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Tata Steel
Strong Steel Price Trends, Growing Raw Materials Footprints; Stay OW
What's Changed
Price Target Rs865.00 to Rs836.00
F11, F12, F13 EPS Down 14%/6%/7%
Out top pick in India metals and mining: Tata is a
unique mix of high vertical integration in its Indian
operations, and sizeable exposure to European markets
where steel prices are rising fast. Even in India, steel
prices should grow materially from here, ahead of Street
expectations, driving positive earnings surprises in
F4Q11 and F1H12. We also feel that Tata’s improving
balance sheet, growing raw materials integration for
ex-India operations (via Mozambique coal project and
Canadian ore project), and the upcoming 3 mt (about
42% of current Indian capacity) expansion in India will
increasingly be assigned enhanced valuations.
What’s new: We push up our iron ore and coking coal
assumptions in line with our global commodities team’s
changes. Our steel price forecasts for F11 fall because
of a low base effect, but F12 and F13 rise slightly.Our
PAT forecasts are down 2% to 9% for F11-F13. We also
incorporate the recent change in capital structure.
What the current stock price is missing: Steel price
increases that have already taken place, coal assets
in Mozambique, 3 mt expansion. The Street seems to
be fixated on raw materials cost escalation and the
possibility of government intervention in steel pricing in
India. As a result, general perception is that steel
companies, even those like Tata Steel that have high
backward integration, could see steep margin
contraction, which in our view, is a misconception.
Why Overweight
• Our constructive stance on steel prices
• Good way to play the coking coal
up-cycle: Tata’s high and rising coking
coal and iron ore self sufficiency.
• Corus’s cost control initiatives may
surprise the Street on the upside. The
market should assign a higher multiple
to Corus’s earnings as they gain
stability. We expect EBITDA per ton of
US$60 in F11 and US$90/t in F12
• We estimate standalone operations
should see expansion in EBITDA per
ton from US$400/t in F1H11 to
US$448 in F12. Commissioning of the
new 3mt Indian Brownfield expansion
by December 2011 should aid EBITDA
growth of 29% and 24% in F12 and
F13.
• Valuation of 4.6x F12e EV/EBITDA
seems to reflect an unduly dim view on
Corus and steel prices.
Key Value Drivers
• Steel prices (on 1% increase, F12 EPS
would rise 9%).
• Iron Ore and Coking Coal prices (for
1% rise, F12 EPS would fall by 0.5%
and 0.9%).
• Successful Corus cost-cutting; pace of
Indian expansion project.
Catalysts
• Project progress on Benga, DSO ore
and Jamshedpur
• Positive steel exports data from China
• Quarterly results in C1H11, evidence
of rebound and sustainability in Corus
earnings
• Beginning of construction in Orissa
Key Risks
• Steel prices pull back sharply,
Property curbs in China
• Government intervention in steel
pricing in India or increase in taxes
• Sensex takes a dip after recent rally.
Tata Steel: Volume Growth, Strong and Rising RM Integration;
Top Pick in the Metals Pack – Stay Overweight
Why We Are Positive on Tata Steel
• Strong steel pricing trends in India and Europe to
drive profitability of the consolidated entity.
• Strong play on rising coking coal prices – the
Indian operations, which contribute 70% of
consolidated EBITDA, have 55% coking coal
self-sufficiency, and European operations should
have more than 25% sufficiency by F13. Currently
Tata produces about 3 mt coking coal and 4 mt
thermal coal, each of which should jump to about
6 mt by F14.
• The low-cost 3mt brownfield expansion to be
commissioned by F3Q12 should add about
US$950 mn to F13 consolidated EBITDA, easing
concerns on Tata’s balance sheet since this
represents about 9% of current net debt and 16%
of consolidated EBITDA.
• Tata Europe EBITDA to improve with restructuring
at existing facilities. We estimate EBITDA per ton
of US$90 and US$106 in F12 and F13 vs. US$70
in F1H11 and 38/t in F2H11.
• On our F12 and F13 estimates, the stock trades at
EV/EBITDA of 4.6x and 3.1x based on just the
Indian operations’ EBITDA, figures which indicate
that the sum of Tata Europe, Tata SE Asia and
Riversdale are being assigned an unduly high
negative valuation.
Given the solid price hikes in the last 6 weeks most steel
companies have already positioned themselves for healthy
sequential expansion in F4Q11. We expect flat EV/EBITDA/t,
but ahead of consensus expectations in F1H12. Similarly Tata
Europe’s EBITDA expansion should come in ahead of
expectations in C1H11 even though F3Q11 results (to be
announced in mid February) may be lackluster.
