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We initiate coverage on Tata Steel with an
OUTPERFORM rating and a price target of Rs755.
Tata Steel’s earnings are highly leveraged to the
outlook for iron ore/coal prices. Given our bullish view
on iron ore/coal prices, we estimate Tata Steel would
post earnings CAGR of 26.5% over FY11-13E.
We value its India operations at 10x FY12E EPS and
Europe at 8x FY12E EPS, in line with global peers.
Earnings a direct play on iron ore/coal – We expect
rising raw material costs to push up steel prices globally.
In our model, we build in FY12 HRC price of US$675/
tonne for India and US$760/tonne for Europe, at which
prices conversion margin over raw materials for
steelmakers will be well below historical average. Given
this, Tata Steel’s earnings are leveraged to absolute iron
ore/coal prices, and any reversion to mean in conversion
margins could lead to significant earnings upside.
Supply bottlenecks to lift iron ore/coking coal prices
– Our global resources team is bullish on iron ore and
coking coal. We forecast iron ore price of US$200/tonne
in the next 12 months and believe that coal could exceed
previous highs.
Domestic profitability to mitigate overseas drag –
Given sluggish European demand, we don’t expect Tata
Steel Europe to pass on the full rise in raw material
prices. Nevertheless, the strength at Tata Steel’s Indian
operation is likely to more than make up for the shortfall
in Europe’s EBITDA. We estimate consolidated FY11-
13E earnings CAGR of 26.5%.
we have not factored in upside from the DSO (direct
shipping ore) captive iron ore and the Mozambique coke
projects in our earnings projections, they provide an
option value of Rs79/sh.
Valuation – Price target of Rs755: We value Tata Steel
India at 10x and Europe at 8x FY12E EPS. At our price
target of Rs755, it would trade at 6.6x FY12E
EV/EBITDA, in line with global peers. The imputed FY12
P/BV of 2x is reasonable given RoE of 20.6%.
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