Tata Steel - High value, high cost; visit note; Buy: Edelweiss Research

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Tata Steel (TATA IN, INR 627, Buy)

Following “one-company”, product differentiation and sectoral approach

Our facilities visit of Tata Steel Europe (TSE) reveals that the earlier approach of working in geographic and SBU-wise silos is changing to a “one-company” approach. Focus on improving product mix with target to increase sector-based sales from 40% to 65% of volumes in five years will be key profitability drivers.

Targeting EBITDA/t of USD 75 in two years; five year target of USD 100

The company is targeting EBITDA/t of USD 75 in two years and USD 100 in five years via better product mix, improving efficiency, and cutting energy costs. Benefits of international raw material projects not considered in this target. Targets imply matching/beating costs of the best European steel plants.

Ijmuiden and Port Talbot plants have strong points, but are high cost

High quality and improving flats’ product mix, injection of thermal coal in blast furnaces (amongst the highest in Ijmuiden at 250 kg) and port location to save on freight are the key strengths of Ijmuiden and Port Talbot plants. However, lack of captive resources and high wage bill imply an elevated cost structure. 

Margam coking coal mine: High potential; feasibility study underway

Located at Port Talbot (UK) with potential resources of 70-80 mt; 1.2-1.5 mt of coal in four years. Feasibility study is underway; decision is likely in two months.

High capex may lead to equity dilution and no reduction in net debt

Management targeting consolidated net debt:EBITDA and net debt:equity within 2.75x and 1.3x, respectively, and raising capital through hybrid securities (if required) to avoid equity dilution. Considering capex of USD 2.2 bn p.a. for the next two years and our profitability estimates, we do not expect any reduction in net debt and possibly an additional round of equity raising in this time-frame.

Outlook and valuations: Positive, maintain ‘BUY’

We believe our EBITDA/t estimate for TSE for FY12 and FY13 of USD 60 is achievable. Management targets are higher, especially for FY13. Proposed carbon-related regulations are a concern, but the impact will be felt only post 2013 and maybe mitigated by management actions. We reiterate our ‘BUY/SO’ recommendation/rating with a fair value of INR 778/share.