Indian operations: Fast progress toward achieving
US$5bn EBITDA. Post commissioning of the new 3 mt
capacity in late C2011 Tata India’s capacity will reach 10.2
mtpa and should clock EBITDA of about US$4bn in F13.
We also assume that construction work on Tata Steel’s Orissa
project will start by C2H11. We have assigned a value of Rs68
per share to this project and expect the start of construction to
act a catalyst for the stock. By F2014, we estimate Tata India
should be producing 13 mt with sustainable EBITDA of more
than US$5bn.
We think the stock has yet to fully reflect the gains from
cost reduction initiatives at Tata Europe… The Street will
likely start factoring in: (a) falling staff costs; (b) growing
self-sufficiency for coke; (c) refurbishing of steelmaking
facilities at Port Talbot. These should be reflected in earnings
over the next 3–4 quarters.
Teesside plant sale, for which Tata will get about US$500mn
(about 5% of Tata’s net debt) should improve the balance
sheet further.
Tata’s investments in Riversdale is worth US$1.64bn but
not properly understood by the market, in our view:
Riversdale’s board of directors unanimously recommended
Rio Tinto’s cash offer A$16/share (see Cameron Judd’s report,
Riversdale Mining Limited: Race to Secure Long Term Coal
Heats Up, January 25). This bid assesses Riversdale’s equity
value at US$3.78bn. If Tata Steel sells its stake in Riversdale
as well as Benga tenement, it could receive US$1.6 bn (~18%
of Tata’s consolidated net debt), on our estimates
Equity issuance to bring net debt/equity below 1x: Recent
issuance of 57mn new shares has fetched Tata another
US$0.7bn, driving down net debt by 7% in lieu of 5% equity
dilution. Accordingly, we now forecast net debt/equity ratio of
1.6x and 1x at F2011 and end-F2012.
We think that the market is looking only at Tata’s stake of 24%
in Riversdale – and is overlooking its direct stake in Benga
tenement of 35%, which on our calculation is US$0.74bn.
Exhibit 5
Sale of Stake in RIV, Benga Could Fetch Tata Steel
US$1.64bn
US$b
Market value of Riversdale at A$16.0 3.74
Equity value of Tata's 24.2% stake 0.91
Cash inflow for Tata if Riversdale
stake is sold----A 0.91
Equity Value of Benga* 2.11
Equity value of Tata's 35% stake----B 0.74
Total cash inflow for Tata if stakes in
Riversdale and Benga are
sold…(A+B) 1.64
Source: Company data, Morgan Stanley Research
However, we believe Tata Steel is likely to focus on cost
reduction with mining assets and will not sell its stake in
Riversdale and Benga, at least at the current offer price.
Canadian DSO project shaping up as another
Mozambique for Tata Steel: Now that New Millennium Steel
(the company that is leading the project) has received the
environmental approvals for the project, we believe iron ore
production could start by December 2012 (vs. the company’s
expectation of mid-C2012).
Tata holds an 80% stake in this project where annual
production will likely be about 4 mt. We estimate this project
could add about US$600mn to the company’s EV (about 3%
of the EV and 7% of its net debt).
Balance sheet concerns, in our view, have been the biggest
reason why Tata’s stock price does not properly reflect its
improving fundamentals. As balance sheet gains further
support from solid cash flows of the upcoming 3 mt expansion
project, this stock overhang should gradually ease.
We look for the proportion of high EBITDA per ton from India
to expand and Corus EBITDA per ton to strengthen.
What would impact our Overweight stance?
• Poor progress on mining projects and Indian steel
projects.
• Clouding of our steel price outlook due to slump in
demand in Europe and China.
• Massive deterioration in emerging market equities
outlook.
Earnings Estimate Changes
1) We incorporate changes in steel, coking coal and iron ore
prices.
2) We build in the equity issuance of 57mn shares (implying
US$770mn) resulting in a 6% increase in share count.
3) We have pushed forward the first phase of 3mt Orissa
project commissioning from the end-F2012 to early
F2015.
Valuation
The stock trades at a P/BV of 1.4 x and 1.1x and EV/EBITDA
of 4.6x and 3.1x, on our F2012 and F2013 estimates,
respectively. We believe that growing signs of improving
sustainability in Corus profitability and rising confidence in its
debt situation can slowly help Tata’s valuation discount versus
its regional peers narrow.
