three months and consensus
does not yet reflect this. Further PLN weakness should be supportive for JSW.

JSW’s available debt is not capped at PLN 450m as management implied in 2Q14
if it is able to refinance the acquisition debt on more favourable terms. Leverage
(ND/LTM EBITDA) will only be 1.6x at YE2014 so there is no reason why JSW
should be prevented from borrowing more. Concerns over liquidity should
diminish if this can be achieved.

Capex will fall to PLN 1.4bn if prices are weak next year. They could temporarily
reduce it to PLN 1.2-1.3bn for a short period if prices remain weak, allowing it to
stem cash flow losses.

JSW might be able to retain their premium price realisations vs. the benchmark
(although we see this as unlikely).

The market appears to be underweight JSW (as is the sell-side consensus). The stock
is in danger of a classic short squeeze if the coal price reaches an inflection point.

The flooding in Australia in 1Q14 could cause a rapid rise in the coal price, as it did
in 2011. While this is hard to predict, it represents a potential upside surprise.

Another potential “black swan” factor would be if management can persuade the
unions to work a longer working week rather than the current five-day week,
which could add over 20% to our EBITDA forecasts as production would rise in
line with hours worked and unit costs would fall due to economies of scale.
Simplified cash flow forecasts, assuming the bull case (rapid price recovery and flat premiums)
DCF value (PLN/share)
Key assumptions
Benchmark HCC price, PLN/t
Benchmark SS price, PLN/t
Blended Benchmark coking coal price, PLN/t
Realised coking coal price, PLN/t
Premium, PLN/t
% premium
PLN/$
Coal production total, mt
Coal production ex-KS, mt
Mining cash cost, PLN/t
Financials (in PLN mn)
EBITDA
Operating CF
Investment CF (mainly capex/M&A)
FCF
Dividends
Net debt
Net debt/EBITDA
2014
147.4
2015
2016
2017
2018
2019
2020
2021
126
150
160
160
164
168
172
177
93
110
114
114
116
119
122
125
362
442
465
470
481
491
503
515
411
508
535
540
553
564
578
592
49
67
70
70
72
74
75
77
13.5% 15.1% 15.0% 15.0% 15.0% 15.0% 15.0% 15.0%
3.14
3.30
3.30
3.30
3.30
3.30
3.30
3.30
13.86 17.71 17.91 18.04 18.16 18.17 18.17 18.17
12.27 13.63 13.63 13.63 13.63 13.63 13.63 13.63
360
333
338
343
349
356
361
369
572 2,656 3,124 3,275 3,722 3,870 4,049 4,171
485 2,352 2,746 2,893 3,248 3,366 3,510 3,607
-3,092 -1,392 -1,569 -1,712 -1,631 -1,692 -1,647 -1,509
-2,608
961 1,177 1,181 1,618 1,675 1,863 2,098
-252
-368
-406
-504
-536
-573
901
-60
-985 -1,797 -3,008 -4,179 -5,506 -7,031
1.57 -0.02 -0.32 -0.55 -0.81 -1.08 -1.36 -1.69
Source: Wood Research, company data
JSW
5
WOOD & COMPANY
The bear case — refinancing denied, ongoing production
issues and collapsing premiums
The bear case, however, would result in the stock falling to close to zero in a rights issue
scenario.

The premium vs. the benchmark prices could fall to zero. Without this premium
in 2015E, our base case EBITDA would fall PLN 658m to PLN 455m, a huge
incremental value driver.

Recent dollar strength and weak Chinese steel production suggest there could be
further pressure on coal prices in the short term. The pace of mine closure
announcements has slowed in 2H14, so a rapid recovery in prices is unlikely.

Significant cuts in capex would reduce medium-term production if sustained for
more than one year.

The production issues experienced in 1H14 may reoccur.

Refinancing may not be possible given JSW's rate of cash losses and the lack of a
catalyst for a coal price rally, which will limit it to only PLN 450m in further debt,
which might lead to a forced rights issue, without government support or asset
sales.

