CFO Leaders: Lessons In Financial Fitness - By JSW Steel’s Seshagiri Rao
Seshagiri Rao is at his animated best when talking about costs. Ask him about anything—acquisitions, market leadership, why even a question on India’s steel capacity catching up with China—and it will elicit a detailed response on costs.
It’s what JSW Steel Ltd., the company where he’s joint managing director and chief financial officer, does best.
The largest steel manufacturer in India is also among the lowest-cost steel producers in the world. Well, actually it would be more accurate to say lowest cost converter. Because the company has limited access to captive iron ore and coking coal. JSW Steel buys over 85 percent of its iron ore requirement and 100 percent of its coking coal through the open market, domestically or via imports. Tata Steel sources 100 percent of its iron ore and 30 percent of its coking coal requirements from captive resources.
This is a function of the time in which it was born. Most steel companies founded in India after 1990 “never got resources of either iron ore or coking coal,” Rao says. Mines for these were at the time allocated on the discretion of state governments. And so JSW Steel focused on becoming the most cost-effective converter with emphasis on value addition.
“That means entire raw materials used for steelmaking we used to buy. If your capital cost is competitive, (but) if you want to buy all the 100 percent raw material, then how you will be competitive at the operating cost level? That is where JSW Steel focused on. That means how do we convert raw material at the best conversion cost into finished and very high-grade steel and not commodity grade steel.”
Majority of JSW Steel’s cost savings come from significantly lower labour costs, which will be very hard for Tata or SAIL to replicate, even in the long run, says a report by Phillip Capital.
But Rao’s detailing of cost-competitiveness goes beyond that. If any company wants to be competitive, it has to be so on an operating cost level and total cost level, he says as he describes JSW Steel’s cost-control strategies.
“If you look at total cost level, what are the two items which are very important as a finance person? It is interest and depreciation. Your interest and depreciation have to be competitive relative to others. You have to work carefully on that. One is - what capital do you allocate for one tonne of installed capacity of steel. Are you competitive in that respect? That’s the focus of JSW Steel.
Today when I say I am an 18 million tonnes per annum steel company, we have invested Rs 66,000 crore to create that 18 mtpa capacity. That means I have spent Rs 3,500-3,600 crore per million tonne. You look at competition either in India or overseas. Globally, they pay $1 billion, which is Rs 7,200 crore in today’s exchange rate, for creating a million tonne capacity - whereas I am able to create at half the cost. So, this ability, to execute a large technology-and-capital-intensive project within time and effective cost, that’s a benefit you will give to the company throughout the life of the project. That is where we score.
If we look at my interest and depreciation - it is Rs 4,800 per tonne. I have Ebitda of Rs 13,000 (as of December 2018). If that Rs 13,000 comes down to Rs 5,000, still I am profitable. I have created limited interest and depreciation by way of very limited capital allocation and effective execution of projects.”
The question is what does JSW Steel do differently from competitors? Rao offers an interesting illustration—that not all companies may be able to adopt. By the way, JSW deploys this strategy across group companies, he says.
“For instance, another steel company or cement company or power company, what do they generally do? They don’t want to take project completion risk for the plant working successfully. For example, If I want to set up a blast furnace, it will have 250 packages. We divide these into various packages. I pick the supplier and contractor and place the order myself. Then we take the responsibility that all this will work together when we set up the blast furnace. What is the other model - that competition follows? Competition calls L&T and says I want to set up a blast furnace and I want to give you the EPC contract.”
Which model would you like to follow? If you have conviction, you have execution capacity inhouse, you will be able to divide the project into 250 packages and will be able to supervise everybody and set up a blast furnace which works eventually. If that conviction and capacity is there within the organisation, then that risk can be taken. What is the difference in cost? You look at any EPC contract, the difference is 20-25 percent. That makes a very big difference.”
Another, simpler, cost-saving method is to stick to standard sizes, Rao says.
“Similarly, when you are buying equipment, look at conveyors, cranes. These items are standard sizes. If you want to import this from China, if you want customised products then it costs more. If you go for a standard product with standard size and specifications, the cost will be significantly lower. Which product will go for customisation, which product will go for standardisation, that makes a huge difference. Which item you will fabricate at site, which you will ask the supplier to fabricate and bring to your site, makes a huge difference. Therefore there are a lot of things. It is not specific to JSW. Anyone can do this. But this is the reason why our costs are lower.”
