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Plant visit underscores conviction in company's regeneration strategy
Our visit to Tata Steel’s European facilities has helped reaffirm our conviction in its
stated regeneration strategy for its European operations. However, we think the
company will need to step up annual capex in Europe to ~USD650mn (up from
~USD250-300mn) to achieve its identified strategic targets. We believe that
company is on track to achieve its target of a sustainable EBITDA of USD100/t at
its European operations. If requisite investments are made in time, company may
achieve its targets well before the stated timeline of 4-5 years. Maintain Buy
Closing the efficiency and profitability gap between UK and European ops
The foundations of Tata Steel’s regeneration strategy for Europe are built on a
combination of (i) energy optimization, (ii) value addition, (iii) operational
efficiencies, and (iv) increasing raw material integration. The focus of the
regeneration strategy in Europe is aimed at closing the efficiency and profitability
gap between its Ijmuiden and UK plants (15-20% cost gap), indicating that bulk of
the investments will be aimed at the UK operations. The company's strategy will
also be guided by the evolving carbon conscious regulatory landscape in Europe.
Capex on a treadmill but capacity expansion at Jamshedpur to assuage
balance sheet concerns
We are revising up our annual capex assumptions for the consolidated entity to
USD2.5/2.4 bn for FY12/13. While we believe that the capex is heavy, we are
encouraged by the strong cash flow generation in FY13 from company’s 2.9mn
tonnes expansion at Jamshedpur, expected to be commissioned by 3Q’FY12.
Despite the increased capex assumptions, we forecast a gradual improvement in
the net debt/equity ratio for the consolidated entity over FY11-13.
Revising target price to INR708/share; reiterate Buy
We are revising our target price to factor in the impact of increased capex
assumptions. We value Tata Steel on SOTP valuation: Indian/European/Asian ops
valued at FY12E EV/EBITDA of 7x/6x/4.5x. Key risks: high leverage, and a higherthan-
anticipated rise in raw material prices
Tata Steel Europe – Site visit
Not just about squeezing the lemon
Our visit to Tata Steel’s European facilities has helped not only reaffirm our conviction in Tata
Steel’s regeneration strategy for its European operations but also the fact that this strategy
will have to focus on much more than just “squeezing the lemon”. Tata Steel’s core strategy
remains focused on growth and profitability with a blueprint firmly built around the group’s
two pronged approach – (1) volume growth in India to capitalize on company’s integrated
operations and low cost status and (2) improving the efficiency and profitability of its
European operations to levels benchmarked to some of the world’s most efficient steel
companies (without captive raw materials).
Ironically, the visit has helped us realize the high levels of underinvestment by incumbent
management of the erstwhile Corus, particularly in the legacy United Kingdom operations
(we visited Port Talbot and its satellite Llanwern works in the UK). The scale of
underinvestment in the UK operations - prior to the acquisition by Tata Steel - has been so
immense that while it creates a strong opportunity for the Tata Steel management in
reinvigorating operations and improving efficiencies, it also indicates that the Tata group will
have to do some heavy lifting, which will go beyond just routine rolling expenditure. We
estimate that the company will have to make new investments across the steel production
chain, from the blast furnaces (relining and rebuilding some, enriching oxygen and coal
injection capabilities and building new power plants) to finishing mills (to increase value
addition and move up the steel value chain). Tata steel estimates that it will need to step up
annual capital expenditure in Europe to about USD650mn (up from about USD250-300mn) to
achieve its identified strategic targets.
Can management deliver its stated target of achieving a
sustainable EBITDA of USD100/tonne at the European
Operations?
Our visit has also provided conviction and color on management’s target of achieving a
sustainable EBITDA of USD100/tonne at its European operations over next four to five years
(from USD50-55 currently). This target is the quantitative end objective of Tata Steel’s holistic
regeneration strategy for European operations and does not include any benefits of the
captive raw materials from its African coal assets and North American iron ore assets.
We believe that, based on the company’s articulation of its regeneration strategy for the
European operations, the target should be not only achievable but can be reached even
before the five year period if the identified investments are undertaken and the company is
able to support its strategic intent by providing the financial, technological, emotional and
intellectual energy for the stated objective.
The foundations of Tata Steel’s regeneration strategy for Europe are built on the following
four pillars:
The need to reconfigure the product mix of steel in Europe to meet the demands of
a restrictive, carbon conscious regulatory landscape: The pressure to comply with
stringent carbon emission norms will compel European steel producers to move away
from volume to value add and niche products, similar to what we have seen in Japan. In
order to intercept the challenges of a drastic change in the regulatory landscape,
European steel makers will be compelled to cede market share in low margin
commodity grade steels to China and other emerging markets and focus on high margin,
value added and niche steel products.