Price Target Down from Rs865 to Rs836
Key factors include:
1) We increase our share count by 6% from 914mn to
971mn and also adjust for net debt to account for the
equity issuance.
2) We push out the first phase of 3mt Orissa project
commissioning from F2012 to F2015.
3) We also increase our steel, iron ore and coking coal price
assumptions.
We value the stock by applying DCF models to three
businesses:
i) Jamshedpur plant;
ii) Orissa project
iii) Tata Europe (Corus) and other operations, separately.
Exhibit 10
Tata Steel: WACC Calculation of 12.8%
Risk Free Return (Rf) (%) 7.9
Market Premium (Rm-Rf) (%) 6.5
Assumed Beta 1.21
Cost of Equity (Re) (%) 15.7
Equity (%) 70
Cost of Debt (Rd) (%) 9.0
Tax rate (%) 33.1
After-tax cost of debt (Rd [1-t]) (%) 6.0
Debt (%) 30
WACC (%) 12.8
Source: Company data, Morgan Stanley Research
Exhibit 11
Tata Steel: DCF Calculation of Rs836 per share
(A) Present value of the explicit phase 333,957
Terminal value 596,918
Terminal growth rate (%) 2
(B) Present value of the terminal value 368,346
(A+B) Total present value 702,302
Net present value 762,702
Net debt without Corus 90,000
Equity Value Rs mn 672,702
Shares (mn) 971
Implied DCF value per share (Rs) Jamshedpur 693
Orissa Plant's value per share (Rs) 68
Corus value per share (Rs) 76
Total (Rs/Share) 836
Source: Company data, Morgan Stanley Research
Company Description
Tata Steel, a flagship company of the Tata group, is the
second-largest steel maker in India. It has capacity of 5mtpa and
a high level of vertical integration. Its sales basket is 40% long
products and 60% flat products. It has brownfield expansion
plans of 5mtpa and greenfield expansion plans of 11mtpa at
various stages of implementation. Tata Steel purchased
UK-based Corus Group Plc for an enterprise value of
US$13.5bn, after which it has become the sixth-largest steel
maker globally, with total capacity of about 24mtpa.
India Steel
Industry View: Attractive
India Equity Research Reports, IPO and Stock News
Visit http://indiaer.blogspot.com/ for complete details �� ��
Tata Steel
Strong Steel Price Trends, Growing Raw Materials Footprints; Stay OW
What's Changed
Price Target Rs865.00 to Rs836.00
F11, F12, F13 EPS Down 14%/6%/7%
Out top pick in India metals and mining: Tata is a
unique mix of high vertical integration in its Indian
operations, and sizeable exposure to European markets
where steel prices are rising fast. Even in India, steel
prices should grow materially from here, ahead of Street
expectations, driving positive earnings surprises in
F4Q11 and F1H12. We also feel that Tata’s improving
balance sheet, growing raw materials integration for
ex-India operations (via Mozambique coal project and
Canadian ore project), and the upcoming 3 mt (about
42% of current Indian capacity) expansion in India will
increasingly be assigned enhanced valuations.
What’s new: We push up our iron ore and coking coal
assumptions in line with our global commodities team’s
changes. Our steel price forecasts for F11 fall because
of a low base effect, but F12 and F13 rise slightly.Our
PAT forecasts are down 2% to 9% for F11-F13. We also
incorporate the recent change in capital structure.
What the current stock price is missing: Steel price
increases that have already taken place, coal assets
in Mozambique, 3 mt expansion. The Street seems to
be fixated on raw materials cost escalation and the
possibility of government intervention in steel pricing in
India. As a result, general perception is that steel
companies, even those like Tata Steel that have high
backward integration, could see steep margin
contraction, which in our view, is a misconception.
Why Overweight
• Our constructive stance on steel prices
• Good way to play the coking coal
up-cycle: Tata’s high and rising coking
coal and iron ore self sufficiency.
• Corus’s cost control initiatives may
surprise the Street on the upside. The
market should assign a higher multiple
to Corus’s earnings as they gain
stability. We expect EBITDA per ton of
US$60 in F11 and US$90/t in F12
• We estimate standalone operations
should see expansion in EBITDA per
ton from US$400/t in F1H11 to
US$448 in F12. Commissioning of the
new 3mt Indian Brownfield expansion
by December 2011 should aid EBITDA
growth of 29% and 24% in F12 and
F13.
• Valuation of 4.6x F12e EV/EBITDA
seems to reflect an unduly dim view on
Corus and steel prices.