Asset sales (such as the coking plants) are not possible in a weak coal price
environment, which leaves little alternative to a rights issue in the scenario above.
Simplified cash flow forecasts, assuming the bear case (no production recovery from 2014, HCC prices fall to
USD 110/tonne with no premium)
2014
-158.4
DCF value (PLN/share)
Key assumptions
Benchmark HCC price, PLN/t
126
Benchmark SS price, PLN/t
93
362
Blended Benchmark coking coal pri
Realised coking coal price, PLN/t
411
Premium, PLN/t
49
% premium
13.5%
PLN/$
3.14
Coal production total, mt
13.86
Coal production ex-KS, mt
12.27
Mining cash cost, PLN/t
360
Financials (in PLN mn)
EBITDA
572
Operating CF
485
Investment CF (mainly capex/M&A) -3,092
FCF
-2,608
Dividends
Net debt
901
Net debt/EBITDA
1.57
2015
2016
2017
2018
2019
2020
2021
110
81
323
323
0.0%
3.30
16.35
12.27
354
110
78
319
319
0.0%
3.30
16.55
12.27
358
110
78
322
322
0.0%
3.30
16.68
12.27
363
113
80
329
329
0.0%
3.30
16.80
12.27
369
116
82
336
336
0.0%
3.30
16.81
12.27
376
118
84
344
344
0.0%
3.30
16.81
12.27
382
121
86
353
353
0.0%
3.30
16.81
12.27
389
-468
-596
-1,392
-1,987
2,888
-6.17
-541
-779
-1,489
-2,267
5,156
-9.52
-551
-947
-1,634
-2,580
7,736
-14.05
-458
-1,034
-1,562
-2,596
10,332
-22.56
-453
-1,211
-1,642
-2,853
13,185
-29.13
-395
-1,353
-1,616
-2,969
16,154
-40.87
-383
-1,548
-1,500
-3,048
19,202
-50.18
Source: Wood Research, company data
JSW
6
WOOD & COMPANY
Cokingg coal prices
p
to
o recov
ver, butt not in the near term
m
The 4Q14 quarterly benchm
mark hard co
oking coal (H
HCC) contracct recently seettled at USD
D
wn only USD
D 1/tonne qoq
q. This was a good achievvement by th
he producers,,
119/tonne, dow
n FOB coking coal spo
ot prices trad
ding currenttly at c.USD
D 114/tonne,
witth Australian
acccording to th
he Bloomberg ENPBDQU
UE index. This was due primarily
p
to: a) significantt
cap
pacity addittions in rece
ent years; and
a
b) the recent slow
wdown in Chinese
C
steel
pro
oduction.
Haard coking co
oal prices hav
ave been fallin
ing since 2011
Sou
urce: Wood Rese
search, Bloombeerg
The World Steeel Association
n reported in
n September that steel pro
oduction wass up only 1%
%
yoy in August and
a only 2.6%
% ytd. This compares
c
to 8.7% growth
h last year and a 13% p.a.
CA
AGR over 200
03-13.
Leaading indicaators for steeel productio
on growth, such
s
as Chinese propertty sales and
d
ind
dustrial produ
uction, all su
uggest a further slowdown
n and potentiial yoy reducctions in steel
output in the n
near term. Th
his is likely to
o be a significant drag on
n coking coal demand, in
n
0.8 tonnes off coking coal per tonne off
our view, as blast furnace steel typicallyy uses c.0.7-0
C
has beeen the grow
wth engine for coking coal demand forr
steeel, especiallyy given that China
the
e past decadee.
Leading ind
dicators sugge
gest Chinese steel
s
producttion could weaken
we
furtheer in the nearr term
140%
35.0%
120%
30.0%
100%
25.0%
80%
20.0%
60%
15.0%
40%
10.0%
20%
5.0%
0%
0.0%
-20%
-40%
Apr-07
-5.0%
-10.0%
Apr-09
Apr-11
20%
53
15%
52
10%
51
5%
50
0%
49
-5%
48
-10%
O
Oct-11
Apr-13
47
Apr-12
Oct-12
Apr-1
13
Oct-13
Ap
pr-14
China propeerty sales yoy 6MM
MA (rhs)
Ch
hina crude steel prroduction, yoy (lhss)
China crudee steel production yoy 6MMA (lhs)
Ch
hina Manufacturing PMI (rhs)
Source: Wood
d Research, Waltter Energy
To emphasise this point, China
C
currenttly consumess c.600mt off coking coaal in a global
ma
arket of 1bn tonnes. How
wever, in the seaborne market, wheree it imports c.76mt
c
out off
300mt, a 1% decline
d
in ste
eel productio
on (and domestic coal co
onsumption) would causee
an 6mt fall in imports,
i
an 8%
8 fall yoy ((assuming flaat domestic production).
p
W
With leadingg
JSW
7
WOOD
D & COMPA
ANY
indicators appearing as negative as they do now, there is a real possibility of Chinese
imports falling in a material way for the rest of 2014 and into next year.
On top of this, China announced recently that it will start to apply import duties to coal
from 15 October in order to support its ailing coal industry (3% on coking coal, 6% on
thermal). This should slow the rate of mine closures in China, delay the rebalancing of the
global coal market and reduce imports.
While US economic data continues to improve, Europe is still stagnating, suggesting that
relief is unlikely to come from elsewhere.
US PMIs suggest steel production could improve, while Europe stagnates
75%
65
70%
55%
60
50%
35%
55
15%
50
60
55
30%
50
10%
-5%
45
-25%
40
-45%
35
-30%
-65%
Oct-01 Oct-03 Oct-05 Oct-07 Oct-09 Oct-11 Oct-13
30
-50%
Jan-08
45
-10%
40
35
Jan-10
Jan-12
US crude steel production, yoy (lhs)
EU crude steel production, yoy (lhs)
US Manufacturing PMI (rhs)
EU Manufacturing PMI (rhs)
Jan-14
Source: Wood Research, Walter Energy
The recent surge in the dollar will also limit demand for dollar-priced commodities, in our
view. A combination of a weak China and a strong dollar is creating a tough environment
for industrial metals prices, including the ferrous value chain. Iron ore prices have fallen
more than coking coal recently, suggesting that more downside is possible.
Coal has outperformed iron ore recently
400
350
300
250
200
150
100
50
0
Oct-10
Oct-11
Oct-12
Iron ore spot price, $/t
Oct-13
Coking coal spot price, $/t
Source: Wood Research
On the supply side, current benchmark prices suggest that c.40% of the seaborne supply
is loss-making, so further closures of capacity are likely.
JSW
8
WOOD & COMPANY
Rou
oughly 40-45%
% of currentt seaborne su
upply is produ
duced at a losss
Sou
urce: Wood Reseearch, Walter En
nergy
Wee saw c.17mtt of closures announced in 1H14 following the large fall
f in benchm
mark prices.
Planned miine closures announced
a
th year
this
Company
Country
Mines
Region
Annualised impact,
i
mt
Glencore Xstrataa
Ravensworth
New South Wales
Australia
W
2.1
1
Abashevskaya
Russia
Evraz
Kemorovo
o
1.0
0
New South Wales
W
0.3
3
Hall Creek
Australia
Rio Tinto
n
British Colum
mbia
3.6
6
Wolverine/Brazion
Canada
Walter
Firmwide
Kentucky/Virginia
1.2
2
USA
Arch
Wells
West Virgin
nia
1.4
4
USA
Patriot
Kentucky/Virginia
0.9
9
Firmwide
USA
Consol
nia
1.1
1
West Virgin
Bluestone
USA
Mechel
Kentucky/Virginia
1.5
5
Firmwide
USA
Alpha
0.3
3
Alabamaa
Shoal Creek
USA
Drummond
Tete
0.8
8
Pinnacle
Mozambique
Beacon Hill
Grasssy Creek/Hominy Creek
C
Kentuckyy
0.5
5
USA
Alpha
Australia
Integra
New South Wales
W
1.4
4
Vale
NZ
0.5
5
New Zealand
Stockton
Solid Energy
USA
0.3
3
Virginia
Cherokee
Alpha
Australia
nd
0.3
3
Queenslan
Duralie/Stratford
Yancoal
Queenslan
nd
1.5
5
Australia
Burton
Peabody
Virginia
0.3
3
USA
Cumberland Riverr
Arch
Peace River
mbia
1.5
5
British Colum
Canada
Anglo American
20..5
Total
Annou
uncement date
Actio
on
Mar-14
Suspended from
m September
Mar-14
Closed 1Q14
ut by 300kt
Apr-14
Guidance cu
Idleed
Apr-14
Guidance cut byy 1.2mt in April
Apr-14
Reducing production
Apr-14
ut by 0.9mt
Guidance cu
Apr-14
Idleed
Apr-14
Guidance cu
ut by 1.5mt
Apr-14
Idleed
Apr-14
May-14
Will not resume saless until prices recovee
Idleed
May-14
Idleed
May-14
Jun-14
Reeduce production frrom 1.9 to 1.4mtpa
Jun-14
End of mine life
Jun-14
Suspen
nded
Reducing production
Jul-14
Idleed
Jul-14
Idleed
Sep-14
Source: Wood
d Research, comp
mpany data
Ho
owever, sincce then, th
he pace of
o closures has slowed
d. Few maajor closuree
announcements have happ
pened since, with only 3.3mt
3
of plaanned capacity reduction
n
ural Resource
es has annou
unced to wo
orkers that, iff
announcements since July. Alpha Natu
n improve, further closu
ures are likelyy. This would
d result in a loss of c.2mtt
conditions do not
p
However,
H
wee have seen little elsewhere. With the recent dollarr
of annualised production.
ucer currencies have been weakening
g, which sho
ould lower th
he cost curvee
streength, produ
and provide so
ome relief forr struggling miners.
m
In ad
ddition, bencchmark prices have fallen
n
o long-term contracts
c
do not yet fullyy
only -0.8% qoq despite thee sharper falll in spot, so
w market reality. Benchmark prices will
w need to ta
ake another leg down, in
n
refflect the new
our view, in ord
der to trigger another wavve of closuress required to balance the market.
pot prices c.U
USD 5/tonnee below the benchmark,
b
w
weak
Chinesee growth and
d
As a result of sp
e strong dollar, it is likely
y that bench
hmark prices trend lowerr in 1Q15, unless we seee
the
siggnificant supp
ply disruption
ns (such as th
he Australian floods that caused
c
a rallyy above USD
D
300/tonne in 1Q
Q11). Prices will remain depressed
d
un
ntil we see:
a)
The fulll effects of previously-ann
nounced clossures;
b) A new
w wave of closures
c
trigggered by lo
ower benchm
mark prices/sstrengtheningg
produccer currencies; and/or
c)
JSW
An inflection point in Chinese stteel production.
9
WOOD
D & COMPA
ANY
We suspect these factors will not happen in the next few months, so we expect flat/slightly
lower prices in the near term. Prices should eventually rise towards a level near the top of
the cost curve, where we see supply remaining at a sustainable level, but this could be a
long, slow process. When the market does start to recover, some idled mines may come
back onstream. In addition, the large capacity expansions planned for the next few years
have largely been pushed back until 2016/17E, when we could see another wall of
production hit the market.
Planned new production capacity according to Bloomberg Intelligence
30
25
20
15
10
5
0
2014
2015
2016
2017
Excluding capitally constrained project
2018
2019
2020
Incremental additions from potential projects
Source: Bloomberg Intelligence
We expect the market surplus to fall gradually towards a balance, but it is likely to take
several years, in our view.
Global seaborne exports and imports
Exports, mt
Australian
2009
135
growth yoy
Canadian
28
growth yoy
US
31
growth yoy
Other
26
growth yoy
2010
159
2011
133
2012
145
2013
170
2014E
184
2015E
189
2016E
195
2017E
200
18%
-17%
9%
17%
9%
3%
3%
3%
33
33
35
39
39
37
36
35
17%
0%
4%
13%
-1%
-4%
-3%
-3%
46
57
58
55
48
42
39
37
51%
24%
0%
-5%
-12%
-12%
-7%
-6%
40
41
46
45
49
50
51
52
53%
3%
11%
-3%
10%
2%
2%
2%
Global
220
278
265
283
308
320
318
321
324
Imports, mt
Japan
2009
66
2010
77
2011
69
2012
71
2013
77
2014E
78
2015E
79
2016E
79
2017E
79
17%
-10%
4%
8%
2%
1%
0%
0%
25
28
25
27
28
30
31
32
38%
9%
-10%
10%
4%
7%
3%
2%
growth yoy
South Korea
18
growth yoy
European
43
growth yoy
China
41
growth yoy
India
27
growth yoy
Other
12
Notional market balance
54
49
57
58
59
59
59
-10%
-11%
17%
2%
1%
1%
1%
43
46
55
76
71
67
70
73
6%
7%
21%
38%
-7%
-5%
4%
4%
32
29
30
33
37
40
44
48
21%
-11%
4%
10%
11%
8%
10%
9%
24
33
36
25
24
26
27
28
98%
38%
7%
-31%
-1%
7%
4%
4%
207
262
259
266
295
297
301
310
319
13
16
6
17
13
23
17
11
5
growth yoy
Global
61
41%
Source: Bloomberg, Eurostat, Wood Research
JSW
10
WOOD & COMPANY
We show our pricing outlook in the table below. We model semi-soft coking coal diverging
to a 29% discount to HCC (vs. 25% in 2Q14), in line with the average in 2011-1H14.
Macro forecasts
HCC benchmark, $/t
SS benchmark, $/t
Average Polish thermal coal price , PLN/t
PLN/$
Realised prices, PLN/t
Coking coal
Premium over weighted HCC/SS benchmark
Thermal coal
Coke (realised price)
Coke (realised price), FCA
2014
2015
2016
2017
2018
2019
2020
2021
2022
126
93
221
3.14
124
91
233
3.30
135
96
244
3.30
152
108
247
3.30
156
111
251
3.30
160
113
255
3.30
164
116
258
3.30
168
119
262
3.30
172
122
266
3.30
411
407
13.5% 11.9%
232
245
717
707
668
658
412
5.0%
256
717
666
446
0.0%
260
773
722
457
0.0%
264
791
738
466
0.0%
268
808
754
477
0.0%
272
828
772
489
0.0%
276
849
791
502
0.0%
280
870
811
Source: Wood Research
For our thermal coal prices, we use our in-house forecasts used in our Bogdanka and utilities
models. We forecast average Polish thermal coal prices adjusted to a 21.5MJ/kg basis (as
reported by Bogdanka in its results presentations). We see prices growing broadly in line
with inflation, which is typically how thermal coal is priced in Poland. Prices are usually
negotiated annually and bear little relation to international benchmarks, such as API2.
We adjust JSW's realised thermal coal price for its coal quality (recently 21MJ/kg) and
assume that the 2Q14 premium over the calorie-adjusted benchmark is sustainable in
deriving these forecasts.
In coking coal, our realised coking coal price reflects: a) the changing blend between
HCC and semi-soft coal; and b) the falling premium vs. the benchmark, which we assume
falls to zero by 2016E.
JSW
11
WOOD & COMPANY
Does JSW’s coal continue to deserve a premium to
benchmark prices?
The background
It is important to highlight how important JSW is in the European coking coal market.
Europe is currently and is likely to remain dependent on coking coal imports for around
two-thirds of its consumption.
European coking coal market balance — Europe remains a large importer
70%
120
80
70%
70
100
68%
80
66%
68%
60
50
66%
40
60
64%
40
62%
20
64%
30
20
62%
10
0
60%
0
60%
2010 2011 2012 2013 2014E 2015E 2016E 2017E 2018E
