Buy Tata Steel - signs agreement for Taconite iron ore project; Edelweiss

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Tata Steel (TATA IN, INR 613, Buy)

n  Tata Steel signs agreement to develop Taconite iron ore project

Tata Steel has signed an agreement with New Millennium Capital Corp. (NML) to develop the LabMag and KeMag iron ore deposits (together known as The Taconite project) in Canada with reserves of 5.6 bt (at ~30% Fe) and total reserve and resources of 9.1 bt. As per the agreement, Tata Steel will help conduct a feasibility study for the project and also contribute 64% of the cost, estimated to be CAD 50 mn. Post successful completion of the feasibility study (expected in 21 months), Tata Steel will have a maximum period of four months to make an investment decision in the project. If affirmative, Tata Steel and NML will form a JV for the development of these deposits, either one or both. The concentrate/pellets from this project will be supplied to Tata Steel Europe at market price.

n  Outlook and valuations: Positive, no immediate impact; maintain ‘BUY’

The Taconite project is an extension to the under-development DSO project in Canada that is expected to start operations by Q3CY12 (delayed by a quarter compared with last disclosure by Tata Steel). The DSO project, with reserves of 64 mt, will potentially contribute 4 mtpa of iron ore from CY13. In the past, Tata Steel has indicated long-term target of 50% iron ore integration for Tata Steel Europe, which will imply a requirement of ~10 mtpa from Taconite project against its capacity of 22 mtpa. This will imply that Tata Steel will require minimum of 45% stake in the project.

Overall, we are positive on Tata Steel’s strategy to secure iron ore (Canada) and coking coal (Mozambique) supplies for Tata Steel Europe. However, the benefits would flow in only H2FY13 onwards and, hence, will not have significant earnings impact even for FY13. However, increasing value of the project portfolio of NML could provide valuation upside for Tata Steel that holds ~27% in NML. We maintain ‘BUY/Sector Outperformer’ recommendation/rating on the stock with a fair value of INR 778/share.