Tata Steel - Buy: Motilal oswal

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Embarking on new earnings growth path; upgrade to Buy
 Tata Steel will embark upon a new earnings growth path, with expansion of capacity
from 6.8mtpa to 10mtpa at Jamshedpur, start of coking coal production at Benga
project, Mozambique, and start of iron ore production at DSO, Canada over 12-15
months.

 Sale of Teesside Cast Products' (TCP) slab plant for nearly USD500m will help to
deleverage the balance sheet and reduce earnings volatility for Tata Steel's Europe
operations.
 Post the acquisition of Corus and the financial crisis, Tata Steel has made longterm
strategic investments (examples: USD3b capex at Jamshedpur, Riversdale
(RIV), New Millennium Capital (NML), Dhamra port, JV with Bluescope, JV with
NYK) over the last 3-4 years. Over the next 12-15 months, some of these
investments will start generating cash flows - Jamshedpur expansion to 10mtpa
would be completed by December 2011, and coking coal and iron ore production
would start in 2HCY11.
 Tata Steel Europe's (TSE) earnings volatility is likely to reduce on completion of
TCP sale and cost-cutting initiatives in the last 2-3 years. TSE margins will remain
under pressure until full economic recovery in the European region. Though TSE
remains the largest contributor to group crude steel production, its share in
consolidated EBITDA and the group's enterprise value is getting diluted. TSE
contributes just 1/4th of our target EV of Rs929b.
 Though the earnings contribution from RIV and NML will be marginal in FY13, Rio
Tinto group's keen interest in RIV with a firm bid of AUD3.9b and possible counterbid
is likely to get reflected in Tata Steel's valuations sooner than expected.
 Tata Steel's focus is now shifting towards high RoE projects rather than pure
strategic investments. It has sold ~Rs12b of its investments in group companies
like TCS, Tata Power and Tata Motor to unlock value in FY10 and FY11, with
further potential of USD873m over 2-3 years.
 Steel prices have recovered by 10-15% across the world over the past one month
due to end of de-stocking, supply correction, and raw material cost pressures.
HRC prices have risen to USD670/tonne.

 Demand is likely to pick up over the next couple of months, as buyers return to
the market post winter vacations in the western world. A strong steel price scenario
is expected for 4-5 months.
 We are introducing FY13 estimates and moving our target price to SOTP value of
Rs1,017 (upside of 43%) to better reflect the value of its diverse assets across the
globe. We expect EPS to grow at a CAGR of 16% to Rs100.2 over FY11- FY13.
We have valued Indian operations at EV/EBITDA of 6.5x, TSE at EV/EBITDA of
5x and investments at current market value. We believe that the value of investments
will grow, as iron ore and coking coal production ramp up. At our target price, the
stock will trade at 10.1x FY13E EPS and an EV of 6.7x FY13E EBITDA. We
400 upgrade the stock to Buy.


Indian operations: steel and iron ore production growth to drive earnings
 Salable steel from Indian operations is likely to grow at a CAGR of 13.4% to 9.5m
tonnes over FY11-FY14. We expect EBITDA for Indian operations to grow at a
CAGR of 10% to Rs134.6b by FY13.
 Though steel volumes, operating efficiency and iron ore production growth will drive
earnings, declining coking coal integration on account of lack of growth at coal mines
and appreciation of Indian currency (Rs43/USD for FY13) will drag margins.


Raw material investment overseas: sooner than expected value unlocking
 Tata Steel holds 24% in Riversdale (RIV) and 35% stake in its Benga project, which
it bought for ~USD500m (including USD100m for 35% stake in Benga). RIV has a
small operating mine Zululand with production of ~0.7mtpa, 65% stake in Benga project
with total coal reserves of 4b tonnes and 100% stake in Zambeze with total reserves
of ~9b tonnes under feasibility study stage.


 A non-binding agreement between RIV and WISCO (Chinese steel maker) for 40%
stake in Zambeze project for AUD800m has valued 9b tonnes of coal reserves with
no near-term production at AUD2b. This implies valuation of AUD1.9b (ignoring
Zululand for simplicity) for RIV's 65% stake in Benga project and a valuation of
nearly AUD969m for Tata Steel's 35% stake in Benga project. Adding AUD936m for
24% in RIV, Tata Steel's total value in coal assets is AUD1.9b, which will grow with
time.


 Though the coal production is expected to be small at ~1m tons (on attributable basis
from Benga) in FY13 and logistic bottlenecks remains in evacuating large quantity of
coal from Mozambique, the keen interest of Rio Tinto group with a firm bid of A$3.9b
for RIV and possible counter bid is likely to get reflected in valuation of Tata steel
sooner than expected.