2010 2011 2012 2013 2014E 2015E 2016E 2017E 2018E
Coking coal production, lhs
Net imports, lhs
Coking coal usage, lhs
% imported, rhs
HCC production, lhs
Net imports, rhs
HCC consumption, lhs
% imported, rhs
Source: JSW K-S acquisition presentation, slide 6. Figures in million metric tonnes. HCC = Hard coking coal
Within this, JSW is an important part of the supply equation, supplying 27% of Europe’s
production in 2013 (and which should reach close to one-third when it fully integrates
and ramps up the K-S project). Given the financial difficulties experienced by European
producers at current prices (especially NWR, which is likely to reduce production by
2.2mt of coking coal by 2021), it is likely that European supply will stagnate or decline
further, placing greater importance on imports and JSW.
With the acquisition of K-S, JSW should reach nearly one-third of European coking coal
production
45
35%
40
30%
35
25%
30
25
20%
20
15%
15
10%
10
5%
5
0%
0
2011
2012
2013
2014E
European coking coal production
2015E
JSW
2016E
2017E
2018E
JSW % of European production
Source: Wood Research, company data
This makes JSW a key supplier to the European steel mills and allows it to cultivate strong
relationships with customers. It also has a transport cost advantage, which allows it to
receive greater net-back prices than its global peers.
It also has a diversified but localised customer base. Aside from ArcelorMittal, no other
customer accounts for more than 12% of JSW’s total revenue. Its diversified customer base
reduces its exposure to any one customer and gives JSW more pricing power. The
JSW
12
WOOD & COMPANY
proximity of supply (most sales are within CEE) also de-risks the potential supply shortfall,
which gives JSW further pricing power.
JSW’s sales revenue split by customer (lhs) and by country (rhs) shows a diversified customer base with a
local focus
Netherlands
2%
ArcelorMittal
24%
Other
28%
Others
4%
Poland
44%
Italy
12%
Slovakia
3%
PGNiG Termika
2% EDF
3%
Koksownia Czestochowa Ilva Spa
Nowa
12%
3%
Czech Republic
10%
Voestalpine
10%
ThyssenKrupp PGE
3%
4%
US Steel
2%
Moravia Steel
Salzgitter
5%
4%
Austria
10%
Germany
15%
Source: Wood Research, company data
Strong client relationships reduce price volatility
A further benefit of JSW’s proximity to its clients means that it has long-standing close
relationships. In the past, JSW has not increased coal/coke prices in response to rapid
price increases, such as in 2011. The benefit of this is that the same customers now pay a
premium over benchmark prices in order to prevent JSW from closing facilities and risking
supply. Steel mills are often sensitive to the exact grades of coke and coking coal used in
production, and prefer to use the same supplier despite the potential to buy cheaper coal
for a short-term profit. This reciprocal relationship reduces price volatility and is beneficial
in the current depressed coal market.
Interdependency with local clients leads to lower price volatility than the benchmark — the lhs chart shows
realised coking coal prices vs. the production-weighted coking coal benchmark and the rhs chart shows the
same comparison for steam coal
1000
900
800
20%
400
25%
15%
350
20%
300
10%
700
600
15%
250
5%
10%
200
500
400
0%
300
‐5%
200
100
0
1Q11
3Q11
1Q12
3Q12
Benchmark, PLN/t lhs
1Q13
3Q13
5%
150
0%
100
‐10%
50
‐15%
0
‐5%
‐10%
1Q11
1Q14
Realised price, PLN/t lhs
3Q11
1Q12
3Q12
1Q13
Benchmark, PLN/t lhs
Premium to benchmark, rhs
3Q13
1Q14
Realised price, PLN/t lhs
Premium to benchmark, rhs
Source: Wood Research, company data. Coking coal benchmark prices are derived from the relevant hard coking coal and semi-soft
benchmarks weighted by JSW’s sales split. The thermal coal benchmark is based on average Polish coal prices with a calorific adjustment
Will this coking coal premium be sustainable going forward?
On the positive side, its transport costs to customers should be lower than imports from
Australia/North America, so the net-back price received should exceed the FOB Australia
benchmark. Australia to Rotterdam freight rates are currently as low as USD 12/tonne,
which is low in comparison to historic levels. Logically, this would suggest a sustainable
premium in line with the freight differential above Australian FOB prices. Average rail
prices to customers should also be lower for JSW than its peers transporting coal from the
coast. However, historical premiums have not been consistently positive, implying that
JSW
13
WOOD & COMPANY
there must be an offsetting factor such as a quality discount relative to premium Australian
HCC, but it is not clear to us from company disclosure what this may be. However, that
the premium has averaged close to zero since the IPO suggests to us that it would be
conservative to assume that premiums return to this average in the medium term (we
assume by 2016E). This coincides with a rising benchmark price, leading to a slower price
rebound than its peers.
However, this represents a meaningful source of upside. If premiums of PLN 53/tonne can
be maintained, this equates to PLN 857m of EBITDA based on 2017E coking coal
production, which would increase our EBITDA assumption by c.49%. Falling production
from neighbouring company NWR could also increase demand and premiums for JSW’s
local coking coal, and, after the recent restructuring, it should reduce coking coal
production by c.2.2mt by 2021E.
JSW’s thermal coal has consistently received premiums over the quality-adjusted Polish
average coal price benchmark (adjusted for calorific value), we assume for quality reasons
(lower sulphur/other impurities). We see no reason for this premium to change, so assume
this stays flat from the 2Q14 level, although this is less material for the investment case
than the coking coal premium.
JSW
14
WOOD & COMPANY
Operationally, JSW appears to be moving in the right
direction
Production and sales — legacy assets should recover after a weak 2014
2014 has been a tough year for JSW. It set out to produce 13.79mt of coal at the start of
the year but, due to problematic geology (specifically, intrusions in some coal seams),
production was only 3.19mt in 1Q14 and fell further to 2.48mt in 2Q14, nearly 1mt short
of the required run rate.
JSW’s quarterly mine production has declined significantly in recent quarters due to
geological problems
4.0
3.5
3.0
2.5
2.0
1.5
1.0
0.5
0.0
1Q11
2Q11
3Q11
4Q11
1Q12
2Q12
3Q12
4Q12
1Q13
2Q13
3Q13
Hard coking coal, mt
Semi‐soft coking coal, mt
Thermal coal, mt
2014 guidance run‐rate
4Q13
1Q14
2Q14
Source: Wood Research, company data
We believe JSW will not meet guidance of 13.8mt this year and looks set to fall at least
1.5mt short, in our view. However, this appears to be a temporary geological set-back and
management does not expect it to continue into next year. Management announced in
August that July production was 1,108kt, up from an average of 827kt/month in 2Q14.
The rate accelerated further in September. Deputy CEO Mr. Borecki announced on 29
September that the average mining rate for the month was 56ktpd, implying 1,120kt for
the month (assuming 20 working days as JSW does not work weekend shifts). If this rate is
maintained until the end of the year as management expects, it should reach 12.27mt for
the year, 1.5mt short of the guidance for 2014E. However, this annualises to 13.4mt, close
to the 13.6mt reached in 2013, so it does not have to accelerate much to return to
previous production levels, in our view.
Management expects to produce close to 14mtpa from the legacy assets once the current
problems have been overcome, although we model production flat at 13.6mtpa from
2015E, in line with the 2013 levels. While further efficiencies/debottlenecking operations
may unlock underground mining capacity, the prevailing low coal price is likely to limit
the short-term maintenance capex. This could prevent this 14mt target from being reached
before prices rebound to normalised levels, in our view.
Growth to follow the Knurow-Szczyglowice acquisition
In August, JSW completed the acquisition of the Knurow-Szczyglowice mine from
Kompania Weglowa. The mine produces 3.8mtpa currently, but JSW expects to increase
output to 4.5mtpa by 2018E. Once the acquisition is complete and streamlined, it could
increase JSW’s production to 18.5mt by 2018E (although we model a peak of 18.17mtpa
from 2019E).
JSW
15
WOOD & COMPANY
JSW should reach 18.2mt by 2018E following the K-S acquisition on our base case and
18.5mt on management’s guidance
20.0
18.0
16.0
14.0
12.0
10.0
8.0
6.0
4.0
2.0
0.0
2011
2012
2013
2014
2015
2016
Legacy JSW assets, mt
2017
2018
2019
2020
2021
2022
Knurow‐Szczyglowice, mt
Source: Wood Research
Product mix should worsen following the acquisition, but improve going
forwards
Kompania Weglowa operated the K-S project primarily as a thermal coal mine as it is a
state thermal coal company. As a result, following JSW’s acquisition of these assets, the
product mix for the consolidated group will worsen.
The product mix for JSW will worsen post acquisition, but conversion of K-S to a
predominantly coking coal mine should improve the proportion of coking coal going
forward
20
70%
18
60%
16
50%
14
12
40%
10
30%
8
6
20%
4
10%
2
0
0%
2011
2012
2013
2014
2015
2016
2017
2018
2019
Hard coking coal, mt lhs
Semi‐soft coking coal, mt lhs
% HCC, rhs
% SS, rhs
2020
2021
2022
Thermal coal, mt lhs
Source: Wood Research
However, deeper levels (1,050m deep) should yield higher quality coking coal. By
accessing these levels and upgrading the processing plant, JSW should convert the K-S
project from a 0%/38%/62% HCC/semi-soft coking coal/thermal coal split to
12%/68%/20% by 2019E.
JSW
16
WOOD & COMPANY
Change in the product mix from the Knurow-Szczyglowice complex
2014
2019
Hard coking
coal
12%
Semi-soft
coking coal
38%
Thermal coal
62%
Thermal coal
20%
Semi-soft
coking coal
68%
Source: Wood Research, company data
Whether this is achievable is another matter. This is dependent upon funding being
available for the development of the 1,050m level and the refurbishment of the wash
plant, both of which are at risk due to the lack of operating cash flow being generated by
the group at present.
This should drive higher sales of coking coal going forward as coke production
stays flat
Coking capacity is to remain flat in the medium term, according to management.
Following the K-S acquisition, capex priorities have changed and the plan to expand
capacity through the construction of battery number 6 at Victoria has stalled. We model
3.96mtpa flat going forward (vs. 3.94mt in 2013). As a result, additional volumes from K-S
and the recovery in output at the legacy assets should result in higher external sales of this
coal.
External sales volumes — coke sales to remain flat, so additional coal mining volumes will
be sold to third parties
2,000
1,800
1,600
1,400
1,200
1,000
800
600
400
200
1Q12
2Q12
3Q12
4Q12
Coking coal
1Q13
2Q13
Thermal coal
3Q13
4Q13
1Q14
2Q14
Coke
Source: Wood Research
Unit costs should also fall with greater volume
Management estimates that roughly 80% of JSW’s costs are fixed, so mining unit costs
should fall significantly from the 2Q14 level of PLN 428/tonne. They were up 13% qoq in
1Q14 to PLN 358/tonne and up a further 20% qoq to PLN 428/tonne in 2Q14, due largely
to falling volumes. As we expect volumes to rebound as geological conditions improve,
unit costs and margins should improve in the legacy production assets.
JSW
17
WOOD & COMPANY
Unit costs increases in 1H14 should reverse as volumes pick up due to the high fixed
cost base
500
4.00
450
3.50
400
3.00
350
300
2.50
250
2.00
200
1.50
150
1.00
100
.50
50
‐
‐
1Q11 2Q11 3Q11 4Q11 1Q12 2Q12 3Q12 4Q12 1Q13 2Q13 3Q13 4Q13 1Q14 2Q14 3Q14E 4Q14E
Unit mining cash costs, PLN/t
Coal production volume, mt
Source: Wood Research, company data
JSW also plans to hire less staff than leave in the next few years, leading to an annual
headcount attrition rate of c.0.7% p.a. (hiring only 500 people for every 700 who leave)
as management expects labour productivity to improve. Furthermore, new workers will be
hired on cheaper contracts. Currently, most of the workforce enjoys significant benefits
following successful union bargaining agreements. Management is planning to hire new
labour for a different subsidiary called SIG (Szkolenie i Górnictwo). They will receive
training, but pay and benefits will be c.20% lower than the contracts enjoyed currently by
the majority of the labour force. Attrition, plus a higher proportion of workers on lower
benefit contracts, should result in a real fall in labour costs of 1.1% p.a.
There may also be scope for cutting costs through further efficiencies. JSW has enjoyed
several years of high coking coal prices and cost creep, and has only recently started to
lose money, so the pressure to find cost savings will be greater now than it has been in the
past. If savings are possible, 2015 is likely to be the year when they become apparent, in
our view. However, we do not model efficiency savings now without guidance from
