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UBS Investment Research
Tata Steel Ltd.
Riversdale developments +ve for Tata Steel
„ Rio Tinto considering A$3.5b acquisition of Riversdale; deal in early stage
Riversdale Mining (RIV) informed the Australian Securities Exchange (ASX) that
it has had discussions with Rio Tinto (RIO) for a possible transaction at an
indicative price of A$15/sh. Tata Steel owns 24.2% in RIV and also holds a 35%
stake in the Benga project of the company. RIV has 13bt of resources (Benga 4bt,
Zambeze 9bt) in Mozambique. Benga is the most advanced project and RIV
expects to produce 10Mtpa (6Mt Hard Coking Coal/4Mt thermal coal) by 2013—
Tata Steel has 40% coking coal offtake rights. Zambeze is in the early stage of
development.
„
Rio Tinto’s interest in Riversdale positive for Tata Steel, in our view
Tata Steel has said that RIV is a strategic investment and it is monitoring the
developments. We believe there are three possible outcomes: 1) Tata sells the
24.2% stake—Tata Steel could get cUS$850m and still retain a 35% stake in the
Benga project and the 40% offtake right. This would help in paying down debt and
could increase our valuation by Rs42. 2) Status quo—maintain the stake in RIV
and Benga. Tata would benefit from RIO’s mining expertise. 3) Counter bid—
theoretically, Tata could counter bid for the remaining 76% but this seems unlikely
given the already high leverage.
We expect Tata to retain its 35% interest in Benga irrespective of the outcome. It
has net debt of US$10bn. Counter bidding by a third party could be positive for
Tata.
„ Valuation: maintain Buy and price target of Rs710
We value Tata Steel on a SOTP basis with the Indian business at 7.4x, Europe at
6x, and others at 6.5x EV/EBITDA on normalised EBITDA (FY11-12E).
Tata Steel has said that RIV is a strategic investment and it is monitoring the
developments. We believe there are three possible outcomes:
(1) Tata sells 24.2% stake—Tata Steel would get cUS$850m and still retain
the 35% stake in the Benga project and the 40% offtake right. This would
help in paying down debt and could increase our valuation by Rs42.
Tata Steel is a minority owner in RIV and can only access the dividends of
RIV (in terms of cash flows). However, RIV has not paid dividends in the
past couple of years and UBS Australian mining analyst, Glyn Lawcock
does not forecast any dividends from RIV at least till 2013. So, Tata Steel
only has an economic interest and no access to cash flows of RIV with
respect to this 24.2% stake.
By selling the 24.2% stake, Tata Steel’s interest in the Benga project is not
affected. It would still own 35% in Benga and would still have 40% offtake
rights. A global mining house with a controlling stake would likely be able
to optimise the large resources by its expertise and large capital base.
(2) Status quo—Maintain the stakes in RIV and Benga. Tata would likely
benefit from RIO’s mining expertise.
(3) Counter bid—Theoretically, Tata could counter bid for the remaining 76%
but this seems unlikely given the already high leverage. Tata Steel has net
debt of US$10bn and net debt/equity of ~1.6x. In addition, Tata Steel will
need to invest further capital for the development of the mining projects.
We believe, given global overcapacity in steel and the slow growth outlook
in Europe, steel prices are likely to be range-bound. In such a muted
outlook for the steel industry, we believe it would not be prudent to further
leverage the balance sheet. We believe this is the least likely outcome.
We believe there could be a counter bid by a third party or a higher offer by RIO
and it would likely be positive for Tata. We expect Tata to retain its 35% interest
in Benga irrespective of the outcome.
Riversdale’s main mining projects
Riversdale’s major shareholders are Tata Steel (24.2%), CSN (16.3%), and
Passport Capital (15.7%). Riversdale’s significant assets are located in the Tete
region in Mozambique, which is considered to contain high-quality coking coal
deposits. Riversdale is currently developing Benga and Zambeze projects and
also has licences in the East Tete blocks.
Q Benga project: The Benga project is a 65:35 JV between Riversdale and Tata
Steel. Benga has JORC-compliant 2P reserves of 502mt (346 proved and 156
probable) and has a large JORC-compliant resource base of 4bt. The project
is currently under development and is expected to start production in H2
FY12. RIV expects the project to reach full production capacity in FY14 and
plans to have 20mtpa run of mine (ROM) with 6mt of hard coking coal and
4mt of thermal coal output. Tata Steel has 40% life of mine coking coal
offtake agreement, and 10% life of mine coking coal offtake agreement with
Wuhan Steel (WISCO) is pending definitive agreement. Tata Steel’s landed
cost of coking coal is expected to be US$95/t from this project.
Q Zambeze project: The project is adjacent to Benga and in an early stage of
development. Zambeze has a large JORC-compliant resource base of 9bt and
has potential for 90mtpa ROM at full capacity with hard coking coal and
export thermal coal as the primary products. Riversdale has entered into a
MoU with WISCO for a 40% stake in the Zambeze project for US$800m and
40% life of mine coking coal offtake agreement with WISCO is pending
definitive agreement.
Q East Tete licences: Riversdale also holds licences in five other coal blocks in
the East Tete region where it has 100% ownership. The logistics developed
for Benga and Zambeze can be leveraged for these projects. Coal seams of
Benga extend into adjacent tenements, which Riversdale owns and the
company plans to develop this region as its third Hard Coking Coal
operation.
Mozambique in global sea-borne met coal market
Australia, the US, and Canada are the key sources of metallurgical coal and
UBS expects them to account for 83% of the global sea-borne supply in 2010—
Australia 55% (142mt), the US 17% (45mt), and Canada 11% (27mt). While no
metallurgical coal is being produced from Mozambique, it is promising to be
one of the key sources of new supply to the seaborne trade within five years.
Currently, Vale is the only major mining company currently investing to build a
major presence in Mozambique. According to UBS Australian mining analyst
Glyn Lawcock, Vale is focused on the Moatize project, which is scheduled to be
delivered in mid-2011. Stage 1 involves an investment of US$1.658bn, for
nominal capacity of 11Mtpa, of which 8.5Mtpa of metallurgical coal—hard
coking coal—and 2.5Mtpa of thermal coal.
Metallurgical coal demand-supply outlook
The UBS global mining team forecasts the metallurgical coal market to tighten
further in 2011-12 (deficit of 4-6Mt i.e. 1-2% of demand). We expect supply to
increase after that as Mongolian and Mozambican supplies steadily increase
after 2012.
UBS expects met-coal demand to increase 16%/5%/2% in 2010/11/12 to
259mt/273mt/279mt.
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