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Tata Steel Limited
Reuters: TISC.BO Bloomberg: TATA IN Exchange: BSE Ticker: TISC
Project Orissa to de-risk earnings; reiterate Buy
3Q'FY11 – in line with our forecasts
Tata Steel reported 3Q'FY11 consolidated recurring earnings of INR10bn (5%
above DBe; in line with street estimates). The Indian operations reported an
impressive performance with EBITDA/tonne rising by 4% QoQ, driven by an
improving product mix and recovery in long product prices. EBITDA/tonne at its
Tata Steel Europe (USD25/t) came in above DBe of USD19/t. We are adjusting our
FY12 earnings (-13%) and target price (-5%) to INR750/share for the recent equity
dilution and higher coking coal assumptions. Reiterate Buy
Profitability of Indian operations to help de-risk company earnings
Tata Steel India’s high value added product mix coupled with raw material
integration will continue to provide strong stability to consolidated earnings. Indian
operations constituted 84% of the consolidated EBITDA in 3Q’FY11. We expect
the ~3mn tonne expansion at Jamshedpur to help de-risk company’s consolidated
earnings further when it is commissioned next year. Increasing production in India
should result in Indian operations constituting an overwhelming 70% of the
consolidated EBITDA by FY12 from 46% in FY08 when Corus was acquired.
Encouraging progress at Greenfield steel plant in Orissa is a strong positive
Tata Steel’s planned Greenfield plant in Orissa remains critical to de-risking
company’s earnings from the vagaries of volatile raw material prices. Company’s
announcement on completion of boundary wall (covering the part required for
implementation of phase I) and commencement of construction work at Orissa, is
a very positive data point. Ground breaking at Orissa justifies the increased debt
levels (higher than our estimates) on balance sheet. We expect capex to remain
aggressive and net debt levels elevated over next two years with need to fund
projects at Orissa, Jamshedpur and Europe, simultaneously.
Revising target price to INR750/share; reiterate Buy
We are revising our target price to factor in the impact of recent equity dilution.
Our target price is based on an SOTP valuation (we have raised benchmark
multiples in line with expanding multiples globally): Indian ops valued at FY12E
EV/EBITDA of 7x, European ops valued at FY12E EV/EBITDA of 6x, Asian ops at
FY11E EV/EBITDA of 4.5x. Key risks: delay in steel demand recovery in Europe,
high leverage, and a higher-than-anticipated rise in raw material prices
Tata Steel – Consolidated
earnings in line with forecasts
Consolidated earnings in line with forecasts; Tata Steel Europe surprises positively
Tata Steel's 3Q'FY11 consolidated recurring earnings came in 5% above our forecasts and in
line with street estimates. The operating performance at Tata Steel Europe (formerly Corus)
was better than our expectations with EBITDA/tonne at US$25/tonne - higher than our
expectation of US$19/tonne. This was primarily driven by higher than expected blended
saleable steel realizations in Europe. The European division’s earnings continued to be aided
by revenues from the sale of carbon credits.
Greenfield plant in Orissa – Very positive development
We are excited over company providing details on the progress at its Greenfield plant in
Orissa. The company stated that it has now managed to secure the project site with a
boundary wall and fence. In our view, the construction of the boundary wall a very positive
development and signals that work on this – long delayed – plant is now progressing well.
Unlike other Greenfield plants in Orissa, there are no environment approvals pending for the
project. Also, Tata Steel is also building up capability to feed the new plant through its
existing iron ore mines in case there are unforeseen delays in securing approvals for new iron
ore mines.
The performance of the Indian operations was in line with our expectations. A higher than
expected increase in steel realizations on account of value addition and recovery in long steel
product prices was the key reason for EBITDA/tonne improving by 4% over 2Q’FY11. We
believe that the EBITDA at the Indian operations is set to expand sharply in 4Q following the
aggressive price hikes taken by Indian steel producers since January 2011. We estimate that
Indian steel producers (including Tata Steel) have raised steel prices by almost 12-15% since
the beginning of the year. The ensuing quarter is seasonally the strongest quarter for Indian
steel companies, thus, raising expectations of sequential recovery in steel volumes as well.
EBITDA at the Indian operations constituted 84% of consolidated EBITDA in 2Q’FY11. This
validates our belief that the highly profitable Indian operations will structurally constitute a
dominant 70-75% of group’s consolidated EBITDA from FY12 onwards, thus, boosting the
profitability of the consolidated entity and progressively de-risking the company from the
vagaries of raw material prices and non-integrated operations which expose the company to
a high degree of cyclical risk, until the captive raw material initiatives in Mozambique and
other parts of Africa raise the vertical integration levels at Tata Steel Europe (FY14 onwards).