management.
We expect unit costs in the legacy assets (ex-KS) to grow slower than inflation
500
400
300
200
100
0
2011
2012
2013
2014
2015
2016
Legacy assets' mining cash costs
2017
2018
2019
2020
2021
2022
2014 cash cost + assumed Polish CPI
Source: Wood Research, company data
JSW
18
WOOD & COMPANY
FCF negative for years and it could get worse…
Despite modelling significant operational improvements in 2015E, it is hard to see FCF
turning positive in the near future. We assume that the price recovery is slow and a
normalisation of JSW’s premium to the benchmark will mean that its prices rise slower
than the benchmark prices. Even with production rising and labour costs falling in real
terms, the impact of the consolidation of the currently loss-making K-S project and limited
price growth should result in EBITDA rising to only PLN 1,133m on our forecasts next
year and PLN 1,212m in 2016E. This will rise more in 2017E when the premium has
reached zero and JSW has full participation in the global price rally. However, only when
the K-S synergies are fully realised and prices reach USD 156/tonne in 2018E do we
expect FCF to turn positive on our base case.
Simplified cash flow forecasts on our base case assumptions
DCF value (PLN/share)
Key assumptions
Benchmark HCC price, PLN/t
Benchmark SS price, PLN/t
Blended Benchmark coking coal price, PLN/t
Realised coking coal price, PLN/t
Premium, PLN/t
% premium
PLN/$
Coal production total, mt
Coal production ex-KS, mt
Mining cash cost, PLN/t
Financials (in PLN mn)
EBITDA
Operating CF
Investment CF (mainly capex/M&A)
FCF
Dividends
Net debt
Net debt/EBITDA
2014
18.9
2015
2016
2017
2018
2019
2020
2021
126
124
93
91
362
364
411
407
49
43
13.5% 11.9%
3.14
3.30
13.86 17.71
12.27 13.63
360
332
135
96
392
412
20
5.0%
3.30
17.91
13.63
336
152
108
446
446
0.0%
3.30
18.04
13.63
342
156
111
457
457
0.0%
3.30
18.16
13.63
347
160
113
466
466
0.0%
3.30
18.17
13.63
354
164
116
477
477
0.0%
3.30
18.17
13.63
360
168
119
489
489
0.0%
3.30
18.17
13.63
367
572 1,113 1,212 1,765 2,066 2,156 2,286 2,364
485 1,022 1,088 1,594 1,832 1,918 2,034 2,115
-3,092 -1,392 -1,569 -1,721 -1,654 -1,737 -1,713 -1,599
-2,608
-370
-481
-127
178
181
321
516
-14
-72
-88
-111
901 1,271 1,752 1,878 1,715 1,605 1,372
967
1.57
1.14
1.45
1.06
0.83
0.74
0.60
0.41
Source: Wood Research, company data
This scenario assumes capex of PLN 1.4bn next year, in line with recent guidance, but
reverts to a normalised level of capex spending thereafter as management has said in the
past that it could start to affect production in the medium term if capex below PLN 1.5bn
is sustained for a more than a temporary period.
However, despite these cash flow losses, leverage (net debt/EBITDA) peaks at only 1.45x
at the end of 2015E as EBITDA accelerates in 2017E as the global coal market normalises.
If we assume spot prices prevail, but the premium remains, the company remains lossmaking until the K-S project synergies are fully realised and the product mix improves by
2021E. However, in this scenario, the FCF losses in 2015/16E are similar to our base case,
so leverage does not increase above 1.54x in this scenario.
JSW
19
WOOD & COMPANY
Simplified cash flow forecasts on spot HCC prices and premiums
DCF value (PLN/share)
Key assumptions
Benchmark HCC price, PLN/t
Benchmark SS price, PLN/t
Blended Benchmark coking coal price, PLN/t
Realised coking coal price, PLN/t
Premium, PLN/t
% premium
PLN/$
Coal production total, mt
Coal production ex-KS, mt
Mining cash cost, PLN/t
Financials (in PLN mn)
EBITDA
Operating CF
Investment CF (mainly capex/M&A)
FCF
Dividends
Net debt
Net debt/EBITDA
2014
-1.83
2015
2016
2017
2018
2019
2020
2021
126
119
119
119
119
119
119
119
93
89
89
89
89
89
89
89
369
353
352
355
354
353
353
353
416
405
405
408
407
406
406
406
48
53
53
53
53
53
53
53
12.9% 14.9% 14.9% 14.9% 14.9% 14.9% 14.9% 14.9%
3.19
3.30
3.30
3.30
3.30
3.30
3.30
3.30
13.86 17.71 17.91 18.04 18.16 18.17 18.17 18.17
12.27 13.63 13.63 13.63 13.63 13.63 13.63 13.63
360
329
324
321
318
317
314
313
635 1,070 1,197 1,403 1,653 1,703 1,781 1,809
547
982 1,075 1,248 1,467 1,507 1,575 1,601
-3,092 -1,386 -1,551 -1,687 -1,607 -1,652 -1,602 -1,476
-2,545
-405
-477
-440
-139
-144
-28
126
838 1,243 1,719 2,159 2,298 2,443 2,470 2,345
1.32
1.16
1.44
1.54
1.39
1.43
1.39
1.30
Source: Wood Research, company data
For FCF to turn positive in 2015E, the HCC benchmark price would have to average USD
131/tonne (with an unchanged premium), which implies finishing the year at USD
143/tonne, assuming a linear increase from the 4Q14 benchmark, a scenario we see as
unlikely.
There are, however, several potential company-specific scenarios whereby leverage
increases faster than we expect:
Reoccurring production issues in 2015E: the management team has said little about the
problems experienced in 2Q14. In the 2Q14 report, the only explanation given was: “The
volume of coal production in H1 2014 was 5.7 million tons, i.e., 1.1 million tons less than
in H1 2013 due to difficulties of a mining and geological nature”. Management failed to
expand on this much on the 2Q14 conference call, just adding that various intrusions in
the seams affected production. This was not anticipated by management, so there is
chance of this reoccurring, in our view. We model production returning to normal levels
in 2015E (13.6mt, in line with the 2013 levels), excluding the K-S project, as production is
already improving in 3Q14. However, there is a risk that production could be much lower
and, as 80% of cash costs are largely fixed, cash costs would be affected negatively in this
scenario. In the table below, we show the impact of production remaining at our 2014E
level.
JSW
20
WOOD & COMPANY
Simplified cash flow forecasts on spot HCC prices and premiums, but assuming production does not recover
from the 2014E low
DCF value (PLN/share)
Key assumptions
Benchmark HCC price, PLN/t
Benchmark SS price, PLN/t
Blended Benchmark coking coal price, PLN/t
Realised coking coal price, PLN/t
Premium, PLN/t
% premium
PLN/$
Coal production total, mt
Coal production ex-KS, mt
Mining cash cost, PLN/t
Financials (in PLN mn)
EBITDA
Operating CF
Investment CF (mainly capex/M&A)
FCF
Dividends
Net debt
Net debt/EBITDA
2014
-25.57
2015
2016
2017
2018
2019
2020
2021
126
119
119
119
119
119
119
119
93
89
89
89
89
89
89
89
369
352
351
354
353
352
352
352
416
404
404
407
406
405
404
404
48
52
52
53
53
53
52
52
12.9% 14.9% 14.9% 14.9% 14.9% 14.9% 14.9% 14.9%
3.19
3.30
3.30
3.30
3.30
3.30
3.30
3.30
13.86 16.35 16.55 16.68 16.80 16.81 16.81 16.81
12.27 12.27 12.27 12.27 12.27 12.27 12.27 12.27
360
351
346
342
339
337
334
333
635
702
830 1,027 1,265 1,314 1,390 1,419
547
602
681
823 1,006 1,020 1,059 1,055
-3,092 -1,386 -1,471 -1,601 -1,514 -1,559 -1,510 -1,383
-2,545
-784
-790
-778
-508
-539
-451
-328
838 1,622 2,412 3,190 3,697 4,237 4,688 5,016
1.32
2.31
2.91
3.11
2.92
3.22
3.37
3.54
Source: Wood Research, company data
In this scenario, the company remains loss-making until 2021E. Leverage, however, does
not rise to a normal covenant breach level of c.3.5x until 2021E. We assume that, even if
JSW fails to resolve the problems from 2Q14 immediately in 2015E, it is unlikely to persist
unless insufficient maintenance capex is spent.
The premium collapses to zero from 2015: early elimination of the premium from our
base case leads to a rapid rise in leverage to 9.2x by year-end 2016E, before falling with
the price recovery. The average premium has been zero since 2011, so this scenario is
possible, in our view.
Simplified cash flow forecasts assuming spot prices, but the HCC premium collapses to zero in 2015
DCF value (PLN/share)
Key assumptions
Benchmark HCC price, PLN/t
Benchmark SS price, PLN/t
Blended Benchmark coking coal price, PLN/t
Realised coking coal price, PLN/t
Premium, PLN/t
% premium
PLN/$
Coal production total, mt
Coal production ex-KS, mt
Mining cash cost, PLN/t
Financials (in PLN mn)
EBITDA
Operating CF
Investment CF (mainly capex/M&A)
FCF
Dividends
Net debt
Net debt/EBITDA
2014
-82.27
2015
2016
2017
2018
2019
2020
2021
126
93
369
384
15
4.1%
3.19
13.86
12.27
360
119
89
353
353
0.0%
3.30
17.71
13.63
328
119
89
352
352
0.0%
3.30
17.91
13.63
323
119
89
355
355
0.0%
3.30
18.04
13.63
320
119
89
354
354
0.0%
3.30
18.16
13.63
318
119
89
353
353
0.0%
3.30
18.17
13.63
316
119
89
353
353
0.0%
3.30
18.17
13.63
313
119
89
353
353
0.0%
3.30
18.17
13.63
312
245
268
378
549
738
779
853
881
157
139
170
244
332
283
262
196
-3,093 -1,386 -1,551 -1,687 -1,607 -1,652 -1,602 -1,476
-2,936 -1,248 -1,381 -1,444 -1,274 -1,368 -1,341 -1,279
1,229 2,477 3,858 5,302 6,576 7,945 9,285 10,564
5.01
9.23 10.20
9.66
8.91 10.20 10.89 11.99
Source: Wood Research, company data
JSW
21
WOOD & COMPANY
What can JSW do in order to reduce the FCF losses?
In order to avoid breaching its debt ceiling, JSW can potentially reduce cash outflows
through lower capex, lower opex or release of working capital, but in our view, these are
temporary rather than permanent cuts that may buy the company some time before
eventually running out of funding if prices fail to improve.
One potential positive surprise would be if management were able to persuade the unions
to work a six rather than a five-day working week, which would provide a longer lasting
sustainable boost to cash flow, but we do not model this in our base case. Management
has been hoping for this agreement for a long time, but it does not appear close to reality,
in our view.
Capex savings possible in the short term, but not sustainable for long
JSW has already reduced its capex guidance to PLN 1.4bn in 2015E vs. PLN 1.8bn
initially in 2014E (although it now expects to spend PLN 1.6-1.7bn in 2014E due to a
lower cash flow). Management has said that it does not believe capex below PLN 1.5bn
can be sustained in the medium term without a short-term impact on production,
however, so the scope to cut much further is limited. However, in 2009/2010, when
prices last fell to unsustainable levels, JSW’s capex was PLN 940m and PLN 770m,
respectively, so, in the short term, cuts can be made if necessary. JSW is also far more
capital intensive than its regional peers.
Capex in PLN/tonne of production — JSW is the most capex-intensive coal miner in CEE
and should have the most scope to cut capex in response to lower prices
160
140
120
100
80
60
40
20
‐
2011
2012
JSW
Bogdanka
2013
NWR
2014E
Other Polish producers
Source: Wood Research, company data
JSW, however, has higher underground opex than its CEE peers, so a higher level of
maintenance capex should be expected due to the relative geological complexity of its
mines, especially compared to Bogdanka, which employs significantly longer long walls.
It has also enjoyed a stronger balance sheet and higher profitability than NWR in recent
years, so NWR’s spending is likely affected by funding availability rather than necessity.
As a result, we doubt that JSW could return to a sustainable level of capex spending close
to its regional peers.
What is necessary maintenance capex?
We estimate that, excluding the K-S project, JSW needs to spend c.PLN 900m p.a. in the
legacy coal business in order to maintain production in the medium term. In 2013, capex,
excluding vertical and horizontal mine developments, was PLN 929m. This consisted of
mainly PLN 504m in mine development costs in order to gain access to areas of the mine
necessary for near-term production and PLN 425m on general maintenance capex. Nondevelopment capex was higher in 2012 and 2011 at PLN 1,124m and PLN 1,006m,
JSW
22
WOOD & COMPANY
respectively, although this may have been a function of inefficient spending given the high
coal prices at the time, in our view.
Further maintenance spending will be required at the coking and power assets, which
should bring full group maintenance capex to c.PLN 1.1bn ex-KS. With the K-S project, it
should be closer to PLN 1.25bn (guidance for maintenance capex at K-S averages PLN
150m p.a., according the acquisition presentation).
Average maintenance capex in PLN m p.a. for the group
Average maintenance capex
Coal business ex-KS including maintenance and near term pit development
Knurow & Szczyglowice maintenance capex
Coke and other
Total
900
150
200
1,250
Source: Wood Research
Despite this, we believe management’s 2014 guidance assumes spending less than this as
it plans to continue developing the more advanced vertical expansion projects at Budryk,
Pniowek and KS, where we expect it to spend c.PLN 300m in 2015E, implying only PLN
1.1bn on maintenance. In a stressed scenario, this capex could be saved as these projects
are long term in nature and current mine lives are long enough to sustain medium-term
production without these developments, in our view. However, maintenance capex
cannot be reduced much below PLN 1.2bn for much longer than one year. Below, we
show our base case capex forecasts, where we model deferrals of the less important