A relentless and focused quest to close the productivity and efficiency gap between
Ijmuiden and other more efficient steel plants and between Ijmuiden and UK
operations: We understand that Port Talbot and Scunthorpe’s operating costs could be
16-20% higher on average than the corresponding operating costs of the Ijmuiden
operations. We believe that this pillar will form the hallmark of the company’s strategic
intent to close the efficiency and cost gap. This will include focusing on energy
optimization, enhancement of blast furnace steelmaking efficiency through injecting
pulverized and granulated coals, enriching the UK iron and steel making facilities with
more oxygen (UK operations are oxygen constrained; company is bringing on new
oxygen plants to eliminate these constraints ) and building new power plants to reduce
dependence on the grid.
We were surprised to discover that the Port Talbot plant flares gases generated
from the steel making operations. Most efficient steel plants including Tata Steel’s
Jamshedpur plant recycle the blast furnace and coke oven gases which are used as
a fuel either for captive power plants or reheating furnaces. We understand that Tata
Steel will now be transferring some of its best practices from its Indian operations
where it recycles the gases. The UK operations should be able to bring down its
energy costs sharply once it has successfully recaptured its waste gases. While this
will entail an investment in new power plants (could these be set up in partnership
with group company Tata Power?), it has the potential to bring down the operating
cost per tonne in a range of USD20-25/tonne. Increasing levels of coal injection will
increase the level of gas generation as well. The company also plans to fully revamp
its BF-4 at a total investment of GBP185 mn in 2012. This is also likely to help
improve the operating parameters at the Port Talbot Plant and bridge the efficiency
gap with Europe’s more efficient plants.
Tata Steel also plans to raise its blast furnace efficiency in UK (Port Talbot) by
increasing coal injection. Pulverized (In the case of Port Talbot, it will be granulated
coal injection) coal injection has assisted the steel industry to lower operating costs,
extend coke oven life and lower greenhouse emissions. Hot metal production is the
most energy intensive stage of the steel making process. The aspiration to increase
granulated coal injection at Port Talbot from the current level of about 180kgs/thm to
levels close to Ijmuiden (PCI of 220-240/thm) will be yet another determinant of
bridging the cost gap between Ijmuiden and UK operations. The increased thrust on
coal injection will help reduce the total energy costs and also aid the quest for lower
energy emissions. Incremental coal injection also results in higher gas generation,
which can be used as a fuel for captive power plants.
Increasing customization and reorienting product mix towards Original
Equipment manufacturers (OEMs): Tata Steel Europe will integrate its
technological improvements with the needs of its customers allowing it to offer
optimally customized products and solutions, deepening its association with its end
users and emerging as a “preferred” long term supplier. This strategy has been
deployed by Japanese steel producers successfully. This is aimed at increasing the
composition of high margin steel products and reducing dependence on low margin
commodity grades. The company plans to increase direct sales to the OEM
segment from 40% to 65-70% over the next 3 years.
Tata Steel’s regeneration strategy is also premised on the changing composition of
end use steel demand in Europe. European demand for construction is expected to
remain sedate while demand for automotive mechanical engineering products and
tubes is expected to accelerate. Consequently, the company is focused on
realigning its product portfolio towards the faster growing sectors.
The foundations of this pillar will rely on a combination of developing close relationships
with end users including the early vendor relationship with auto manufacturers. Tata
Steel Europe has developed its strongest relationship with Nissan and is now working
with most other European auto producers including Volkswagen and BMW. The
company has already realigned its product mix in strips from the construction sector to
the auto sector. In UK the company is now selling 0.4mn tonnes of strips to the auto
sector (up twice from two years ago) and plans to take this to 0.7mn tonnes. A
continued thrust on value addition will mean additional investments in new galvanizing
lines and balancing investments in downstream units including rolling and finishing mills.
Improvement in raw material integration: The company is also exploring the option the
supplying a part of its coking coal requirements from the Margan coal mine, which is
located in close proximity to Tata’s Port Talbot plant. The feasibility studies are currently
underway at this mine and the resources are estimated to be 37 mn tonnes. The coal
supplies from this mine can potentially provide a coal value in use benefit of GBP 5/thm.
Capex on a treadmill but Jamshedpur expansion to assuage
concerns on balance sheet
Following our visit to Tata Steel Europe’s plants and listening to the company’s articulation of
its regeneration strategy for Europe, we are revising up our annual capex assumptions for the
European operations by USD300mn tonnes to USD650mn per annum. We believe that the
increase in capex at the European operations is well justified as it is integral to company
raising its sustainable EBITDA by ~80% to USD100, over the next 3-4 years. Consequently,
our total annual capex for the consolidated entity for FY12 and FY13 stands revised to
USD2.5bn and USD2.4bn, respectively.
