Explained - Why Jefferies is not worried about expensive steel stocks

Brokerage firm Jefferies has reiterated its positive stance on Indian steel companies, arguing that elevated valuation multiples should not be a deterrent for investors, given the sector's earnings cyclicality and improving profitability outlook.

The brokerage on Wednesday, June 10, noted that valuation remains a key concern for investors at current stock prices.

JSW Steel is trading at 10 times one-year forward Enterprise Value / Earnings Before Interest, Tax, Depreciation, and Amortisation, significantly above its long-term average of 6.9 times, while Tata Steel trades at 7.4 times forward EV/EBITDA compared with its historical average of 6.3 times.

However, Jefferies said historical data suggest that steel stock returns have often been stronger when investors have entered at above-average valuation multiples.

Also read: Tata Steel

According to the brokerage, JSW Steel has delivered average 12-month returns of 34% when the stock was bought at an above-average EV/EBITDA multiple, compared with 19% when purchased below its long-term average valuation.

A similar trend is visible for Tata Steel

, where average 12-month returns were around 40% when the stock traded above its historical valuation multiple, versus just 1% when bought below its long-term average.

Jefferies attributed this apparent valuation paradox to the highly cyclical nature of steel earnings. The brokerage said EV/EBITDA multiples typically expand during periods of depressed steel spreads, as investors anticipate a recovery in margins and earnings, often leading to significant earnings upgrades ahead of the cycle turning.

The brokerage also highlighted improved return ratios as justification for higher valuation multiples. It expects JSW Steel to generate a return on equity (ROE) of 19% in FY27-FY28, compared with its long-term average ROE of 13%. Tata Steel's ROE is also projected at 19%, significantly above its historical average of 9%.

JSW Steel currently trades at 2.7 times FY27 estimated price-to-book value compared to its long-term average of 1.7 times, while Tata Steel trades at 2.2 times FY27 estimated price-to-book compared with a historical average of 1.1 times.

JSW Steel remains Jefferies' top pick

Jefferies continues to prefer JSW Steel within the sector and retained it as its top pick. The brokerage expects JSW Steel's EBITDA and earnings per share (EPS) to grow at a compound annual growth rate of 35% and 65%, respectively, between FY26 and FY28.

It also highlighted the company's expansion plans, which aim to more than double steelmaking capacity by FY32, potentially placing it among the world's three-largest steel producers.

For Tata Steel, Jefferies expects EBITDA and earnings per share to grow at a CAGR of 25% and 46%, respectively, over FY26-FY28, supported by an improving earnings cycle and operational performance.

Shares of JSW Steel are trading 2.2% higher on Wednesday at ₹1,289.8. The stock is up 10% so far this year, while those of Tata Steel have given up their initial gains, currently trading 1% lower at ₹201.27. The stock is down 5% over the last one month but is still higher by 11% for the year so far.