projects before spending accelerates, when we assume that prices recover. We also show
a “stressed scenario”, where capex is cut to minimum levels without any long-term
development capex.
Capex assumptions under our base case scenario and potential stressed scenario capex savings
Capex (total)
Legacy JSW
KS capex
2013
2014
2015
2016
2017
2018
2019
2020
2021 2022
-1,783 -1,603 -1,401 -1,578 -1,730 -1,663 -1,746 -1,722 -1,608 -1,627
-1,783 -1,538 -1,233 -1,342 -1,483 -1,406 -1,482 -1,464 -1,435 -1,449
-65
-168
-236
-246
-257
-264
-258
-173 -178
Coal segment
Capex ex-near term pit development, o/w:
Maintenance capex
-1,379 -1,285 -1,035 -1,071 -1,167 -1,082 -1,150 -1,214 -1,246 -1,255
-875
-809
-610
-621
-676
-564
-619
-670
-688 -684
-425
-386
-340
-354
-382
-409
-419
-430
-440 -451
Maintenance capex per tonne
Long term development capex
Near term pit access capex
ST development capex per tonne
Coke segment
Other segment
Total group capex ex-KS
31.2
31.5
25.0
26.0
28.0
30.0
30.8
31.5
32.3
33.1
-450
-504
-422
-476
-269
-425
-267
-450
-295
-491
-155
-518
-200
-531
-240
-544
-248
-558
-232
-572
37.0
38.8
31.2
33.0
36.0
38.0
39.0
39.9
40.9
41.9
-232
-152
-91
-94
-120
-123
-126
-102
-90
-92
-151
-109
-106
-177
-196
-201
-206
-148
-99 -101
-1,762 -1,545 -1,233 -1,342 -1,483 -1,406 -1,482 -1,464 -1,435 -1,449
Stressed scenario capex (no LT development capex)
-1,079 -1,194 -1,296 -1,369 -1,407 -1,421 -1,357 -1,391
Source: Wood Research
If we assume that either prices remain low, production problems persist, or the JSW price
realisations fall in line with the benchmark, JSW would be forced to implement the capex
cuts we outline above. Below, we show these three scenarios, but assuming that capex
falls to maintenance only levels, i.e., by stripping out any long-term development capex
from our base case forecast. We show this capex scenario as the “stressed scenario capex”
in the table above.
JSW
23
WOOD & COMPANY
Simplified cash flow forecasts on spot HCC prices and premiums, assuming capex is cut to maintenance levels
Key assumptions
Benchmark HCC price, PLN/t
Benchmark SS price, PLN/t
Blended Benchmark coking coal price, PLN/t
Realised coking coal price, PLN/t
Premium, PLN/t
% premium
PLN/$
Coal production total, mt
Coal production ex-KS, mt
Mining cash cost, PLN/t
Financials (in PLN mn)
EBITDA
Operating CF
Investment CF (mainly capex/M&A)
FCF
Dividends
Net debt
Net debt/EBITDA
2014
2015
2016
2017
2018
2019
2020
2021
126
93
369
416
48
12.9%
0.00
13.86
12.27
360
119
89
353
405
53
14.9%
0.00
17.71
13.63
329
119
89
352
405
53
14.9%
0.00
17.91
13.63
324
119
89
355
408
53
14.9%
0.00
18.04
13.63
321
119
89
354
407
53
14.9%
0.00
18.16
13.63
318
119
89
353
406
53
14.9%
0.00
18.17
13.63
317
119
89
353
406
53
14.9%
0.00
18.17
13.63
314
119
89
353
406
53
14.9%
0.00
18.17
13.63
313
635
547
-3,092
-2,545
838
1.32
1,070
982
-1,079
-97
936
0.87
1,197
1,075
-1,194
-120
1,055
0.88
1,403
1,248
-1,296
-48
1,103
0.79
1,653
1,467
-1,369
99
1,005
0.61
1,703
1,507
-1,407
101
904
0.53
1,781
1,575
-1,421
153
750
0.42
1,809
1,601
-1,357
244
506
0.28
Source: Wood Research, company data
Simplified cash flow forecasts on spot HCC prices and premiums, but assuming production does not recover
from the 2014E low and assuming capex is cut to maintenance levels
Key assumptions
Benchmark HCC price, PLN/t
Benchmark SS price, PLN/t
Blended Benchmark coking coal price, PLN/t
Realised coking coal price, PLN/t
Premium, PLN/t
% premium
PLN/$
Coal production total, mt
Coal production ex-KS, mt
Mining cash cost, PLN/t
Financials (in PLN mn)
EBITDA
Operating CF
Investment CF (mainly capex/M&A)
FCF
Dividends
Net debt
Net debt/EBITDA
2014
2015
2016
2017
2018
2019
2020
2021
126
93
369
416
48
12.9%
0.00
13.86
12.27
360
119
89
352
404
52
14.9%
0.00
16.35
12.27
351
119
89
351
404
52
14.9%
0.00
16.55
12.27
346
119
89
354
407
53
14.9%
0.00
16.68
12.27
342
119
89
353
406
53
14.9%
0.00
16.80
12.27
339
119
89
352
405
53
14.9%
0.00
16.81
12.27
337
119
89
352
404
52
14.9%
0.00
16.81
12.27
334
119
89
352
404
52
14.9%
0.00
16.81
12.27
333
635
547
-3,092
-2,545
838
1.32
702
602
-1,079
-477
1,315
1.87
830
681
-1,194
-513
1,828
2.20
1,027
823
-1,296
-473
2,301
2.24
1,265
1,006
-1,369
-362
2,663
2.11
1,314
1,020
-1,407
-387
3,050
2.32
1,390
1,059
-1,421
-363
3,412
2.45
1,419
1,055
-1,357
-302
3,714
2.62
Source: Wood Research, company data
JSW
24
WOOD & COMPANY
Simplified cash flow forecasts assuming spot prices, but the HCC premium collapses to zero in 2015E and
assuming capex is cut to maintenance levels
Key assumptions
Benchmark HCC price, PLN/t
Benchmark SS price, PLN/t
Blended Benchmark coking coal price, PLN/t
Realised coking coal price, PLN/t
Premium, PLN/t
% premium
PLN/$
Coal production total, mt
Coal production ex-KS, mt
Mining cash cost, PLN/t
Financials (in PLN mn)
EBITDA
Operating CF
Investment CF (mainly capex/M&A)
FCF
Dividends
Net debt
Net debt/EBITDA
2014
2015
2016
2017
2018
2019
2020
2021
126
93
369
384
15
4.1%
0.00
13.86
12.27
360
119
89
353
353
0.0%
0.00
17.71
13.63
328
119
89
352
352
0.0%
0.00
17.91
13.63
323
119
89
355
355
0.0%
0.00
18.04
13.63
320
119
89
354
354
0.0%
0.00
18.16
13.63
318
119
89
353
353
0.0%
0.00
18.17
13.63
316
119
89
353
353
0.0%
0.00
18.17
13.63
313
119
89
353
353
0.0%
0.00
18.17
13.63
312
245
157
-3,093
-2,936
1,229
5.01
268
139
-1,079
-940
2,169
8.08
378
170
-1,194
-1,024
3,194
8.44
549
244
-1,296
-1,052
4,246
7.74
738
332
-1,369
-1,036
5,282
7.15
779
283
-1,407
-1,123
6,406
8.23
853
262
-1,421
-1,159
7,565
8.87
881
196
-1,357
-1,161
8,726
9.90
Source: Wood Research, company data
Assuming prices do not recover but production normalises to 2013 levels and the
premium remains, JSW should remain within its PLN 450m borrowing limit if capex can
be cut back to maintenance levels, allowing it to avoid a rights issue scenario, even if
refinancing is unavailable. With the other two, it merely delays the point at which this
breach occurs. If production does not recover, it should happen before the end of 2015E.
If premiums fall to zero, the breach would happen in mid-2015E.
Opex savings may be possible in the short term, but are hard to predict and,
therefore, model
We model the savings that JSW expects to make from the gradual attrition of the
workforce (assuming that 700 leave each year, to be replaced by 500 on new lower paid
contracts) and assume that new employees who join through the SIG programme (JSW’s
mining academy) receive lower non-salary benefits than current employee contracts
(management guides for 20% lower benefit packages). However, beyond this, we model
no other sustainable cuts in our base case. Management alluded to opex savings of c.PLN
300m during the 2Q14 conference call, but we believe these will be largely short-term
deferrals of non-essential services in response to the current price environment and not
permanent cost savings. These are excluded from the forecasts above, but we believe that
up to PLN 300m (5.7% of the 2013 cash cost of sales) are possible. This could delay a
breach of the PLN 450m debt cap if implemented, but not for long.
Working capital release should be limited following good working capital
management in 2012/13
Working capital savings could also buy JSW time in the event of a prolonged period of
lower prices. However, we believe that the scope for a further working capital release may
be limited. In the time of crisis in 2009, JSW released PLN 364m in working capital,
which improved cash flow significantly. However, working capital management since has
been much stronger. The company released PLN 345m in 2012 and PLN 450m in 2013.
This rate of release is unsustainable, in our view, as much of the low hanging fruit has
already been taken.
JSW
25
WOOD & COMPANY
Working capital movements since 2008 show good management of working capital
500
400
300
200
100
(100)
(200)
(300)
(400)
(500)
2008
2009
2010
2011
2012
2013
2014
Source: Wood Research
Coal and coke inventories fell significantly in 2Q14 and now stand at 915kt, the lowest
level since 2011, when JSW cut inventories significantly to compensate the fall in supply
from the flooded Australian mines and take advantage of high prices. However, this now
leaves limited scope for further inventory release.
Inventories (kt) of finished products have already fallen to the lowest level since 2011
2,000
1,800
1,600
1,400
1,200
1,000
800
600
400
200
1Q12
2Q12
3Q12
4Q12
Coking coal
1Q13
2Q13
Thermal coal
3Q13
4Q13
1Q14
2Q14
Coke
Source: Wood Research
JSW’s CFO suggested that some further working capital release may be possible from
extending payment terms, but we believe the scope for further working capital
optimisation is limited given the optimisation of the past two years, and we model zero
movement going forward.
The impact of the six-day working week
It is difficult to estimate the effect of a six-day week on costs, but if we assume that this
boosts production 20% and assume all costs including maintenance capex scale with
tonnage, the higher EBITDA would instantly improve credit metrics and improve the
chances of refinancing.
JSW
26
WOOD & COMPANY
The effect of 20% higher production, assuming unit costs stay flat
2014
2015
2016
2017
2018
2019
2020
2021
Base case
EBITDA
Operating CF
Investment CF (mainly capex/M&A)
FCF
Dividends
Net debt
Net debt/EBITDA
572
485
-3,092
-2,608
901
1.57
1,113
1,022
-1,392
-370
1,271
1.14
1,212
1,088
-1,569
-481
1,752
1.45
1,765
1,594
-1,721
-127
1,878
1.06
2,066
1,832
-1,654
178
-14
1,715
0.83
2,156
1,918
-1,737
181
-72
1,605
0.74
2,286
2,034
-1,713
321
-88
1,372
0.60
2,364
2,115
-1,599
516
-111
967
0.41
Extra 20% production
EBITDA
Operating CF
Investment CF (mainly capex/M&A)
FCF
Dividends
Net debt
Net debt/EBITDA
572
485
-3,092
-2,608
901
1.57
1,336
1,226
-1,607
-381
1,282
0.96
1,455
1,306
-1,808
-502
1,784
1.23
2,118
1,913
-1,980
-67
1,851
0.87
2,479
2,198
-1,928
270
-14
1,595
0.64
2,587
2,302
-2,018
284
-72
1,383
0.53
2,743
2,441
-1,997
444
-88
1,027
0.37
2,836
2,538
-1,871
668
-111
470
0.17
Source: Wood Research, company data
Fixed costs, such as head office costs, would obviously not scale with production in
practice and economies of scale would reduce unit costs, further boosting cash flow. An
8% fall in mining unit costs would eliminate the cash losses in our base case scenario,
which is absolutely possible in this scenario. If management can achieve this, it would put
JSW on a sustainable footing, in our view, but a deal with the unions is a long way from
agreement, so we cannot consider this in our base case.
JSW
27
WOOD & COMPANY
Under what conditions would a rights issue happen?
As we demonstrate above, on spot prices, JSW would continue to lose money, even if
capex savings are made at the expense of the long-term future of the company. Even with
these capex savings, a rapid fall in premiums over the benchmark or a recurrence of the
1H14 production issues could easily lead to JSW needing more than PLN 450m in
additional funding, the specified limit according to current debt agreements.
Polish banks appear to be unwilling lenders
During the 2Q14 conference call, JSW’s management suggested that the banks’ appetite
for lending to JSW was limited given it is currently producing negative cash flow. The CFO
said that it can borrow up to an additional PLN 450m without violating the terms of the
existing debt. It lost PLN 664m in 1H14 alone, excluding the K-S acquisition, so it should
not take long to breach this level on our base case (early-2016E on our base case; earlier if
premiums collapse or production fails to recover).
However, it has said that the borrowing to fund the acquisition (PLN 1.2bn) should be
seen effectively as bridge financing and it will look to refinance this debt on better terms.
We assume that such a refinancing solution would leave more headroom to take on debt
as current leverage is low. On our numbers, net debt at the end of 2014E will be PLN
901m once the final payments for the K-S acquisition are complete (PLN 1.09bn in 2H14),
1.6x our expected 2014 EBITDA (which is a trough EBITDA estimate given the production
problems and low coal prices). PLN 450m in additional debt would only be 2.4x this
trough 2014 EBITDA, 1.2x our 2015E EBITDA once production recovers, so we assume
there should be more financing available. However, management did not give the market
much room for optimism when it described the banks’ reluctance to lend, leaving some
investors wondering what happens if it cannot refinance.
As mentioned above, some capex cuts and temporary opex cuts are possible on top of our
base case, which might be enough to avoid breaching this limit if prices remain flat.
However, with premiums unlikely to remain at current levels and with the possibility of
further production issues, these savings may just be delaying the inevitable if PLN 450m is
the limit of JSW’s lending.
Management has not clearly explained JSW’s options beyond that, but if the banks are
unwilling to lend, JSW will be forced to sell assets, rely on government support or raise
equity, in our view.