Key Value Drivers
• Steel prices (on 1% increase, F12 EPS
would rise 9%).
• Iron Ore and Coking Coal prices (for
1% rise, F12 EPS would fall by 0.5%
and 0.9%).
• Successful Corus cost-cutting; pace of
Indian expansion project.
Catalysts
• Project progress on Benga, DSO ore
and Jamshedpur
• Positive steel exports data from China
• Quarterly results in C1H11, evidence
of rebound and sustainability in Corus
earnings
• Beginning of construction in Orissa
Key Risks
• Steel prices pull back sharply,
Property curbs in China
• Government intervention in steel
pricing in India or increase in taxes
• Sensex takes a dip after recent rally.
Tata Steel: Volume Growth, Strong and Rising RM Integration;
Top Pick in the Metals Pack – Stay Overweight
Why We Are Positive on Tata Steel
• Strong steel pricing trends in India and Europe to
drive profitability of the consolidated entity.
• Strong play on rising coking coal prices – the
Indian operations, which contribute 70% of
consolidated EBITDA, have 55% coking coal
self-sufficiency, and European operations should
have more than 25% sufficiency by F13. Currently
Tata produces about 3 mt coking coal and 4 mt
thermal coal, each of which should jump to about
6 mt by F14.
• The low-cost 3mt brownfield expansion to be
commissioned by F3Q12 should add about
US$950 mn to F13 consolidated EBITDA, easing
concerns on Tata’s balance sheet since this
represents about 9% of current net debt and 16%
of consolidated EBITDA.
• Tata Europe EBITDA to improve with restructuring
at existing facilities. We estimate EBITDA per ton
of US$90 and US$106 in F12 and F13 vs. US$70
in F1H11 and 38/t in F2H11.
• On our F12 and F13 estimates, the stock trades at
EV/EBITDA of 4.6x and 3.1x based on just the
Indian operations’ EBITDA, figures which indicate
that the sum of Tata Europe, Tata SE Asia and
Riversdale are being assigned an unduly high
negative valuation.
Given the solid price hikes in the last 6 weeks most steel
companies have already positioned themselves for healthy
sequential expansion in F4Q11. We expect flat EV/EBITDA/t,
but ahead of consensus expectations in F1H12. Similarly Tata
Europe’s EBITDA expansion should come in ahead of
expectations in C1H11 even though F3Q11 results (to be
announced in mid February) may be lackluster.
Indian operations: Fast progress toward achieving
US$5bn EBITDA. Post commissioning of the new 3 mt
capacity in late C2011 Tata India’s capacity will reach 10.2
mtpa and should clock EBITDA of about US$4bn in F13.
We also assume that construction work on Tata Steel’s Orissa
project will start by C2H11. We have assigned a value of Rs68
per share to this project and expect the start of construction to
act a catalyst for the stock. By F2014, we estimate Tata India
should be producing 13 mt with sustainable EBITDA of more
than US$5bn.
We think the stock has yet to fully reflect the gains from
cost reduction initiatives at Tata Europe… The Street will
likely start factoring in: (a) falling staff costs; (b) growing
self-sufficiency for coke; (c) refurbishing of steelmaking
facilities at Port Talbot. These should be reflected in earnings
over the next 3–4 quarters.
Teesside plant sale, for which Tata will get about US$500mn
(about 5% of Tata’s net debt) should improve the balance
sheet further.
Tata’s investments in Riversdale is worth US$1.64bn but
not properly understood by the market, in our view:
Riversdale’s board of directors unanimously recommended
Rio Tinto’s cash offer A$16/share (see Cameron Judd’s report,
Riversdale Mining Limited: Race to Secure Long Term Coal
Heats Up, January 25). This bid assesses Riversdale’s equity
value at US$3.78bn. If Tata Steel sells its stake in Riversdale
as well as Benga tenement, it could receive US$1.6 bn (~18%
of Tata’s consolidated net debt), on our estimates
Equity issuance to bring net debt/equity below 1x: Recent
issuance of 57mn new shares has fetched Tata another
US$0.7bn, driving down net debt by 7% in lieu of 5% equity
dilution. Accordingly, we now forecast net debt/equity ratio of
1.6x and 1x at F2011 and end-F2012.
We think that the market is looking only at Tata’s stake of 24%
in Riversdale – and is overlooking its direct stake in Benga
tenement of 35%, which on our calculation is US$0.74bn.