Orissa steel plant at takeoff stage
We believe that in addition to the expansion at Jamshedpur, investors have been eagerly
looking forward to the visibility on the implementation of work at Greenfield plant in Orissa,
which will eventually allow the company to grow its volumes and scale significantly to
leverage on India’s robust steel demand growth trajectory as the country embarks on its
strongest ever period of materials intensive growth. The Orissa plant – with captive access to
iron ore, proximity to the ports, promises to be even more efficient than the low cost,
existing Jamshedpur plant. We believe that expanding further at Jamshedpur will be very
difficult and hence progress on the Orissa plant assumes critical status. Announcement of
ground breaking at Orissa and implementation of construction of this plant is a very strong
positive.
The operating performance at Tata Steel Europe (formerly Corus) in the seasonally weak
3Q’FY11 was better than our expectations with EBITDA/tonne at US$25/tonne - higher than
our expectation of US$19/tonne. This was primarily driven by higher than expected blended
saleable steel realizations in Europe. The European division’s earnings continued to be aided
by revenues from the sale of carbon credits. We are not perturbed about the sharp decline in
EBITDA/tonne in Europe (both on YoY and QoQ basis) and this is in line with the seasonal
trend and our expectations.
Bunching together of three projects may result in balance sheet
being stretched in medium term
Tata Steel surprised us in 3Q’FY11 by stating that its net debt has risen to INR528bn, a jump
of 7% from 2Q’FY11. We believe that the increase in net debt levels is testimony to company
becoming confident on the implementation of project Orissa and its ability to turnaround the
European operations (where Port Talbot has had a very successful turnaround already)
We estimate that total capex over next three years will amount to INR250bn – the highest
ever for the company. This is attributed to the simultaneous need for funds in Europe
(amount to be spent on de-bottlenecking which is critical to increase sustainable EBITDA to
about USD80/tonne from USD60/tonne currently) and India (for both – completion of
Jamshedpur as well as new Greenfield plant in Orissa).
We expect net debt levels – despite the recent equity infusion – to stay at elevated levels
over our forecast period. We expect net debt equity to improve gradually over FY12-13 once
the cash flows from the capacity expansion at Jamshedpur come through. These cash flows
will be used to fund additional expenditure for phase II of project Orissa (FY14 onwards).
Rising raw material prices will also put additional pressure on working capital needs, primarily
at the European operations.
Valuation
Valuation methodology and argument
We continue to believe that EV/EBITDA is an appropriate methodology to value Tata Steel, as
this approach best captures the dynamics of the Corus transaction and eliminates the biases
of the funding structure, typical of leveraged buyouts. We prefer to use a sum-of-the-parts
valuation given the dynamics of the three key regional geographies and divergent nature of
individual steel assets. We value the Indian operations at a multiple of 7x FY12E EV/EBITDA,
at a 5% discount to the corresponding valuation of companies similar in profile, such as CSN.
Though it is at a premium to the historical valuations of the Tata Steel’s Indian operations, we
believe there is a strong case for the re-rating of the India operations on account of the
company’s access to captive raw material (100% iron ore, 60% coking coal) and the
improving visibility over raising production in India at the new Greenfield plant in Orissa, thus
providing a sustainable cost advantage. We believe that over the course of the current
decade valuation multiples of Indian steel companies are set for a re-rating on account of a
structural demand growth (sustainable double digit demand growth in emerging markets
relative to low single digit sustainable demand growth in the developed world), coupled with
captive access to raw materials (Tata Steel and SAIL).
We have assigned a valuation of 6x to Tata Steel’s European operations. Given Tata Steel
Europe’s lower profitability relative to the Indian operations and lack of captive access to raw
materials, we assign a 15% discount to the valuation multiple of Tata Steel India. Our target
multiple is in line with European peers like Voestalpine. Asian operations are converters and
do not have upstream steelmaking capacity. Hence, we believe they should be valued at a
marked discount to the Indian and European operations - both of which are integrated steel
producers. We thus assign a multiple of 4.5x. Our SOTP methodology leads to a target price
of INR750/share, which translates into a blended implied FY12E EV/EBITDA multiple of 6.7x
and FY12E PER(x) of 9.4x.
Downside risks
(1) Higher-than-anticipated increase in steel-making raw material prices. In the case that raw
material price hikes are higher than our assumptions, there could be a risk to our target price
and recommendation.
(2) Steel demand environment remaining challenging in Europe, especially in the long product
segment into CY10 and delay in steel demand recovery.
(3) The overhang of the inflation-wary government of India. In the case that the inflation-wary
government of India frowns on the price hikes, the sentiment for all steel stocks, including
Tata Steel, may be affected negatively.
