Fundamental Analysis

• Fundamental analysis of a business involves

1. Analyzing its financial statements and health
2. Its management and competitive advantages
3. Its competitors and markets

• When applied to futures and forex, it focuses on the overall state of the economy,
interest rates, production, earnings, and management.

• Fundamental analysis is performed on historical and present data, but with the goal of
making financial forecasts. There are several possible objectives:
1. To conduct a company stock valuation and predict its probable price evolution,
2. To make a projection on its business performance,
3. To evaluate its management and make internal business decisions,
4. To calculate its credit risk.

 Fundamental analysis includes:

1. Economic analysis
2. Industry analysis
3. Company analysis

On the basis of these three analyses the intrinsic value of the shares are determined. This is
considered as the true value of the share. If the intrinsic value is higher than the market price it
is recommended to buy the share. If it is equal to market price; hold the share and if it is less
than the market price sell then the shares.

The top-down investor starts his analysis with global economics, including both international
and national economic indicators, such as GDP growth rates, inflation, interest rates, exchange
rates, productivity, and energy prices. He narrows his search down to regional/industry analysis
of total sales, price levels, the effects of competing products, foreign competition, and entry or
exit from the industry. Only then he narrows his search to the best business in that area.

Economy
 Steel Production as on 2009

21%

China
European Union
Japan
5% 47%
Russia
5% US
India
5%
Others

7%

11%

2007 - 3.92 2008 - 4.16 2009 - 4.64

Government Policy on Steel Industry

a. Steel industry : Important Policy Measures

 In the new Industrial Policy announced in July, 1991 Iron and Steel industry, among others, was
removed from the list of industries reserved for the public sector and also exempted from the
provisions of compulsory licensing under the Industries ( Development and Regulation) Act,
1951.

 With effect from 24.5.92, Iron and Steel industry has been included in the list of `high priority'
industries for automatic approval for foreign equity investment up to 51%. This limit has been
recently increased to 74%.

 Price and distribution of steel were deregulated from January, 1992. At the same time, it was
ensured that priority continued to be accorded for meeting the requirements of small scale
industries, exporters of engineering goods and North Eastern Region of the country, besides
strategic sectors such as Defense and Railways
 The trade policy has been liberalized and import and export of iron and steel is freely allowed.
There are no quantitative restrictions on import of iron and steel items, covered under Chapter
No. 72 of the ITC (HS) Code. The only mechanism regulating the imports is the tariff mechanism.
Tariffs on various items of iron and steel have drastically come down since 1991-92 levels and
the government is committed to bring them down to the international levels.

 Freight equalization scheme was modified in January'92, removing freight disadvantage to

states located near steel plants in the country. At the same time, it was ensured that far-flung
areas and distant states were protected by stipulating that the main producers charge either
actual freight or freight element existing prior to withdrawal of the scheme, whichever is less.

 Levy on account of Steel Development Fund was discontinued from April'94 providing greater
flexibility to main producers to respond to market forces.

 Iron & Steel are freely importable as per the Extant Policy To check unbridled cheap imports of
steel the Government has fixed floor prices for seven items of finished steel viz. HR coils, HR
sheets, CR coils, Tinplates, CRNO and ASBR.

 Iron & Steel are freely exportable

b. Policy on Iron Ore Exports

 The existing Export & Import Policy (EXIM Policy) permits direct exports of iron ore from Goa
and Redi sector to all destinations by the iron ore producers, irrespective of the iron content.
The Kudremukh Iron Ore Company Ltd. (KIOCL) is the canalizing agency for its own products
(iron ore concentrates and iron ore pellets) since it is a 100% Export-Oriented Unit (EOU). Iron
ore of Fe content up to 64% is completely decimalized. Exports of ore with iron content
exceeding 64% from other sectors of the country are canalized through a Government agency,
namely MMTC. The major buyers of Indian Iron Ore are the Japanese Steel Mills (JSMs).

 The earlier contract for supply of iron ore by MMTC/KIOCL to the Japanese Steel Mills (JSMs)
terminated on 31.3.96. The Cabinet in its meeting held on 8.12.95 approved the proposal of
Ministry of Commerce for entering into another five year contract with Japan for export of iron
ore.

 Iron ore surplus to domestic requirement may continue to be exported; and

 The export of high grade ore (run of mine Fe content above 65%) would be within the
prescribed ceilings.

 Cabinet Ceilings on export of high grade are :The cabinet in its meeting held on 21.7.98
approved the following ceilings proposed by Ministry of Commerce w. e. f. 1.4.1998 and which
would be valid for a period of three year Steel in Budget 2008-09

 Government’s increased emphasis on infrastructure coupled with the strong demand from
housing and automobile sectors will ensure that the steel consumption reaches a few hundred
million tonnes a few decades from now. In fact, if we are to bridge the gap between the
domestic per capita consumption of 39 kgs and global average of 150 kgs, then demand will
have to grow by at least 10% to achieve the target by the year 2020. Further, with the supply
not in a position to be able to catch up with the demand at least until few years from now, we
could see the continuation of the current robust steel cycle in the medium term. Availability of
iron ore, however, may come under threat if the government continues to permit
indiscriminate exports of the same.