Exhibit 5
Sale of Stake in RIV, Benga Could Fetch Tata Steel
US$1.64bn
US$b
Market value of Riversdale at A$16.0 3.74
Equity value of Tata's 24.2% stake 0.91
Cash inflow for Tata if Riversdale
stake is sold----A 0.91
Equity Value of Benga* 2.11
Equity value of Tata's 35% stake----B 0.74
Total cash inflow for Tata if stakes in
Riversdale and Benga are
sold…(A+B) 1.64
Source: Company data, Morgan Stanley Research
However, we believe Tata Steel is likely to focus on cost
reduction with mining assets and will not sell its stake in
Riversdale and Benga, at least at the current offer price.
Canadian DSO project shaping up as another
Mozambique for Tata Steel: Now that New Millennium Steel
(the company that is leading the project) has received the
environmental approvals for the project, we believe iron ore
production could start by December 2012 (vs. the company’s
expectation of mid-C2012).
Tata holds an 80% stake in this project where annual
production will likely be about 4 mt. We estimate this project
could add about US$600mn to the company’s EV (about 3%
of the EV and 7% of its net debt).
Balance sheet concerns, in our view, have been the biggest
reason why Tata’s stock price does not properly reflect its
improving fundamentals. As balance sheet gains further
support from solid cash flows of the upcoming 3 mt expansion
project, this stock overhang should gradually ease.
We look for the proportion of high EBITDA per ton from India
to expand and Corus EBITDA per ton to strengthen.
What would impact our Overweight stance?
• Poor progress on mining projects and Indian steel
projects.
• Clouding of our steel price outlook due to slump in
demand in Europe and China.
• Massive deterioration in emerging market equities
outlook.
Earnings Estimate Changes
1) We incorporate changes in steel, coking coal and iron ore
prices.
2) We build in the equity issuance of 57mn shares (implying
US$770mn) resulting in a 6% increase in share count.
3) We have pushed forward the first phase of 3mt Orissa
project commissioning from the end-F2012 to early
F2015.
Valuation
The stock trades at a P/BV of 1.4 x and 1.1x and EV/EBITDA
of 4.6x and 3.1x, on our F2012 and F2013 estimates,
respectively. We believe that growing signs of improving
sustainability in Corus profitability and rising confidence in its
debt situation can slowly help Tata’s valuation discount versus
its regional peers narrow.
Price Target Down from Rs865 to Rs836
Key factors include:
1) We increase our share count by 6% from 914mn to
971mn and also adjust for net debt to account for the
equity issuance.
2) We push out the first phase of 3mt Orissa project
commissioning from F2012 to F2015.
3) We also increase our steel, iron ore and coking coal price
assumptions.
We value the stock by applying DCF models to three
businesses:
i) Jamshedpur plant;
ii) Orissa project
iii) Tata Europe (Corus) and other operations, separately.
Exhibit 10
Tata Steel: WACC Calculation of 12.8%
Risk Free Return (Rf) (%) 7.9
Market Premium (Rm-Rf) (%) 6.5
Assumed Beta 1.21
Cost of Equity (Re) (%) 15.7
Equity (%) 70
Cost of Debt (Rd) (%) 9.0
Tax rate (%) 33.1
After-tax cost of debt (Rd [1-t]) (%) 6.0
Debt (%) 30
WACC (%) 12.8
Source: Company data, Morgan Stanley Research
Exhibit 11
Tata Steel: DCF Calculation of Rs836 per share
(A) Present value of the explicit phase 333,957
Terminal value 596,918
Terminal growth rate (%) 2
(B) Present value of the terminal value 368,346
(A+B) Total present value 702,302
Net present value 762,702
Net debt without Corus 90,000
Equity Value Rs mn 672,702
Shares (mn) 971
Implied DCF value per share (Rs) Jamshedpur 693
Orissa Plant's value per share (Rs) 68
Corus value per share (Rs) 76
Total (Rs/Share) 836
Source: Company data, Morgan Stanley Research
Company Description
Tata Steel, a flagship company of the Tata group, is the
second-largest steel maker in India. It has capacity of 5mtpa and
a high level of vertical integration. Its sales basket is 40% long
products and 60% flat products. It has brownfield expansion
plans of 5mtpa and greenfield expansion plans of 11mtpa at
various stages of implementation. Tata Steel purchased
UK-based Corus Group Plc for an enterprise value of
US$13.5bn, after which it has become the sixth-largest steel
maker globally, with total capacity of about 24mtpa.
India Steel
Industry View: Attractive
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