India Equity Research Reports, IPO and Stock News
Visit http://indiaer.blogspot.com/ for complete details �� ��
Tata Steel Limited
Reuters: TISC.BO Bloomberg: TATA IN Exchange: BSE Ticker: TISC
Project Orissa to de-risk earnings; reiterate Buy
3Q'FY11 – in line with our forecasts
Tata Steel reported 3Q'FY11 consolidated recurring earnings of INR10bn (5%
above DBe; in line with street estimates). The Indian operations reported an
impressive performance with EBITDA/tonne rising by 4% QoQ, driven by an
improving product mix and recovery in long product prices. EBITDA/tonne at its
Tata Steel Europe (USD25/t) came in above DBe of USD19/t. We are adjusting our
FY12 earnings (-13%) and target price (-5%) to INR750/share for the recent equity
dilution and higher coking coal assumptions. Reiterate Buy
Profitability of Indian operations to help de-risk company earnings
Tata Steel India’s high value added product mix coupled with raw material
integration will continue to provide strong stability to consolidated earnings. Indian
operations constituted 84% of the consolidated EBITDA in 3Q’FY11. We expect
the ~3mn tonne expansion at Jamshedpur to help de-risk company’s consolidated
earnings further when it is commissioned next year. Increasing production in India
should result in Indian operations constituting an overwhelming 70% of the
consolidated EBITDA by FY12 from 46% in FY08 when Corus was acquired.
Encouraging progress at Greenfield steel plant in Orissa is a strong positive
Tata Steel’s planned Greenfield plant in Orissa remains critical to de-risking
company’s earnings from the vagaries of volatile raw material prices. Company’s
announcement on completion of boundary wall (covering the part required for
implementation of phase I) and commencement of construction work at Orissa, is
a very positive data point. Ground breaking at Orissa justifies the increased debt
levels (higher than our estimates) on balance sheet. We expect capex to remain
aggressive and net debt levels elevated over next two years with need to fund
projects at Orissa, Jamshedpur and Europe, simultaneously.
Revising target price to INR750/share; reiterate Buy
We are revising our target price to factor in the impact of recent equity dilution.
Our target price is based on an SOTP valuation (we have raised benchmark
multiples in line with expanding multiples globally): Indian ops valued at FY12E
EV/EBITDA of 7x, European ops valued at FY12E EV/EBITDA of 6x, Asian ops at
FY11E EV/EBITDA of 4.5x. Key risks: delay in steel demand recovery in Europe,
high leverage, and a higher-than-anticipated rise in raw material prices
Tata Steel – Consolidated
earnings in line with forecasts
Consolidated earnings in line with forecasts; Tata Steel Europe surprises positively
Tata Steel's 3Q'FY11 consolidated recurring earnings came in 5% above our forecasts and in
line with street estimates. The operating performance at Tata Steel Europe (formerly Corus)
was better than our expectations with EBITDA/tonne at US$25/tonne - higher than our
expectation of US$19/tonne. This was primarily driven by higher than expected blended
saleable steel realizations in Europe. The European division’s earnings continued to be aided
by revenues from the sale of carbon credits.
Greenfield plant in Orissa – Very positive development
We are excited over company providing details on the progress at its Greenfield plant in
Orissa. The company stated that it has now managed to secure the project site with a
boundary wall and fence. In our view, the construction of the boundary wall a very positive
development and signals that work on this – long delayed – plant is now progressing well.
Unlike other Greenfield plants in Orissa, there are no environment approvals pending for the
project. Also, Tata Steel is also building up capability to feed the new plant through its
existing iron ore mines in case there are unforeseen delays in securing approvals for new iron
ore mines.
The performance of the Indian operations was in line with our expectations. A higher than
expected increase in steel realizations on account of value addition and recovery in long steel
product prices was the key reason for EBITDA/tonne improving by 4% over 2Q’FY11. We
believe that the EBITDA at the Indian operations is set to expand sharply in 4Q following the
aggressive price hikes taken by Indian steel producers since January 2011. We estimate that
Indian steel producers (including Tata Steel) have raised steel prices by almost 12-15% since
the beginning of the year. The ensuing quarter is seasonally the strongest quarter for Indian
steel companies, thus, raising expectations of sequential recovery in steel volumes as well.
EBITDA at the Indian operations constituted 84% of consolidated EBITDA in 2Q’FY11. This
validates our belief that the highly profitable Indian operations will structurally constitute a
dominant 70-75% of group’s consolidated EBITDA from FY12 onwards, thus, boosting the
profitability of the consolidated entity and progressively de-risking the company from the
vagaries of raw material prices and non-integrated operations which expose the company to
a high degree of cyclical risk, until the captive raw material initiatives in Mozambique and
other parts of Africa raise the vertical integration levels at Tata Steel Europe (FY14 onwards).