 For iron ore, Tata Steel has invested in New Millennium Capital (NML CN, Mkt Cap:
CAD357m, CMP: CAD2.4, Not Rated) by purchasing 27.4% of its equity in the parent
company and 80% in DSO (Direct Shipping Ore) project. NML is a mining exploration
company, with three main sets of tenements. Feasibility of DSO was completed in
February 2010. At an investment of CAD300m, DSO is expected to produce 4mtpa
of sinter/pellet feed. Production should begin by 2QFY12. The sinter/pellet feed would
be shipped to TSE's Netherlands unit for use in pellet plant and blast furnace.


 Tata Steel also has an exclusive right to negotiate and settle a proposed transaction in
respect of other two projects - LabMag (3.5b tonnes of proven and probable reserves
of 29.5% Fe grade) and KeMag (2.1b tonnes of proven and probable reserves of
31.3% Fe grade).


Corus renamed Tata Steel Europe: contribution to EV getting diluted
 Tata Steel Europe (TSE) is likely to reduce earnings volatility due to USD500m
investment in improving operating efficiencies over the next 12-15 months, expected
sale of 4mtpa Teesside Cast Product (TCP) slab capacity for ~USD500m, various
cost cutting measure undertaken over the last 2-3 years under "Fit for Future" program,
and re-pricing of raw material more frequently on quarterly basis to better reflect
market conditions.
 TSE came under severe stress in 2HFY09 due to demand collapse and crash of
commodity prices driven by financial crisis. The financials of TSE took longer to
recover, as it chose to consume all of the high cost coking contracted at annual pricing
of USD300/tonne for FY09 rather than spreading the deliveries over three years. It
undertook a number of cost cutting measures to reduce fixed and variable costs.
Weathering the storm resulted in annual savings of USD1.9b.
 TSE reduced headcount by nearly 20%. A corresponding reduction in production levels
due to closure of TCP has resulted in specific staff cost remaining constant.
 Also, it reduced purchases of third-party steel to keep the utilization of its mill high.
TSE mills (excluding TCP) have regained high level of utilization faster than peers in
Europe. TCP was closed as a consortium of 3-4 customers walked out of a 10-year
offtake agreement.
 The margins of TSE recovered in 1HFY11. However, subsequent steel price correction
and raw material cost inflation are likely to compress margins in 2HFY11.
 Steel prices have started recovering once again thereby raising the expectation of
margin expansion in 1HFY12.
 Though TSE remains the largest contributor to group crude steel production, its share
in consolidated EBITDA and the group's enterprise value is getting diluted. TSE
contributes only 1/4th of our target EV of Rs929b.


Strategic investments to drive earnings growth; focus shifting to high RoE
projects; upgrade to Buy, with target price of Rs1,017
 Post the acquisition of Corus and the financial crisis, Tata Steel has made long-term
strategic investments (examples: USD3b capex at Jamshedpur, RIV, NML, Dhamra
port, JV with Bluescope, JV with NYK) over the last 3-4 years. Over the next 12-15
months, some of these investments will start generating cash flows - Jamshedpur
expansion to 10mtpa would be completed by December 2011, and coking coal and
iron ore production would start in 2HCY11.
 TSE earnings volatility is likely to reduce on completion of TCP sale and cost-cutting
initiatives in the last 2-3 years. TSE margins will remain under pressure until full
economic recovery in the European region.
 Though the earnings contribution from RIV and NML will be marginal in FY13, Rio
Tinto group's keen interest in RIV with a firm bid of AUD3.9b and possible counterbid
is likely to get reflected in Tata Steel's valuations sooner than expected.
 Tata Steel's focus is now shifting towards high RoE projects rather than pure strategic
investments. It has sold ~Rs12b of its investments in group companies like TCS, Tata
Power and Tata Motor to unlock value in FY10 and FY11, with further potential of
USD873m over 2-3 years.
 We are introducing FY13 estimates and moving our target price to SOTP value of
Rs1,017 to better reflect the value of its diverse assets across the globe. We expect
EPS to grow at a CAGR of 16% to Rs100.2 over FY11- FY13. We have valued
Indian operations at EV/EBITDA of 6.5x, TSE at EV/EBITDA of 5x and investments
at current market value. We believe that the value of investments will grow, as iron
ore and coking coal production ramp up. At our target price, the stock will trade at
10.1x FY13E EPS and an EV of 6.7x FY13E EBITDA. We upgrade the stock to
Buy.


Steel price recovery may provide further upsides
 Steel prices have witnessed a recovery of 10-15% across the world over the past one
month due to end of de-stocking, supply correction, and raw material cost pressures.
HRC prices have risen to USD670/tonne.
 Demand is expected to pick up over the next couple of months as buyers return to the
market post winter vacations in the western world. A strong steel price scenario is
expected for 4-5 months.
 Tata Steel tends to gain from steel price increase due to raw material integration. A
USD100/tonne increase in steel prices tend to expand the margins of Indian operations
by USD50/tonne, thereby driving the equity value by USD425m only on account of
Indian operations i.e. Rs21/share addition to target price. Margin expansion for RIV
and NML will add further to equity value.