Ordinarily, a fourth of all project cost is made up of interest, depreciation, margin money of working capital and start-of expenditure, Rao notes. The trick, he says, is to restrict those costs “to 12-15 percent instead of 25 percent, then that itself will give you 10 percent advantage”. That helps cushion project viability in case of time and cost overruns.
Rao also places much emphasis on picking the right technology to keep operating costs low. The selection of Corex technology at a time when no one else in India was using it, is one example. It reduced JSW Steel’s reliance on petro-fuels. The company applies the same strategy to raw material procurement.
“When you are buying iron ore or coking coal, there is lot of volatility in prices in line with steel prices. How do we procure iron ore or coking coal which are inferior grades at low cost and at the same time be able to make them high grade usable in steel making? That is one technology where we invested money and time. That made us competitive in terms of operating cost...”
Outsourcing certain activities or seeking partnerships to develop them, is another strategy JSW Steel has devoutly adhered to, to aid operation efficiency and expansion.
For instance, to power the steel manufacturing facilities, the company partnered with Tractebel SA of Belgium in 1994. Eight years later Tractebel exited and the power company went on to become an independent full-fledged JSW Group business.
Rao offers more such instances of partnerships in non-core activities.
“For example, industrial gases like oxygen, argon gas. Steel requires lot of industrial gases. We brought Praxair to India. We gave 76 percent to them and we owned 26 percent. We gave entire management to them.
Similarly, we wanted to set up service centers. Today, so many customisations are happening in steel. So automobiles, consumer durables, they want just-in-time and they want completely customised product. We brought the Japanese company, JFE Steel Corporation, to India. We set up a 50:50 joint venture and we gave entire management to them. So, they set up service centers all over India.
Similarly, high rise buildings which are coming to India today, they need steel completely fabricated. For that, we brought one partner from overseas for a 50:50 joint venture. They were from U.K. and experts in this area. We gave management to them. So, we produce steel and give our joint ventures to partners and they do the other things.”
- Tata Steel (Standalone): Rs 16,110
- JSPL: Rs 11,291
- SAIL: Rs 6,894
- JSW Steel: Rs 11,807
Source: Phillip Capital
A Quick Note On Capital Allocation
The same focus on costs underscores JSW Steel’s inorganic growth or M&A strategy. But before we could get to discussing the company’s successful and not so successful acquisitions, Rao made an interesting point on capital allocation.
“ What is our business strategy? That should be clear. When we prepared the business strategy in 2001-02 we wanted to be 10/10 (10 mtpa by 2010). When you have a limited amount of capital - where would you like to invest? Whether you expand capacity 10/10 or you invest in iron ore or coal mines and have backward integration. These were the options available.
Strategically we thought - as far as iron ore and coking coal is concerned, if we invest money (in that) we can’t expand capacities. Whereas you see co-relation between steel price and raw material price is in the same direction. The co-relation is 0.9 +. That means when iron ore and coking coal prices go up or down, steel prices also go up/ down. If you are good in this process of steel making that means your EBITDA margin is like a utility company. If steel prices come down, you will have problem in one quarter as you have inventory. That inventory loss you will have to take. Next year, you are buying iron ore and coking coal at revised prices, steel prices are also down but margin is okay. Even if I am integrated steel plant, I term myself as a converter. As far as I am efficient in converting coal and iorn ore into finished steel which are saleable and command premium, then I am okay. For 2010 strategy we focused on expanding capacity. We invested all our capital in expanding capacity. So, organically we are growing - any inorganic opportunity comes in, we have to evaluate those opportunities.”
Applying Cost-Competitiveness To M&A Strategy
Most, if not all, the acquisitions made by JSW Steel have been distressed assets. Starting with Siscol (Southern Iron & Steel Co. Ltd.) and Ispat Industries Ltd. to purchasing three steel mills in the U.S. from his brother—also a steelmaker. More recently the company bid aggressively to acquire a few insolvent steel assets—acquiring Monnet Ispat Ltd. and Bhushan Power and Steel.