Government support: the government are 55% shareholders and it is in their
interest to ensure stability in the company for the sake of the workforce and the
local community. Due to EU competition laws, the scope of government
intervention in the coal industry should be limited. We believe, however, they
may be able to exercise influence over the state-controlled banks and assist JSW
in refinancing the debt. This would also have the advantage of savings the
government from using budget money to participate in a rights issue.

Asset sales: it has limited non-core assets to sell, so would have to sell something
meaningful such as the coking business in such a scenario. It generated EBITDA
of PLN 113m in 1H14, so PLN 226m on an annualised basis and EBITDA of PLN
266m, PLN 103m and PLN 297m in FYs 2013, 2012 and 2011, respectively. The
average over this period was PLN 223m, and if we assume a steady state coke
business would sell for 4-6x EV/EBITDA, it could earn JSW PLN 900-1,300m if
there is a willing buyer. We suspect that if it was a forced seller under the threat
of a rights issue, the price received would be at the bottom of this range, possibly
lower. However, this does show that the company has one clear option for
delaying a possible rights issue if the near-term cash shortfall exceeds the PLN
450m that the banks would stretch to.
If, and only if, the two options above are exhausted AND it is unable to refinance its
current debt, do we believe that a rights issue would happen. We therefore see this as
unlikely if coking coal starts to recover in the medium term. However, the two scenarios
described above (lower production/lower premiums) could increase leverage to dangerous
levels if prices do not recover.
JSW
28
WOOD & COMPANY
While we believe the downside risk to HCC prices is limited, further price declines cannot
be discounted, in which case the cash flow outlook would decline further.
What happens if prices fall even lower?
If we assume that coke prices and semi-soft coking coal prices move in proportion with
HCC prices and thermal coal prices in Poland move in line with inflation (our base case
as Polish thermal coal prices are largely decoupled from international benchmarks), a
USD 10/tonne reduction in our benchmark HCC price assumption would lead to a PLN
503m fall in 2015E EBITDA (45% of our base case EBITDA), more than the PLN 450m
debt cap. Benchmark HCC prices have fallen USD 33/tonne on average in 2014 yoy, so
this is far from an inconceivable scenario.
In reality, JSW’s realised prices would probably fall less as the premium paid by customers
increased as prices fell in recent years. The customers’ need for a consistent coking coal
blend and JSW’s long-standing relationships with European steel producers mean it could
benefit from a larger premium than we model currently. Coke prices may also be more
resilient than HCC prices given the niche requirements of some customers. However, even
with this support, the negative EBITDA impact would be significant and make the prospect
of a rights issue probable.
JSW
29
WOOD & COMPANY
Knurow-Szczyglowice acquisition — was it worth it?
In our view, the deal made strategic sense, but the price was too high given the current
coal price environment. JSW is majority-owned and controlled by the government, and it
bought an asset off a troubled government-owned peer in what was effectively a related
party transaction. Given the lack of minority representation on the board, the minorities
had no opportunity to block the deal, which is a risk inherent in investing in statecontrolled businesses, in our view.
We derive an NPV for K-S of PLN 1.95bn on our base case vs. the acquisition price of
PLN 1.5bn, using the same WACC we apply to the group. This is contingent upon us
assuming that JSW implements the mine plan it laid out in August, shifts to largely coking
coal production (from mainly thermal and semi-soft coal now), cuts costs, and unlocks the
synergies it believes exist between K-S and its adjacent Budryk mine. While we see all of
these plans as achievable, as ever, there is execution risk and, given the depressed nature
of the coal price and JSW’s negative FCF, there is also a significant question mark over
JSW’s ability to finance these changes. For such development risk, we would usually add
c.2% to our discount rate, which would reduce the valuation to under PLN 1.4bn.
If the mine remains the loss-making, largely thermal coal mine it is today, it would justify
a much lower valuation. Poland is largely a thermal coal island, with prices rising in line
with inflation, as do costs to a large extent, so we could not expect the economics to
change significantly in the hands of the current owners without the synergies of this
acquisition. There is less scope for a major price recovery than we see in coking coal, so
we find it surprising that a rational buyer would pay a valuation above the value of the
project including synergy benefits and mix improvements. For M&A to generate value, it
should pay for the asset as it operates today with a premium to incentivise the buyer, and
realise the value creation from the synergies and capex investment it intends to put in. We
believe the price paid leaves little room for JSW to create value from this acquisition.
Aside from the realisation of synergies, the other rationale for buying a coal asset in the
current market is a belief in the recovery of the coking coal price to sustainable levels.
However, our DCF for the project also assumes a recovery in coking coal prices from USD
114/tonne in the spot market now to USD 156/tonne by 2018E. Our valuation would be
significantly lower if we assumed the coking coal market would be weaker for longer, so
higher prices are also priced into the deal, leaving no valuation uplift when prices do
recover. In our view, the deal was significantly overpriced.
DCF valuation of the K-S project, assuming synergies/management cost savings are achieved and the product
mix improves as planned
Production
HCC
SS
Thermal
Revenues
Costs to EBITDA
EBITDA
DCF (consolidated from 1 August)
EBITDA
D&A
EBIT
Tax on EBIT
Capex
FCF
Terminal value
FCF+TV
NPV
WACC
TGR
2014
2015
2016
2017
2018
2019
2020
2021
2022
3,840 4,080 4,280 4,410 4,530 4,540 4,540 4,540 4,540
136
306
365
510
545
545
545
545
1,450 1,564 1,734 2,066 2,890 3,086 3,086 3,086 3,086
2,390 2,380 2,240 1,980 1,130
910
910
910
910
1,082 1,164 1,284 1,476 1,702 1,784 1,828 1,874 1,921
-1,155 -1,192 -1,222 -1,260 -1,302 -1,334 -1,337 -1,368 -1,399
-73
-28
62
216
400
450
491
506
522
-42
-116
-158
32
-65
-75
-28
-280
-308
62
-168
-134
62
-280
-219
44
-236
-131
216
-285
-68
14
-246
-16
400
-293
107
-21
-257
122
450
-298
152
-30
-264
156
491
-304
186
-37
-258
196
506
-310
197
-39
-173
294
-75
1,950
10.4%
2.5%
-134
-
-131
-
-16
-
122
-
156
-
196
-
294
-
522
-311
211
-42
-178
302
4,209
4,511
-
Source: Wood Research, company data
To put the acquisition price into context, coal assets typically trade at c.5x EV/EBITDA
through the cycle. A PLN 1.5bn EV suggests that EBITDA generation of PLN 300m is
JSW
30
WOOD & COMPANY
achievable. In 2013, it recorded an EBITDA loss of PLN 9m and coal prices have fallen
further in 2014. We estimate the project to lose EBITDA of PLN 73m this year.
Normalising the K-S workers’ level of pay to JSW levels (which are c.16% higher
currently) would add PLN 83m p.a. to costs when fully implemented, so EBITDA would
be -PLN 156m at 2014 coal prices. To reach PLN 300m, prices would have to rise 42% or
c.USD 38/tonne if no action was taken. Given that the mine is largely steam coal and
prices move gradually with inflation, this seems unlikely based on the KW mine plan.
Accessing lower levels and upgrading the wash plant in order to produce more hard coking
coal and less thermal, increasing production from 3.8mtpa to 4.5mtpa (which management
believes adds PLN 585m to revenues) and achieving cost savings of PLN 168m would raise
EBITDA by PLN 753m p.a. on these assumptions. The revenue uplift is dependent upon
prices used, however. To generate PLN 585m in revenue uplift implies the guidance
assumes prices staying flat relative to 1H14 levels, in our view (c.USD 132/tonne HCC
benchmark price vs. USD 119/tonne now), but using current benchmark prices and the
production guidance, we estimate the revenue uplift at PLN 457m, so the total EBITDA uplift
would be PLN 625m. This would imply EBITDA of c.PLN 469m, assuming flat prices, with
development capex of PLN 462.1m, i.e., a total investment of PLN 1.5bn + PLN 462m =
PLN 1.96bn. This is over 4x 2020E spot pricing EBITDA, despite the turnaround requiring
another five years of negative FCF if prices do not improve, as well as significant execution
and financing risk. This again implies that JSW paid close to full value for the asset,
assuming its turnaround plan works perfectly, instead of paying a price that reflects the value
of the mine today and releasing that additional value through development.
Is further value-destructive M&A likely?
In our view, no. After the KS deal, JSW has limited debt capacity and we believe its equity
is an unattractive acquisition currency in the current coal market.
Other Kompania Weglowa (KW) mines border JSW’s mining licences but, to our
knowledge, these are largely thermal coal deposits. While there may be synergies with
JSW, we believe it would need to have coking coal potential for JSW to attempt an
acquisition, as we saw with KS.
JSW
31
WOOD & COMPANY
Versus consensus
The consensus for JSW is highly variable given the high sensitivity to coal prices and the
relatively infrequent updates from analysts.
Wood estimates vs. full consensus
Revenue
EBITDA
Net income
Net debt
2016E
2017E
Wood
6,853
8,087
8,359
9,080
6,762
7,748
8,355
8,678
% difference
1.3%
4.4%
0.0%
4.6%
Wood
572
1,113
1,212
1,765
Consensus
683
1,180
1,639
2,059
-16.2%
-5.7%
-26.0%
-14.3%
Wood
6,281
6,974
7,147
7,315
Consensus
6,079
6,568
6,716
6,619
% difference
3.3%
6.2%
6.4%
10.5%
Wood
-616
-382
-335
47
Consensus
-574
-323
58
256
% difference
7%
18%
-680%
-82%
Wood
901
1,271
1,752
1,878
2,678
Consensus
620
1,373
1,752
45%
-7%
0%
-30%
Wood
-1,603
-1,401
-1,578
-1,730
Consensus
-1,912
-1,945
-2,153
-1,904
-16%
-28%
-27%
-9%
% difference
Capex
2015E
Consensus
% difference
Revenue-EBITDA
2014E
% difference
Source: Wood Research
Given the lack of frequent updates from sell-side analysts, the number of estimates
published since the 2Q14 results is more limited, but we believe the data more accurately
reflect the integration of the K&S mines, the recent production issues and lower HCC
prices in the spot market.
Wood estimates vs. consensus post 2Q14 results
Revenue
EBITDA
Revenue-EBITDA
Net income
2014E
2015E
2016E
2017E
Wood
6,853
8,087
8,359
9,080
Consensus
6,902
8,183
8,866
9,292
% difference
-0.7%
-1.2%
-5.7%
-2.3%
Wood
572
1,113
1,212
1,765
Consensus
522
1,244
1,740
2,239
% difference
9.6%
-10.5%
-30.3%
-21.2%
Wood
6,281
6,974
7,147
7,315
Consensus
6,380
6,939
7,126
7,053
% difference
3.7%
-1.6%
0.5%
0.3%
Wood
-616
-382
-335
47
Consensus
-776
-338
-4
302
-21%
13%
8725%
-84%
901
1,271
1,752
1,878
Consensus
1,277
2,166
2,535
3,668
% difference
-29%
-41%
-31%
-49%
Wood
-1,603
-1,401
-1,578
-1,730
Consensus
-2,360
-2,380
-2,380
-2,134
-32%
-41%
-34%
-19%
% difference
Net debt
Wood
Capex
% difference
Source: Wood Research
We note a few points here:

