Buy Tata Steel – 3QFY2011 Result; Target Price of Rs. 747.- Angel Broking

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Tata Steel – 3QFY2011 Result Update

Angel Broking maintains a Buy on Tata Steel with a Target Price of Rs. 747.

Tata Steel’s 3QFY2011 consolidated net revenue came in at `29,089cr in line

with our estimate of `27,800cr. However, net profit at `1,003cr was significantly

below our estimate of `1,392cr due to lower other income and higher tax rate.

Going forward, while 3QFY2011 performance of Tata Steel Europe (TSE) was

affected by seasonal trends, 4QFY2011 is expected to be relatively stronger. On

the other hand, the Indian operations are expected to remain strong because of

higher steel prices and high integration levels. We maintain a Buy on the stock.

Standalone EBITDA/tonne continues to increase: Despite the steel prices being

lower qoq, average steel realisations grew by 13.0% yoy and 5.5% qoq to

`41,299/tonne due to improved product mix. Sales volumes grew by a mere

2.7% yoy (marginally down 1.2% qoq) to 1.64mn tonnes. Thus, standalone net

revenues grew 16.0% yoy and 5.1% qoq to `7,397cr. EBITDA/tonne continued to

increase to US $383 (US $332 in 2QFY2011 and US $290 in 3QFY2010). Other

income declined to `11cr as 3QFY2010 and 2QFY2011 included profit on sale

of investments. Interest expense declined 19.3% yoy to `335cr. As a result, net

profit grew 27.0% yoy (down 26.7% qoq) to `1,513cr.

Subdued performance at TSE: In Europe, deliveries were down 8.7% yoy and

1.7% qoq to 3.47mn tonnes on account of weak demand. Further, EBITDA/tonne

for TSE declined to US $25 as compared to US $56 in 2QFY2011 and US $37 in

3QFY2010 on account of higher prices of raw materials. TSE’s net loss for

3QFY2011 was US $120mn.

Key concall takeaways

􀂄 3QFY2011 flat prices for the company stood at `35,300/tonne compared to

`35,600/tonne in 2QFY2011. Long product prices increased to

`29,150/tonne in 3QFY2011 compared to `27,500/tonne in 2QFY2011.

􀂄 While demand was weak in Thailand, deliveries in Nat Steel improved

primarily from its unit in China. For 3QFY2011, South East Asia deliveries

stood at 0.78mn tonnes.

􀂄 Currently, TSE operates at 75-80% capacity utilisation levels and management

expects utilisation levels to remain at ~80% in FY2012.

􀂄 Management has guided for average coking cost of US $190/tonne for

FY2011 as it holds inventory for 80 days as compared to the normal period of

60 days.

􀂄 Consolidated other income included loss of `120cr due to the fire at Ijmuiden.

Tata Steel had declared force majeure on product deliveries from the

Ijmuiden site.

􀂄 During the quarter, restructuring gains include release of provision on account

of the Teesside Cast Product plant

􀂄 Consolidated gross debt at the end of 3QFY2011 stood at `59,085cr

(US $13.2bn), while net debt stood at `52,836cr (US $11.8bn).

􀂄 Phase I of the Orissa project is currently underway and the company plans to

start construction work on the project.

Investment Arguments

Brownfield expansion on track

Tata Steel’s 2.9mn tonne brownfield expansion programme is on track and

expected to be commissioned by 2HFY2012. The product mix constitutes 2.5mn

tonne of HRC and 0.3mn tonne of slabs. We expect this expansion to contribute

~`4,600cr beginning FY2013.

Higher integration levels for TSE to boost earnings

Tata Steel is in the process of developing a coking coal mine in Mozambique and

an iron ore mine in Canada to enhance integration levels of TSE. The projects are

expected to be commissioned in phases beginning 2QFY2012. Total capex

remaining for the Mozambique project is US $100-150mn, while the Canadian

project will involve capex of CAD350mn. We expect these backward integration

projects at Mozambique and Canada to boost TSE’s earnings substantially post

FY2012.

Outlook and Valuation

Domestic steel prices have increased by `2,500-5,000 since the beginning of

January 2011 mainly on account of increase in the prices of key inputs. We expect

Tata Steel’s India operations to benefit significantly on account of the steel price

hikes; however, TSE would continue to suffer on account of higher raw material

prices and subdued demand in Europe.

Nevertheless, we continue to maintain our positive stance on Tata Steel owing to its

buoyant business outlook, driven by: a) higher sales volume in FY2013 on

completion of its 2.9mn tonne brownfield expansion project in Jamshedpur, b) raw

material projects at Mozambique and Canada, and c) cost-reduction initiatives at

Tata Steel Europe (TSE). We maintain a Buy on the stock, with a revised SOTP

Target Price of `747 (earlier `766).

We have lowered our profitability estimates for FY2011 to factor in the

lower-than-expected 3QFY2011 results. While we have raised our price realisation

estimates for FY2012, we have lowered our profitability estimates as we expect

higher raw material prices in FY2012.