JSW Steel M&A History
- Siscol (2004): New product line (long products)
- U.S steel mills (2007): First overseas acquisition
- Ispat (2010): Port-based facility
- Vardhaman Industries (2018 - pending): Value added products, via insolvency proceedings
- Aferpi (2018): Foothold in the European market
- Acero Juntion Holdings (2018): Expand U.S. presence
- Monnet Ispat (2018): Via insolvency proceedings
- Bhushan Power & Steel (2019): Capacity addition
- Asian Colour Coated Ispat (2019 - pending): Value added products, via insolvency proceedings
“The first point which we always evaluate when doing M&A is what is the synergy which we can bring it to table which others cannot bring. Otherwise, everybody will look at excel sheets, projections for future, current situations and what multiple one has to give for the future - it is very easy to do that.
For Ispat, we identified why the company was not doing well. They used to consume 15 crore units of electricity per month. They used to pay Rs 7.5 rupees per unit to the grid. If somebody could supply power to them at a lower cost immediately the power cost could come down. We had JSW Energy’s 1,200 MW plant in Maharashtra, of which only 300 MW (was committed) in long term power purchase agreement, the balance 900 MW we used to sell in the merchant market. In merchant market, we were selling at Rs 4.5 per unit. if we could supply at Rs 4.5 to Ispat - 3x15 crore units is Rs 45 crore saving per month. This could happen very quickly. It wouldn’t take much time. That was the synergy we could bring in from the day we acquired it.”
The company turned around Ispat but continues to struggle to make the U.S. mills’ acquisitions viable. The purpose of the purchase was to build forward integration close to export customers, says Rao.
The three U.S. companies acquired in 2007 are in Texas, supplying plates and pipes to the U.S. oil and gas industry. Rao remembers when the deal was done oil was trading at $147 a barrel. “We were not entering into steel in U.S. but the oil and gas industry,” he says.
“As long as the oil and gas industry does well, this company should do well. We supplied the slabs from India, which we could produce as we have surplus in India. They would convert it into plate and pipe and supply to this industry. For us it was a good business model.
We looked at the cost of slabs, the transfer price from India and the money which we could make in India. The transportation cost, the landed cost there, then conversion cost plus selling price. If you looked at it, it appeared to be a very good model for us.”
But this time the numbers didn’t work to Rao’s calculation. JSW Steel paid over $900 million for the acquisition. Maybe too much?
“Before we acquired it the company was making $77 million per annum before we acquired it. That was the EBITDA. Whereas we thought it has the potential to go up to $250 million. That is how we prepared the plan for short, medium and long term. We took over in November 2007. By June/July we were making $15 million per month. So, we were at $180 million level. So, we did extremely well.
Maybe strategically, one thing which we didn’t do correctly at that time was that pipe prices, when we acquired, was $1,400 per tonne. It went up to $2,200 per tonne. So, it went up quite high. When several tenders used to come, they’d come at $1,700 - 1,800 per tonne, whereas spot price was $2,000. So, by selling at spot we used to make lot of money. We never went for long term tenders.
Unfortunately, the September 2008 event happened. So, this $2,200 price collapsed. We had $100 million of inventory which we had (bought) in slabs at that time. So, we had to take losses on inventory. After that the market never recovered. It took 6-7 years by the time normalcy came in.
The mistake which we did was the value which we paid. At the peak of the cycle, everything was looking bright including Corus. But we always believed this business is a good business. So, if we retain and continue then we can make money at some time.”
Well, has the business turned around?
“It is making positive EBITDA. During this period of 10 years, we didn’t make any investments. We just managed the facility until the market improved. The market started looking up in the last 2-2.5 years. Then we committed $500 million to modernise the entire plant.”
JSW Steel’s recent expansions, to get to 23 mtpa, are likely to test Rao’s number skills again. Net debt is expected to rise from Rs 42,000 crore in financial year 2018-19 to Rs 60,000 crore by FY21. That takes its net debt/Ebitda ratio from 2.2 to 3.3. This at a time when the global and local economies are looking weak. The company’s stock price has almost halved in the last 12 months.
Earlier story in this series...
Lessons From JSW Steel’s Near-Death Experience In The ‘90s
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