JSW
Current consensus costs appear to be in line with our estimates.
32
WOOD & COMPANY

We remain lower on revenues from 2016E-onwards, either due to lower pricing
assumptions or consensus expecting JSW to reach the 14mtpa guidance
management has given. We model 2013 production levels ex-KS at 13.6mtpa flat
as we believe capex to debottleneck and boost production will be limited in the
short term. Also, the possibility of further intrusions into production seams
negatively affecting production cannot be discounted, so we feel more confident
with a more conservative estimate.

Consensus capex is disconnected from both company guidance and economic
reality given the lack of cash flow that JSW generates currently. Management
recently guided for PLN 1.4bn for 2015E (our estimate) and it will only increase
slowly from that level if prices do not recover. The PLN 2bn+ consensus forecasts
would quickly lead to a rights issue.
The main valuation driver for our DCF is clearly the long-term coal price and consensus
appears to be using higher prices than we assume. However, given the deflation in the
global cost curve in recent years and devaluing producer currencies, we are not confident
in coal prices recovering to the top of the existing cost curve to stabilise the market, as we
believe the cost curve will fall further before the market surplus ends. In this scenario, we
believe a more conservative forecast should be adopted.
JSW
33
WOOD & COMPANY
Valuation
Valuing JSW is a difficult job given its sensitivity to coal prices. The following table shows
the sensitivity of our DCF to the change in coal prices (relative to the base case) and
company WACC.
Sensitivity of our base case DCF to coal prices and WACC
Benchmark coal/coke price, $/t
WACC
19
7.4%
8.4%
9.4%
10.4%
11.4%
12.4%
-10%
-46
-44
-43
-42
-41
-40
-5%
3
-4
-8
-11
-14
-16
0%
51
37
26
19
13
9
5%
100
77
61
49
40
33
10%
148
117
96
79
67
57
20%
245
198
165
140
121
105
Source: Wood Research
The DCF can turn negative or provide 50% upside if we lower or raise our coal and coke
price assumptions by 5%. As a result, finding a justifiable price target is difficult. Under
our base case, we derive a DCF value of PLN 18.85/share, which assumes a 28% increase
in benchmark HCC prices by 2017E, something we see as realistic but far from
guaranteed. The current stock price appears to price in a greater rally than that, or
assumes JSW continues to retain some premium to benchmark HCC prices.
Base case DCF valuation
PLN mn
Revenue
EBIT
Tax on EBIT
2014
13,862
-655
138
2015
17,707
-280
62
2016
17,907
-182
40
2017
18,037
348
-77
2018
18,157
610
-134
2019
18,167
674
-148
2020
18,167
771
-170
2021
18,167
823
-181
2022
18,167
895
-197
Tax rate
21%
22%
22%
22%
22%
22%
22%
22%
22%
-517
1,252
-36
-1,603
-904
-219
1,394
-1,401
-226
-142
1,394
-1,578
-326
271
1,417
-1,730
-41
476
1,456
-1,663
269
526
1,482
-1,746
262
601
1,515
-1,722
394
642
1,540
-1,608
574
698
1,549
-1,627
620
0.98
0.89
0.80
0.73
0.66
0.60
0.54
0.49
0.44
0.44
Discounted FCF
Enterprise value
Less Net debt
Less Minority interest
Equity value
Shares O/S
Implied share price
Current price
Upside/(downside)
-885
3,271
-901
-155
2,214
117
18.86
31.00
-39%
-200
-261
-30
177
156
213
281
274
3,547
WACC
Terminal growth rate
Source: Wood Research
10.4%
2.5%
NOPLAT
D&A
Changes in WC
Capex
FCF
Discount factor
TV
8,018
The coal sector trades currently at trough multiples, with most of its peers trading at
premiums to historical levels as the market prices in a rebound in prices, with many
believing the coking coal market is at the bottom. We share this view broadly, but believe
the recovery could be much slower and more gradual than the consensus is pricing in.
Nevertheless, JSW trades at 4.6x 2015/16E EV/EBITDA, on our numbers, implying a
discount to its peers. We believe however, that some discount is justified due to: a) state
control, which may have been a factor in the recently ill-advised K-S deal; and b) greater
uncertainty over its funding situation.
JSW
34
WOOD & COMPANY
JSW vs. coal peers
Price Price Market cap
(LCU) (USD) (USD m)
JSW
EMEA Peers
Bogdanka
Raspadskaya
Mechel
Exxaro
Average
United States
Walter Energy
Peabody Energy
Consol Energy
Average
Other Emerging Markets
Mongolian Mining Corporation
Adaro Energy
Indo Tambangraya
Tambang Batubara
Bumi Resources
Indika Energy
China Shenhua Energy
China Coal Energy
Average
2014
P/E
2015
2016
2014
EV/EBITDA
2015
2016
Dividend Yield
2014
2015
2016
2014
FCF Yield
2015
2016
-10.4%
-13.5%
31.0
9.34
1,100
na
na
na
7.9
4.6
4.6
0.0%
0.0%
0.0%
-30.7%
109.5
16.3
22.7
13,100
109.5
0.40
0.56
131.0
1,121
280
231
4,245
12.4
na
na
15.9
14.1
8.8
na
na
9.7
9.2
8.1
na
na
10.5
9.3
5.2
29.9
14.5
1.7
12.8
5.2
11.2
12.5
2.4
7.8
4.0
6.2
10.4
2.2
5.7
5.0%
0.0%
0.0%
3.8%
2.2%
5.0%
0.0%
0.0%
3.4%
2.1%
3.7%
1.8%
0.0%
3.7%
2.3%
2.8%
1.0%
7.9%
-22.8% -31.1% -21.7%
-181.4% -125.7% -144.6%
4.8%
-0.3%
1.8%
-49.2% -39.0% -39.1%
1.70
10.6
32.6
1.70
10.6
32.6
112
2,886
7,501
na
na
35.2
35.2
na
na
20.5
20.5
na
43.7
13.0
28.4
60.3
11.2
9.8
27.1
18.4
8.4
8.2
11.7
9.7
6.9
6.2
7.6
2.4%
3.3%
0.8%
2.1%
2.4%
3.3%
1.0%
2.2%
2.4%
3.4%
1.2%
2.3%
-254.1% -124.2% -41.6%
1.8%
8.2%
14.5%
-5.7%
-1.8%
2.5%
-86.0% -39.2% -8.2%
1.06
1,010
22,300
11,975
130
655
21.4
4.72
0.14
0.08
1.83
0.98
0.01
0.05
16.9
3.73
506
2,648
2,065
2,260
390
280
39,767
7,614
na
9.2
8.4
13.4
na
na
8.3
33.0
14.5
na
8.3
8.7
12.5
na
na
8.3
17.3
11.0
na
6.9
7.8
9.8
na
na
7.6
14.1
9.2
29.7
3.1
4.7
9.9
7.7
7.5
1.7
8.7
9.1
20.6
3.0
4.6
9.1
6.6
7.5
1.5
7.8
7.6
7.1
2.7
4.0
7.3
9.3
4.6
1.2
7.1
5.4
0.0%
2.4%
9.0%
3.6%
0.0%
0.0%
4.7%
1.4%
2.6%
0.0%
2.4%
9.0%
3.9%
0.0%
0.0%
5.0%
1.6%
2.7%
0.0%
2.4%
9.5%
4.7%
na
5.6%
5.3%
1.8%
4.2%
16.7%
12.2%
9.0%
0.0%
4.2%
-9.0%
5.1%
-32.8%
0.7%
-39%
-71%
-14%
-42%
-61%
-40%
-19%
-40%
-15%
JSW premium to EMEA peers
JSW premium to US peers
JSW premium to other emerging market peers
12.4%
15.3%
10.5%
3.6%
26.8%
-24.6%
7.7%
-14.9%
4.6%
18.5%
16.3%
12.9%
6.8%
na
na
10.3%
-9.3%
9.2%
Source: Wood Research for JSW and Bogdanka (covered by Bram Buring), Bloomberg consensus for other peers
JSW
35
WOOD & COMPANY
In our view, 4.0x EV/EBITDA appears to be a more appropriate multiple for JSW through
the cycle as this corresponds to the average one-year forward EV/EBITDA multiple that
JSW has traded at since its IPO. In our multiples-based valuation, we apply this multiple to
the average of our 2015-17E EBITDA forecasts to account for the recovery in the coal
price that we expect by 2017E. The two-year forward rolling EV/EBITDA average, based
on the Bloomberg consensus, is lower than this, at c.3.5x. The fact that JSW trades at a
premium to these historical averages suggests either that the stock needs to fall or that the
EBITDA needs to rise. On our base case, we see EV/EBITDA next year and in 2016E at
4.6x, so the EBITDA will not rise enough to eliminate this premium on our base case.
One-year forward (lhs) and two-year forward (rhs) EV/EBITDA multiples over time, based on the Bloomberg
consensus, suggest that JSW is trading on expensive multiples relative to history
8.0
8.0
6.0
6.0
4.0
4.0
2.0
2.0
0.0
Jul-11
Jul-12
Jul-13
EV/EBITDA
σ
2σ
Jul-14
0.0
Jul-11
Average EV/EBITDA
-σ
-2σ
Jul-12
Jul-13
EV/EBITDA
σ
2σ
Jul-14
Average EV/EBITDA
-σ
-2σ
Source: Wood Research
Combining these metrics, we arrive at a PT of PLN 24.4/share, justifying our SELL
recommendation. We weight the valuation more towards DCF (70% weighting) at this
point in the cycle, given the depressed nature of coking coal prices.
PT derivation
Metric
Target multiple Implied equity value Per share
EV/EBITDA
DCF
Average
Current price
4,397
2,214
2,869
4.0
1.0
Upside/(downside)
37.5
18.9
24.4
31.0
Weighting
30%
70%
-21%
Source: Wood Research
JSW
36
WOOD & COMPANY
Appendix — more detail on the development projects
On top of the maintenance capex, JSW lists some of its major mine infrastructure
development capex in its quarterly MD&A statements. We list these in the following table.
Below, we explain which projects appear to be higher priority and how we model our
capex to reflect the need to conserve cash in the short term.
Capex spent on major development projects in 2013 and annualised 1H14 spending
Coal business development capex
Vertical development of mines
Budryk mine level 1290m
Pniowek mine level 1000m
Borynia-Zofiówka Mine, Zofiówka Section level 1080m
Total
Horizontal development and development of potential new mining areas
Borynia-Zofiówka-Jastrz ębie Mine, Zofiówka Section - Opening of “Bzie-D ębina 2-Zachód” and “Bzie-D ębina 1-Zachód” deposits
Pniówek Mine - development Paw łowice 1 deposit
Krupinski mine - opening section Zgon and E and former part of the Zory-Suszec deposit
Borynia-Zofiówka-Jastrz ębie Mine, Borynia Section Utilization of the “Żory-Warszowice” deposit
Total
Integration of the Borynia, Zofiowka and Jas-Mos mines
Development capex for coal business
2013
2014*
(99)
(58)
(51)
(207)
(127)
(17)
(66)
(210)
(117)
(29)
(80)
(225)
(75)
(34)
(88)
(1)
(198)
(17)
(450)
(17)
(426)
(425)
(386)
(504)
(440)
(1,379) (1,251)
(232) (169)
Maintenance capex
Near term pit access capex
Total coal capex
Coke capex, o/w:
Modernization of coking batteries in Przyja źń
Building of a power unit in Przyja źń
Modernization of the Jadwiga coking plant
Building a power unit in Koksownia „Radlin” (JSW KOKS)
Construction of coking battery no. 6 with infrastructure in Victoria
Other coke capex
Other capex, o/w:
(9)
(132)
(11)
(13)
(67)
(151)
Construction of the CFB 70 MWe fluidized bed unit in EC Zofiówka (executed by SEJ)
Other non-core capex
Total capex
(3)
(50)
(19)
()
(14)
(83)
(121)
(11)
(48)
(140)
(73)
(1,762) (1,541)
Source: Wood Research, company data; *1H14 capex; *2 for annualised capex run-rate
These vertical and horizontal development projects are largely longer-dated projects.
While they would improve the production mix (in the case of the vertical developments)
or open up new reserves to offset longer-term decline (in the case of most of the horizontal
developments), we do not believe that underinvestment in these projects will adversely
affect near- or medium-term production, so up to PLN 450m of the 2013 capex budget is
potentially available to reduce the 2015E capex if prices do not improve. We believe
some of these longer-dated projects will be deferred, but others are near completion, so
management is likely to continue to spend in 2015E unless a funding shortfall is
imminent.
Vertical expansions
Of all of the long-term development projects, the highest priority projects will be the ones
that offer the most near-term upside. The Budryk and Pniowek vertical developments had
remaining capex of PLN 490m and PLN 71m, respectively, at the end of 2Q14, which
should mean the projects will be completed by 2018E, based on the current rate of
spending. We expect the plans for these two projects to remain unaffected and capex
spending to continue at rates of PLN 136m and PLN 19m p.a., respectively, until mid2018E. These two investments may be cut, in our view, if the prospect of a rights issue is
imminent but, unless this scenario presents itself, management is unlikely to slow the rate
of spending.
The third major vertical development at the Borynia-Zofiowka Mine (the Zofiowka Section
level 1,080m) still requires PLN 503m in spending and is unlikely to be completed before
2021E, in our view. It is not critical to maintain production levels at the mine before 2025,
so the rate of spending here may be slowed, but we see it as a higher priority project than
any of the horizontal developments.
JSW
37
WOOD & COMPANY
Horizontal developments
Here, we see the greatest scope for cuts. Of these projects, only the opening of section
Zgon and E, and the former part of the Zory-Suszec deposit at the Krupinski mine appear
close to fruition. The project had PLN 213m left to spend at the end of 2Q14, having
spent PLN 31m in 2Q14. At this rate of spending, the project could be completed by
2016E. However, Krupinski is mainly a thermal coal mine and is loss-making at the
current price levels. JSW’s CEO said in an interview on 29 September that the company
needs to reduce costs at Krupinski to avoid closing the mine, including suggesting that it
will need to extend the working week from five to six days. Given the marginal nature of
the project, we doubt that it will be a high priority project for JSW in the near term,
despite being close to completion. It will continue to develop this expansion until it makes
a formal decision to close the mine, but we expect the rate of spending here to slow
significantly.
On the other horizontal expansion projects, we expect spending to slow to close to zero
in 2015E. These projects will be important for the long-term future of JSW, but none is
necessary to continue medium-term production and the remaining capex is high relative
to recent spending, implying that it will not start commercial production in the medium
term. Remaining capex at the Borynia-Zofiówka-Jastrzebie mine, the Zofiówka Section,