Industry

Customers
Some companies serve only a handful of customers, while others serve millions. In general, it's
a red flag (a negative) if a business relies on a small number of customers for a large portion of
its sales because the loss of each customer could dramatically affect revenues. For example,
think of a military supplier who has 100% of its sales with the U.S. government. One change in
government policy could potentially wipe out all of its sales. For this reason, companies will
always disclose in their 10-K if any one customer accounts for a majority of revenues.

Market Share
Understanding a company's present market share can tell volumes about the company's
business. The fact that a company possesses an 85% market share tells you that it is the largest
player in its market by far. Furthermore, this could also suggest that the company possesses
some sort of "economic moat," in other words, a competitive barrier serving to protect its
current and future earnings, along with its market share. Market share is important because of
economies of scale. When the firm is bigger than the rest of its rivals, it is in a better position to
absorb the high fixed costs of a capital-intensive industry.

Industry Growth
One way of examining a company's growth potential is to first examine whether the amount of
customers in the overall market will grow. This is crucial because without new customers, a
company has to steal market share in order to grow.
In some markets, there is zero or negative growth, a factor demanding careful consideration.
For example, a manufacturing company dedicated solely to creating audio compact cassettes
might have been very successful in the '70s, '80s and early '90s. However, that same company
would probably have a rough time now due to the advent of newer technologies, such as CDs
and MP3s. The current market for audio compact cassettes is only a fraction of what it was
during the peak of its popularity.

Competition
Simply looking at the number of competitors goes a long way in understanding the competitive
landscape for a company. Industries that have limited barriers to entry and a large number of
competing firms create a difficult operating environment for firms.
One of the biggest risks within a highly competitive industry is pricing power. This refers to the
ability of a supplier to increase prices and pass those costs on to customers. Companies
operating in industries with few alternatives have the ability to pass on costs to their
customers. A great example of this is Wal-Mart. They are so dominant in the retailing business,
that Wal-Mart practically sets the price for any of the suppliers wanting to do business with
them. If you want to sell to Wal-Mart, you have little, if any, pricing power.
Regulation
Certain industries are heavily regulated due to the importance or severity of the industry's
products and/or services. As important as some of these regulations are to the public, they can
drastically affect the attractiveness of a company for investment purposes.
In industries where one or two companies represent the entire industry for a region (such as
utility companies), governments usually specify how much profit each company can make. In
these instances, while there is the potential for sizable profits, they are limited due to
regulation.

In other industries, regulation can play a less direct role in affecting industry pricing. For
example, the drug industry is one of most regulated industries. And for good reason - no one
wants an ineffective drug that causes deaths to reach the market. As a result, the U.S. Food and
Drug Administration (FDA) require that new drugs must pass a series of clinical trials before
they can be sold and distributed to the general public. However, the consequence of all this
testing is that it usually takes several years and millions of dollars before a drug is approved.
Keep in mind that all these costs are above and beyond the millions that the drug company has
spent on research and development.
 All in all, investors should always be on the lookout for regulations that could potentially have a
material impact upon a business' bottom line. Investors should keep these regulatory costs in
mind as they assess the potential risks and rewards of investing.

Rank Country 2008 2009 Change %

1 China 500.3 567.8 13.5
2 Japan 118.7 87.5 (26.3)
3 Russia 68.5 59.9 (12.5)
4 US 91.4 58.1 (36.4)
5 India 55.1 56.6 2.7
6 South Korea 53.6 48.6 (9.4)
7 Germany 45.8 32.7 (28.7)
8 Ukraine 37.3 29.8 (20.2)
9 Brazil 33.7 26.5 (21.4)
10 Turkey 26.8 25.3 (5.6)

AN OVERVIEW OF STEEL SECTOR

Global Scenario

"In 2005 World Crude Steel output at 1129.4 million metric tonne was 5.9% more than the
previous year. (Source: IISI)" China remained the world's largest Crude Steel producer in 2005
also (349.4 million metric tonne) followed by Japan (112.47 million metric tons) and USA (93.89
million metric tons). India occupied the 8th position (38.08 million metric tons). (Source: IISI)
The International Iron & Steel Institute (IISI) in its forecast for 2006 has confirmed the trend of
recent years of an increase in steel use in-line with general economic growth and with the
fastest growth occurring in the countries with the highest GDP growth such as India and China.
Apparent world-wide Steel Demand is forecast to grow to between 1,040 and 1,053 million
tonnes in 2006 from a total of 972 million tonnes in 2004. This is a growth of 4-5% over the two
year period. However, according to IISI the cost of raw materials and energy would continue to
represent a major challenge for the world steel industry.

