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. We expect strong performance of Tata Steel stock to continue
despite a 6.5% rise in the past month and 8.5% outperformance relative to the BSE
Sensex. Catalysts for stock performance include a cost-push-based increase in steel
prices, increasing visibility on timely commissioning of India capacity expansion and
event-based catalyst on overseas raw material projects. Tata Steel trades at an
inexpensive 5.2X FY2012E adjusted EBITDA. BUY with an end-FY2012E TP of Rs725.
Cost-push-based steel price increase likely, will benefit Tata Steel India
We expect steel prices to move up led by (1) a cost-push increase—iron ore prices have increased
by 16% in the past two months to US$170/ ton China CFR on modest revival in demand
combined with persistent supply issues and (2) seasonal increase in demand in 1HCY11. This
should benefit integrated players such as Tata Steel, in our view. A US$10/ ton increase in iron ore
prices benefits earnings by 5%.
Commissioning of value-accretive India capacity expansion
Tata Steel India is on track to commission 2.9 mtpa steel making capacity expansion in Jamshedpur
by end-2011. This will reflect in strong 27% volume growth in FY2013E. Note that the expanded
capacity will be self-sufficient on iron ore and generate profitability in excess of US$300/ ton. More
important, EBITDA contribution from Indian operations may increase to 70% of the overall EBITDA
by FY2013E from less than 50% in FY2008-09. In our view, this will significantly de-risk earnings.
Benefits from overseas raw material projects may surprise on the upside
Tepid recovery in UK, significant overcapacity in the developed markets and impending concerns
on European markets will weigh on Corus performance. On the positive side, investments in raw
material security, i.e. Riversdale Mining and New Millennium (iron ore project in Canada) can
potentially add US$300 mn to annual EBITDA. In any case, Tata Steel’s holding is worth Rs40/share,
in case Rio Tinto formally bids for Riversdale. This value is not captured in our TP and can be a
positive catalyst as long as Tata decides not to counterbid.
BUY into profitable and strong volume growth
Our revised iron ore price forecast underpins our confidence in sustenance of steel prices and a 1-
3% increase in benchmark HRC price assumption. We increase our FY2012E and FY2013E
consolidated EBITDA by 6.3% and 9.2% to US$3.9 and US$4.6 bn, respectively. Tata Steel trades
at an inexpensive 5.9X FY2012E and 4.8X FY2013E EBITDA. BUY with a TP of Rs725 based on end
FY2012E financials. We assign 6.5X to Tata Steel India FY2012E EBITDA and 5.5X to Corus and
Factors driving revision in our estimates and target price
We recently increased our iron ore price forecast (China import Indian iron ore fines 63% FE)
to US$130 and US110/ ton for FY2012E and FY2013E, respectively. On the back of this
change, along with assumption of moderate pricing power, we revise our India HRC price
assumption (excluding excise and VAT) to US$743 and US$738/ ton for FY2012E and
FY2013E respectively from US$718 and US$717/ ton earlier. On the back of change in steel
price assumption, we increase FY2012E and FY2013E EPS estimates by 11.5% and 16.8%
to Rs74.5 and Rs91.1, respectively. Exhibit 1 details key changes to our estimates.
We value standalone India operations at 6.5X FY2012E EBITDA. This is higher than historical
levels, but we believe it is fair as it partly captures volume growth potential for the India
business. Put slightly differently, FY2012E EBITDA does not capture brownfield expansion
while the debt taken for this expansion is fully captured in the EV; assigning higher multiple
corrects this anomaly. We assign 5.5X to Corus and far-east operations, fair noting lower
profitability and lack of raw material security. We value listed investments at a 20% discount
to the market price.
Our target price captures value from MOU signed by Corus for sale of Teeside Cast Products
(TCP) plant to SSI, Malaysia for US$500 mn; this adds Rs24 to fair value. However, our fair
value does not capture any upside from New Millennium Corp (Canadian Iron ore Project) or
Riversdale Mining investment. Note that Riversdale recently announced that it is in discussion
with Rio Tinto for a possible transaction at an indicative price of AUD15/ share, valuing the
company at US$3.5 bn. At the indicative bid price, Tata Steel’s stake in Riversdale is worth
Rs40/share.
Leverage high but still within manageable proportion
Tata Steel has a leveraged balance sheet. With US$3.5-4 bn of capex over the next two
years, we believe the absolute debt is unlikely to change meaningfully. However, the
leverage, though high at debt/EBITDA at 2.4X and debt/equity at 1.1X FY2012E, is within
manageable limits. Some of the recent steps taken by Tata Steel to reduce leverage are in
the right direction. The MOU for the sale of Teeside Cast Products (TCP) will bring in US$500
mn. In addition, the company raised US$288 mn through sale holdings in group companies.
Tata Steel recently refinanced of £3.53 bn of Corus debt. This may lead to an additional
interest burden of US$60 mn per annum, but the revised structure brings in financial
flexibility including (1) termed out maturity of loans; (2) relaxation on EBITDA linked
covenants for 4-5 years; (3) flexibility to borrow for working capital purposes and to incur
capex. The proposed equity raising plan may also address leverage concerns.
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