required for opening the “Bzie-Debina 2-Zachód” and “Bzie-Debina 1-Zachód” deposits
was PLN 2.2bn at the end of 2Q14 vs. only PLN 38m in 1H14 spending. The
development of the Pniówek mine’s Pawlowice 1 deposit required a further PLN 1.3bn at
the end of 2Q14 vs. only PLN 17m capex spending in 1H14. It is safe to assume that
neither will be in production soon and JSW can easily afford to delay major investment in
these projects. The development of the Zory-Warszowice deposit in the Borynia section of
the Borynia-Zofiówka-Jastrzebie mine is clearly a low-priority project given the low levels
of spending on it in the recent past, so we expect insignificant capex here as well.
Coke/non-core business
We expect JSW to cut back on any development capex in the coking business. The power
unit at Przyjazn should be completed by the end of 2014E after PLN 27.2m of spending in
2H14, so the 2015E budget should save PLN 52m relative to 2014E once this project has
been completed. We also expect it to defer spending on Victoria Battery No 6, which was
planned to increase capacity from 0.5mtpa to 0.6mtpa. We also expect deferrals of the
modernisation of other coke batteries, spending on the benzol recovery unit and the plan
to utilise coke gas to generate power at the Radlin Plant.
The major unknown element in the capex budget for the auxiliary business is the 75MWe
CHP planned at Zofiowka. The plant is a planned replacement for existing power capacity
that will soon be in violation of the IED directive, which aims to limit industrial emissions
from 2016. Without the new capacity, it will need to source power and heat from
elsewhere, which implies that this project is largely maintenance capex. It has already
signed a contract to complete the project at a cost of PLN 515m, so it is unclear what
scope (if any) JSW has to slow the rate of spending here. There is a possibility, however,
that this project could be project financed at the project level or as a JV with an
experienced power producer. Taking the risk off-balance sheet could help JSW’s credit
position, however.
Overall, we expect close to PLN 200m in capex on the coke/non-core business units, in
line with the guidance from management.
JSW
38
WOOD & COMPANY
Financials
Income statement, $mn
Revenue
EBITDA
EBIT
Net finance income/(costs)
PBT from continuous operations
Tax
Net income to shareholders
Shares O/S (basis)
Shares O/S (diluted)
EPS (basic), PLN/sh
EPS (diluted), PLN/sh
DPS, PLN/sh
Cash flow, $mn
PBT
D&A
Other
Operating CF before WC movement, tax and interes
Changes in WC
Tax paid
Interest paid
Operating cash flow
Acquisitions
Capex
Other investing CF
Cash flow from investment
Operating Free cash flow
Change in debt
Dividends paid to shareholders
Other financing CF
Cash flow from financing
Change in cash
FX movement
Cash at EoP
Key Balance sheet data, $mn
Total debt
Cash & cash eq
Net debt
Net working capital
Shareholders equity
Minority interest
Ratios
Net debt/EBITDA
Working capital/revenue
Interest coverage (EBITDA/interest)
Margins
EBITDA
EBIT
NIM
2011
9,377
3,553
2,709
-35
2,675
-589
2,067
109
109
18.98
18.98
2.74
2011
2,675
844
205
3,724
-392
-487
-9
2,835
-507
-1,272
112
-1,667
1,563
63
-298
-202
-437
731
2
2,589
2,011
429
2,589
-2,160
81
8,236
207
2011
-0.61
1%
103
2011
38%
29%
22%
2012
8,821
2,375
1,308
-33
1,277
-289
985
117
117
8.39
8.39
5.38
2012
1,277
1,067
-80
2,264
345
-225
-24
2,359
-945
-1,805
116
-2,634
555
-173
-632
-17
-822
-1,096
-2
1,491
2,012
266
1,491
-1,225
-249
8,403
171
2012
-0.52
-3%
71
2012
27%
15%
11%
2013
7,632
1,403
202
-95
110
-28
77
117
117
0.66
0.66
2.52
2013
110
1,202
-13
1,299
450
-83
-36
1,630
-40
-1,783
1,019
-804
-153
53
-296
-37
-281
545
1
2,037
2,013
317
2,037
-1,720
-572
8,185
167
2013
-1.23
-7%
15
2013
18%
3%
1%
2014E
6,853
597
-655
-124
-778
164
-616
117
117
-5.24
-5.24
0.00
2014E
-778
1,252
49
523
-36
28
-30
485
-1,519
-1,603
30
-3,092
-1,119
1,084
-15
1,069
-1,539
2
500
2014E
1,401
500
901
-145
7,577
155
2014E
1.51
-2%
4.8
2014E
9%
-10%
-9%
2015E
8,087
1,113
-280
-210
-490
108
-382
117
117
-3.26
-3.26
0.00
2015E
-490
1,394
210
1,113
-91
1,022
-1,401
9
-1,392
-379
370
370
500
2015E
1,771
500
1,271
-145
7,195
155
2015E
1.14
-2%
5.3
2015E
14%
-3%
-5%
2016E
8,359
1,212
-182
-248
-430
95
-335
117
117
-2.86
-2.86
0.00
2016E
-430
1,394
248
1,212
-124
1,088
-1,578
9
-1,569
-490
481
481
500
2016E
2,252
500
1,752
-145
6,860
155
2016E
1.45
-2%
4.9
2016E
15%
-2%
-4%
2017E
9,080
1,765
348
-288
60
-13
47
117
117
0.40
0.40
0.00
2017E
60
1,417
288
1,765
-13
-158
1,594
-1,730
9
-1,721
-136
127
127
500
2017E
2,378
500
1,878
-145
6,907
155
2017E
1.06
-2%
6.1
2017E
19%
4%
1%
Source: Wood Research
JSW
39
WOOD & COMPANY
Valuation
Market cap (average before current period), PLN mn
Other EV adjustments
EV
EV/EBITDA
EV/EBIT
EV/sales
PE
P/B
Returns
Dividend yield
FCF yield
ROE
ROCE
External Sales, kt
HCC
Semi-soft
Thermal
Coke
Cash costs
Mining cash cost, PLN/t
Coke conversion cost, PLN/t
Macro Assumptions
Realised Prices, PLN/t
Coking Coal
Thermal Coal
Coke
PLN/USD
Benchmark Price
HCCs, USD/t
Semi-soft, USD/t
Average 21.5MJ/kg Polish thermal coal price, PLN/t
2011
11,031
2012
10,987
2013
9,084
2014E
3,642
2015E
3,640
2016E
3,640
2017E
3,640
9,078
2.56
3.35
0.97
5.34
1.34
2011
2.7%
14.2%
9,934
4.18
7.59
1.13
11.15
1.31
2012
5.7%
5.0%
11.8%
19.2%
7,531
5.37
37.30
0.99
117.52
1.11
2013
3.3%
-1.7%
0.9%
2.9%
4,698
7.87
-7.18
0.69
-5.91
0.48
2014E
0.0%
-30.7%
-7.8%
-8.6%
5,066
4.55
-18.07
0.63
-9.52
0.51
2015E
0.0%
-10.4%
-5.2%
-3.2%
5,547
4.58
-30.50
0.66
-10.85
0.53
2016E
0.0%
-13.5%
-4.8%
-2.1%
5,673
3.21
16.31
0.62
77.58
0.53
2017E
0.0%
-3.7%
0.7%
3.9%
4,402
485
3,531
3,018
4,322
581
3,295
3,753
4,383
932
3,860
3,940
3,815
1,699
3,929
3,861
4,133
2,826
5,977
3,960
4,300
2,995
5,836
3,960
4,847
2,974
5,440
3,960
369
137
354
151
334
148
360
150
332
153
336
156
342
159
813
275
1,279
2.96
626
323
1,007
3.25
475
268
802
3.16
411
232
717
3.14
407
245
707
3.30
412
256
717
3.30
446
260
773
3.30
289
208
278
210
148
258
159
112
233
126
93
221
124
91
233
135
96
244
152
108
247
Source: Wood Research
JSW
40
WOOD & COMPANY
Importantdisclosures
This investment research is published by Wood & Company Financial Services, a.s. (“Wood & Co”) and/or one of its branches who are authorised and regulated by the CNB as Home State regulator and in Poland by the KNF, in Slovakia by the NBS, in Italy by the CONSOB and in the UK by the FCA as Host State regulators. Wood’s 12‐month ratings and price targets for JSW 15/10/2013 15/10/2014 SELL PLN 24.4
Explanation of Ratings BUY: The stock is expected to generate total returns of over 15% during the next 12 months as measured by the target price. HOLD: The stock is expected to generate total returns of 0‐15% during the next 12 months as measured by the target price. SELL: The stock is expected to generate a negative total return during the next 12 months as measured by the target price. RESTRICTED: Financial forecasts, and/or a rating and/or a target price is restricted from disclosure owing to Compliance or other regulatory/legal considerations such as a blackout period or a conflict of interest. NOT RATED: Suspension of rating after 30 consecutive weekdays where the current price vis‐à‐vis the target price has been out of the range dictated by the current BUY/HOLD/SELL rating. COVERAGE IN TRANSITION: Due to changes in the Research team, the disclosure of a stock’s rating and/or target price and/or financial information are temporarily suspended. Equity Research Ratings (as of 15 October 2014) Equity Research Coverage IB Clients Buy Hold Sell Restricted Not rated Coverage in transition 46% 31% 21% N.A. 2% N.A. 1% 1%
N.A.
N.A.
N.A. N.A.
Securities Prices Prices are taken as of the previous day’s close on the home market unless otherwise stated. Valuation & Risks Analysis of specific risks to set stock target prices highlighted in our investment case(s) are outlined throughout the report. For details of methodologies used to determine our price targets and risks related to the achievement of the targets referred to in the main body of the report or at http://www.wood.com in the Section Corporate Governance or via the link http://www.wood.com/research.html Users should assume that the investment risks and valuation methodology in Daily news or flash notes not changing our estimates or ratings is as set out in the most recent substantive research note on that subject company and can be found on our website at www.wood.com Wood Research Disclosures (as of 15 October 2014) Company CETV CEZ Erste Group Bank Fortuna S.C. Fondul Proprietatea S.A. ITG KGHM Komercni New World Resources Orco Property Group Pegas Nonwovens Philip Morris PKO BP RC2 SIF2 SNP Telefonica Transgaz Unipetrol Warimpex Disclosures
5 5 5
5
4, 5 3 5
5 5 5
5, 9, 10
5 1, 2, 3 4
10 3 5
1 5 1
# 1 2 3 4 5 6 7 8 9 10 11 12 Description The company currently is, or in the past 12 months was, a client of Wood & Co or its affiliated companies for the provision of investment banking services.
In the past 12 months, Wood & Co or its affiliated companies have received compensation for Corporate Finance/Investment Banking services from this company. In the past 12 months, Wood & Co or any of its affiliated companies have been lead manager, co‐lead manager or co‐manager of a public offering of the company’s financial instruments. Wood & Co acts as corporate broker to this company and/or Wood & Co or any of its affiliated companies may have an agreement with the company relating to the provision of Corporate Finance/Investment Banking services. Wood & Co or any of its affiliated companies is a market maker or liquidity provider in relation to securities issued by this company. In the past 12 months, Wood & Co, its partners, affiliated companies, officers or directors, or any authoring analyst involved in the preparation of this investment research has provided services to the company for remuneration, other than normal course investment advisory or trade execution services.
Those persons identified as the author(s) of this investment research, or any individual involved in the preparation of this investment research, have purchased/received shares in the company prior to a public offering of those shares, and the price at which they were acquired along with the date of acquisition are disclosed above. The authoring analyst, a member of the authoring analyst's household, or any individual directly involved in the preparation of this investment research has a direct ownership position in securities issued by this company. A partner, director, officer, employee or agent of Wood & Co and its affiliated companies, or a member of his/her household, is an officer, or director, or serves as an advisor or board member of this company.
As of the month end immediately preceding the date of publication of this investment research Wood & Co or its affiliate companies, in the aggregate, beneficially owned 1% or more of any class of the total issued share capital or other common equity securities of the company or held a material non‐equity financial interest in this company. As of the month end immediately preceding the date of publication of this investment research the relevant company owned 1% or more of any class of the total issued share capital in Wood & Co or any of its affiliated companies.
Other specific disclosures as described above. WOOD & Company announces that its affiliated company WOOD & Company Funds SICAV p.l.c (through its mutual funds) increased its stake in Pegas Nonwovens to 18.38%. Some entities of WOOD & Company Group are investors of these mutual funds. JSW
41
WOOD & COMPANY
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RECENTLY PUBLISHED REPORTS
Date
14/10/14
13/10/14
13/10/14
10/10/14
10/10/14
07/10/14
07/10/14
03/10/14
02/10/14
Company
PZU
EME Strategy
CEEMEA Energy Biweekly
EME Strategy: Weekly Fund Flows
Bankers Petroleum
KGHM
Sarantis
EME Strategy: Weekly Fund Flows
EME Strategy
Title
Analyst
Dividend continues to eclipse risks
Marta Jezewska-Wasilewska
Polish mutual fund flows
Jerzy Kosinski, Carsten Hesse
Focus: Oil price slide shakes up O&G landscape
Robert Rethy
Outflows for GEMs, inflows for Russia and Poland Carsten Hesse
Sell-off creates buying opportunity
Robert Rethy
Sierra Gorda site visit
Andy Jones
Safe and steady consumer play
Alex Boulougouris
Investors double up on Russian equity recovery bets
Carsten Hesse
CE3 PMIs on the rise again
Carsten Hesse
Although the information contained in this report comes from sources Wood & Company believes to be reliable, we do not guarantee its accuracy, and such information
may be incomplete or condensed. All opinions and estimates included in this report constitute our judgment as of this date and are subject to change without notice. This
report is for information purposes only and is not intended as an offer or solicitation with respect to the purchase or sale of any security.