Buy Tata Steel -Mostly positive, except debt increase; target Rs 863:: Macquarie Research,

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Tata Steel
Mostly positive, except debt increase
Event
 Inline 3Q FY11 results but outlook positive: Tata Steel reported largely
inline earnings on a consolidated basis, but the outlook for the next six
months looks very positive given that Tata Steel is sitting on 80 days of coking
coal inventory and costs will not increase much while it benefits from the
higher steel prices. The only worry for us is its continued increase in debt and
the deleveraging story that has taken a bit of a back seat. Tata Steel is on
track for a turnaround and remains our top pick among pure steel plays.
Maintain Outperform and target price.

Impact
 Q3 results – hit by seasonal weakness: Net sales of Rs286bn are up
10%YoY as realisation increased. EBITDA at Rs29.4bn grew 4% YoY as cost
increases muted the gains. Net profit of Rs10bn is up 112%.
 Indian operations – profits to get even higher: Indian operations reported a
phenomenal US$370/t margin and should increase further in Q4 to around
US$430-440/t. For FY12 we are assuming US$365/t margin, which seems
reasonable. On sales volume our assumption for FY12 stands at 7.2mnt
which is still achievable despite some delays being indicated for the
expansion. It requires only one quarter of operations of the new capacity.
 European operations – carbon credits help offset lower production:
European operations reported US$25/t margin. With large coking coal
inventory and steel prices up strongly, we expect margins to rebound to
US$60-70/t in Q4. With this, Corus is on track to achieve deliveries of 14.7mnt
and average margin of US$57/t for FY11. And for FY12 our assumptions
stand at 15.8mnt and a margin of US$66/t, which should be achievable given
the rebound in the European economy.
 Debt – though not a worry but is still rising: Contrary to our expectation,
the net debt has continued its increasing spree and is up 8% to now
US$11.82bn driven by rising working capital requirements and capex. Tata
Steel has started work on its Greenfield site in Orissa, which means the debt
reduction can be slower than expected.
Earnings and target price revision
 No change.
Price catalyst
 12-month price target: Rs863.00 based on a PER methodology.
 Catalyst: Earnings upgrades and better visibility of its raw material initiatives
Action and recommendation
 Maintain Outperform: Tata Steel remains one of our top picks in the steel
space as it remains on track to improve its sustainable EBITDA margins by
500bps. We believe any correction will be a perfect opportunity for long-term
investors to get exposure.