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Tata Steel Upgrade to BUY
The continued rise in iron ore and coking coal prices is positive for Tata Steel’s
India margins given captive raw materials. FY13 will be a strong profit growth
year for Tata Steel post India expansion to 9.7 mtpa. Completion of the
Teesside plant sale by end-FY11 and successful start of production in
overseas mines in FY13 could boost estimates further. We upgrade FY11-13
EPS 4-10% factoring in CLSA’s new steel and raw material price forecasts.
Balance sheet is set to improve with D/E dropping below 1x by FY12. We
upgrade Tata Steel to BUY from O-PF with a FY13-based target price of Rs810.
Better margin outlook for India capacity; Corus though will stay subdued
Iron ore prices have crossed US$180/t while coking coal prices look set to cross
US$300/t due to the Queensland floods. Steel prices are moving up across regions
in anticipation of this cost-push. With 100% captive iron ore and 50% captive
coking coal, Tata Steel India will see margins expand in this environment over the
next two quarters, but will slip again in 2HCY11 as steel and raw material prices
recede. Corus’ margins, though, will stay under pressure in FY12.
India expansion will boost growth and de-risk Tata Steel
Tata Steel’s 2.9mtpa expansion at Jamshedpur is on track for commissioning by
end-FY12 and will drive strong 26% volume growth in India in FY13. With this
expansion, share of the more profitable and higher visibility India operations will
rise in consolidated volumes and EBITDA besides reducing earnings sensitivity to
steel prices. We see an incremental de-risking of Tata Steel in FY13.
Successful completion of sale of the Teesside plant by FY11-end to Sahaviriya
Steel Industries (SSI) will add US$500m (3%) to valuations. SSI is in the process
of raising equity and debt to fund this purchase. Tata Steel is aiming to start
production in its iron ore mines in Canada and coking coal mines in Mozambique
by FY13 and has a target of 2mtpa production in Year 1. If this target is met, our
FY13 EBITDA could rise 5-6% but we believe that it is a tad early to build this into
a 12m investment view and await confirmation of timely progress in these mines.
Balance sheet worries receding; upgrade recommendation to BUY
The recent re-financing of Corus’ debt with a much-relaxed repayment schedule
has substantially de-risked Tata Steel near-term. Post the ongoing equity issuance
and conversion of warrants by FY12, Tata Steel consol net D/E will drop below 1x
by FY12. We are not hopeful of any revival in European steel demand in FY12 and
build in an EBITDA/t of just US$50 for Corus in FY12. However, we believe that
the non-Corus positives more than outweigh the Corus negatives and upgrade
Tata Steel to BUY. Tata Steel is our top steel pick in India.
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