Macquarie Research: Tata Steel FPO: Subscribe for restructuring gains

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Tata Steel
Subscribe for restructuring gains
Event
 FPO – a good entry point: Tata Steel is restructuring and we think is well on
track to improve its sustainable margins by 500bp over the next two years. It
is also trying to delever and derisk the balance sheet. In our view, this means
a possible re-rating, and the proposed FPO provides a good entry point.
 We retain our Outperform rating. However, we account for the upcoming
equity dilution by reducing our target price to Rs863 from Rs887, even while
we increase our earnings, driven by higher steel price forecasts.

Impact
 Sustainable margins to improve 500bp: We estimate Tata Steel over the
next two years will see its consolidated operating margins improve by 500bp,
driven by: a) a 50% increase in capacity in India, which is higher margin, due
to raw material integration; and b) raw material integration for Corus.
 Balance sheet – reduced risks: Tata Steel has renegotiated its debt for
Corus and reduced the immediate outflow. The proposed FPO as well as
expected US$500m from the sale of Teeside should help reduce net debt to
US$9.2bn and net debt:equity to 0.9x by FY13E.

 Tata Steel – looks better placed than peers: Contrary to common
perception, Tata Steel consolidated has much better margins than Steel
Authority of India or JSW Steel. For 1H FY10, Tata Steel has had
consolidated operating margins of US$170/t, compared with US$100–120/t
for JSW and SAIL.
 Raw material initiatives worth much more: The ongoing bid for Riverdale
has highlighted that the 24% stake held by Tata Steel is worth more than
US$1bn. Also, Tata Steel’s stake in the iron ore projects in Canada is likely to
be in the limelight as media speculation of an acquisition bid for New
Millennium Capital Corporation has pushed up the stock by 33% over the last
few days.

Earnings and target price revision
 No changes.

Price catalyst
 12-month price target: Rs863.00 based on a PER methodology.
 Catalyst: Increase in steel prices.

Action and recommendation
 Attractive valuations: Tata Steel is one of the best picks in our steel
coverage currently. Its Indian operations have gained from the rising raw
material led steel price increase, while Corus gains from recovery in
developed economies. It looks very attractively valued and is one of the
cheapest stocks in the region at 7x PER on FY12E