Orissa steel plant at takeoff stage
We believe that in addition to the expansion at Jamshedpur, investors have been eagerly
looking forward to the visibility on the implementation of work at Greenfield plant in Orissa,
which will eventually allow the company to grow its volumes and scale significantly to
leverage on India’s robust steel demand growth trajectory as the country embarks on its
strongest ever period of materials intensive growth. The Orissa plant – with captive access to
iron ore, proximity to the ports, promises to be even more efficient than the low cost,
existing Jamshedpur plant. We believe that expanding further at Jamshedpur will be very
difficult and hence progress on the Orissa plant assumes critical status. Announcement of
ground breaking at Orissa and implementation of construction of this plant is a very strong
positive.
The operating performance at Tata Steel Europe (formerly Corus) in the seasonally weak
3Q’FY11 was better than our expectations with EBITDA/tonne at US$25/tonne - higher than
our expectation of US$19/tonne. This was primarily driven by higher than expected blended
saleable steel realizations in Europe. The European division’s earnings continued to be aided
by revenues from the sale of carbon credits. We are not perturbed about the sharp decline in
EBITDA/tonne in Europe (both on YoY and QoQ basis) and this is in line with the seasonal
trend and our expectations.
Bunching together of three projects may result in balance sheet
being stretched in medium term
Tata Steel surprised us in 3Q’FY11 by stating that its net debt has risen to INR528bn, a jump
of 7% from 2Q’FY11. We believe that the increase in net debt levels is testimony to company
becoming confident on the implementation of project Orissa and its ability to turnaround the
European operations (where Port Talbot has had a very successful turnaround already)
We estimate that total capex over next three years will amount to INR250bn – the highest
ever for the company. This is attributed to the simultaneous need for funds in Europe
(amount to be spent on de-bottlenecking which is critical to increase sustainable EBITDA to
about USD80/tonne from USD60/tonne currently) and India (for both – completion of
Jamshedpur as well as new Greenfield plant in Orissa).
We expect net debt levels – despite the recent equity infusion – to stay at elevated levels
over our forecast period. We expect net debt equity to improve gradually over FY12-13 once
the cash flows from the capacity expansion at Jamshedpur come through. These cash flows
will be used to fund additional expenditure for phase II of project Orissa (FY14 onwards).
Rising raw material prices will also put additional pressure on working capital needs, primarily
at the European operations.
Valuation
Valuation methodology and argument
We continue to believe that EV/EBITDA is an appropriate methodology to value Tata Steel, as
this approach best captures the dynamics of the Corus transaction and eliminates the biases
of the funding structure, typical of leveraged buyouts. We prefer to use a sum-of-the-parts
valuation given the dynamics of the three key regional geographies and divergent nature of
individual steel assets. We value the Indian operations at a multiple of 7x FY12E EV/EBITDA,
at a 5% discount to the corresponding valuation of companies similar in profile, such as CSN.
Though it is at a premium to the historical valuations of the Tata Steel’s Indian operations, we
believe there is a strong case for the re-rating of the India operations on account of the
company’s access to captive raw material (100% iron ore, 60% coking coal) and the
improving visibility over raising production in India at the new Greenfield plant in Orissa, thus
providing a sustainable cost advantage. We believe that over the course of the current
decade valuation multiples of Indian steel companies are set for a re-rating on account of a
structural demand growth (sustainable double digit demand growth in emerging markets
relative to low single digit sustainable demand growth in the developed world), coupled with
captive access to raw materials (Tata Steel and SAIL).
We have assigned a valuation of 6x to Tata Steel’s European operations. Given Tata Steel
Europe’s lower profitability relative to the Indian operations and lack of captive access to raw
materials, we assign a 15% discount to the valuation multiple of Tata Steel India. Our target
multiple is in line with European peers like Voestalpine. Asian operations are converters and
do not have upstream steelmaking capacity. Hence, we believe they should be valued at a
marked discount to the Indian and European operations - both of which are integrated steel
producers. We thus assign a multiple of 4.5x. Our SOTP methodology leads to a target price
of INR750/share, which translates into a blended implied FY12E EV/EBITDA multiple of 6.7x
and FY12E PER(x) of 9.4x.
Downside risks
(1) Higher-than-anticipated increase in steel-making raw material prices. In the case that raw
material price hikes are higher than our assumptions, there could be a risk to our target price
and recommendation.
(2) Steel demand environment remaining challenging in Europe, especially in the long product
segment into CY10 and delay in steel demand recovery.
(3) The overhang of the inflation-wary government of India. In the case that the inflation-wary
government of India frowns on the price hikes, the sentiment for all steel stocks, including
Tata Steel, may be affected negatively.
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