Market Scenario

 After liberalization, there have been no shortages of iron and steel materials in the
country.
 Apparent consumption of finished (carbon) steel increased from 14.84 Million
Tonnes in 1991-92 to 43.471 million tonnes (Provisional) in 2006-07. During April-June, 2007,
 apparent consumption of finished (carbon) steel was 10.103 million tonnes (Provisionally
estimated).
 Steel industry that was facing a recession for some time has staged a turnaround
since the beginning of 2002.
 Efforts are being made to boost demand.
 China has been an important export destination for Indian steel.
 The steel industry is buoyant due to strong growth in demand particularly by the
demand for steel in China.

The boom in the steel sector is being driven by growth in its user industries -- construction and
automobiles. Giving a huge fillip to the infrastructure sector, the Indian government has
announced plans to spend at least US$17 billion to upgrade roads, airports and ports by 2010.
The heightened activity in sectors such as roads, ports and sea-bridges is attracting
international attention. It has drawn at least two dozen foreign giants in civil engineering,
construction and infrastructure consultancy services to the country. During the last six months,
around 20 civil engineering and construction companies have entered India or have stepped up
their activity, while some big names in the infrastructure consultancy sector are ramping up
their operations here. These trends are expected to send annual consumption rocketing from
current levels of about 36 million tonnes per year. Steel producers also hope the steel industry
will become another sunshine industry, fuelled by a rapid rise in the demand for washing
machines, fridges, TV sets and other consumer items using steel as a major ingredient.
Similarly, the automobile sector has been abuzz with activity. The total number of passenger
vehicles manufactured during 2004-05 was 1,209,654 units, an increase of 22 per cent over the
previous year.

 Steel industry was delicensed and decontrolled in 1991 & 1992 respectively.
 Today, India is the 7th largest crude steel producer of steel in the world.
 In 2007-08(Apri-June''07), production of Finished (Carbon) Steel was 12.088 million tonnes
(Prov).
 Production of Pig Iron in 2007-08(April-June'07) was 1.165 Million Tonnes (Prov).
 The share of Main Producers (i.e. SAIL, RINL and TSL) and secondary producers in the total
production of Finished (Carbon) steel was 33% and 67% respectively during the period 2007-08
(April-June, 2007).

Company
 The purpose of company analysis to analyze the financial and non-financial aspects of a
company to determine whether to buy, sells, or holds onto the shares of a particular company
After determining the economic and industry conditions, the company itself is analyzed to
determine its financial health. This is usually done by studying the company's financial
statements. From these statements a number of useful ratios can be calculated. The ratios fall
under five main categories: profitability, price, liquidity, leverage, and efficiency. When
performing ratio analysis on a company, the ratios should be compared to other companies
within the same or similar industry to get a feel for what is considered "normal." These are
quantitative factors of company analysis; there are also some qualitative factors which should
be considered also.

 Find out as much as possible about the company and their products.

 Do they have any “core competency” or “fundamental strength” that puts them ahead of all
the other competing firms?

 What advantage do they have over their competing firms?

 Do they have a strong market presence and market share? Or do they constantly have to
employ a large part of their profits and resources in marketing and finding new customers and
fighting for market share

Procedures

The analysis of a business' health starts with financial statement analysis that includes ratios. It
looks at dividends paid, operating cash flow, new equity issues and capital financing. The
earnings estimates and growth rate projections published widely by Thomson Reuters and
others can be considered either 'fundamental' (they are facts) or 'technical' (they are investor
sentiment) based on your perception of their validity.

The determined growth rates (of income and cash) and risk levels (to determine the discount
rate) are used in various valuation models. The foremost is the discounted cash flow model,
which calculates the present value of the future

 Dividends received by the investor, along with the eventual sale price. (Gordon model)
 Earnings of the company, or
 Cash flows of the company.
The amount of debt is also a major consideration in determining a company's health. It can be
quickly assessed using the debt to equity ratio and the current ratio (current assets/current
liabilities).

The simple model commonly used is the Price/Earnings ratio. Implicit in this model of a
perpetual annuity (Time value of money) is that the 'flip' of the P/E is the discount rate
appropriate to the risk of the business. The multiple accepted is adjusted for expected growth
(that is not built into the model).

Growth estimates are incorporated into the PEG ratio but the math does not hold up to
analysis. Its validity depends on the length of time you think the growth will continue. IGAR
models can be used to impute expected changes in growth from current P/E and historical
growth rates for the stocks relative to a comparison index.

Computer modeling of stock prices has now replaced much of the subjective interpretation of
fundamental data (along with technical data) in the industry. Since about year 2000, with the
power of computers to crunch vast quantities of data, a new career has been invented. At some
funds (called Quant Funds) the manager's decisions have been replaced by proprietary
mathematical models.

COMPANIES PRODUCTION OF STEEL MARKET SHARE (%)

(tonnes in millions)
SAIL 13.5 32%
TISCO 5.2 11%
RNIL 3.5 8%
ESSAR, ISPAT, JSWL 8.4 19%
OTHERS 14.5 30%
TOTAL 45.1 100