While we believe that the capex is heavy, we are encouraged by the strong cash flow
generation in FY13 from company’s 2.9mn tonnes expansion at Jamshedpur, expected to be
commissioned by 3Q’FY12. Despite the increased capex assumptions, we forecast a gradual
improvement in the net debt/equity ratio for the consolidated entity over FY11-13.
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.
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. 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 INR708/share.
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 CY11 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 �� ��
Plant visit underscores conviction in company's regeneration strategy
Our visit to Tata Steel’s European facilities has helped reaffirm our conviction in its
stated regeneration strategy for its European operations. However, we think the
company will need to step up annual capex in Europe to ~USD650mn (up from
~USD250-300mn) to achieve its identified strategic targets. We believe that
company is on track to achieve its target of a sustainable EBITDA of USD100/t at
its European operations. If requisite investments are made in time, company may
achieve its targets well before the stated timeline of 4-5 years. Maintain Buy
Closing the efficiency and profitability gap between UK and European ops
The foundations of Tata Steel’s regeneration strategy for Europe are built on a
combination of (i) energy optimization, (ii) value addition, (iii) operational
efficiencies, and (iv) increasing raw material integration. The focus of the
regeneration strategy in Europe is aimed at closing the efficiency and profitability
gap between its Ijmuiden and UK plants (15-20% cost gap), indicating that bulk of
the investments will be aimed at the UK operations. The company's strategy will
also be guided by the evolving carbon conscious regulatory landscape in Europe.
Capex on a treadmill but capacity expansion at Jamshedpur to assuage
balance sheet concerns
We are revising up our annual capex assumptions for the consolidated entity to
USD2.5/2.4 bn for FY12/13. While we believe that the capex is heavy, we are
encouraged by the strong cash flow generation in FY13 from company’s 2.9mn
tonnes expansion at Jamshedpur, expected to be commissioned by 3Q’FY12.
Despite the increased capex assumptions, we forecast a gradual improvement in
the net debt/equity ratio for the consolidated entity over FY11-13.
Revising target price to INR708/share; reiterate Buy
We are revising our target price to factor in the impact of increased capex
assumptions. We value Tata Steel on SOTP valuation: Indian/European/Asian ops
valued at FY12E EV/EBITDA of 7x/6x/4.5x. Key risks: high leverage, and a higherthan-
anticipated rise in raw material prices
Tata Steel Europe – Site visit
Not just about squeezing the lemon
Our visit to Tata Steel’s European facilities has helped not only reaffirm our conviction in Tata
Steel’s regeneration strategy for its European operations but also the fact that this strategy
will have to focus on much more than just “squeezing the lemon”. Tata Steel’s core strategy
remains focused on growth and profitability with a blueprint firmly built around the group’s
two pronged approach – (1) volume growth in India to capitalize on company’s integrated
operations and low cost status and (2) improving the efficiency and profitability of its
European operations to levels benchmarked to some of the world’s most efficient steel
companies (without captive raw materials).
management of the erstwhile Corus, particularly in the legacy United Kingdom operations
(we visited Port Talbot and its satellite Llanwern works in the UK). The scale of
underinvestment in the UK operations - prior to the acquisition by Tata Steel - has been so
immense that while it creates a strong opportunity for the Tata Steel management in
reinvigorating operations and improving efficiencies, it also indicates that the Tata group will
have to do some heavy lifting, which will go beyond just routine rolling expenditure. We
estimate that the company will have to make new investments across the steel production
chain, from the blast furnaces (relining and rebuilding some, enriching oxygen and coal
injection capabilities and building new power plants) to finishing mills (to increase value
addition and move up the steel value chain). Tata steel estimates that it will need to step up
annual capital expenditure in Europe to about USD650mn (up from about USD250-300mn) to
achieve its identified strategic targets.
Can management deliver its stated target of achieving a
sustainable EBITDA of USD100/tonne at the European
Operations?
Our visit has also provided conviction and color on management’s target of achieving a
sustainable EBITDA of USD100/tonne at its European operations over next four to five years
(from USD50-55 currently). This target is the quantitative end objective of Tata Steel’s holistic
regeneration strategy for European operations and does not include any benefits of the
captive raw materials from its African coal assets and North American iron ore assets.
We believe that, based on the company’s articulation of its regeneration strategy for the
European operations, the target should be not only achievable but can be reached even
before the five year period if the identified investments are undertaken and the company is
able to support its strategic intent by providing the financial, technological, emotional and
intellectual energy for the stated objective.
The foundations of Tata Steel’s regeneration strategy for Europe are built on the following
four pillars:
The need to reconfigure the product mix of steel in Europe to meet the demands of
a restrictive, carbon conscious regulatory landscape: The pressure to comply with
stringent carbon emission norms will compel European steel producers to move away
from volume to value add and niche products, similar to what we have seen in Japan. In
order to intercept the challenges of a drastic change in the regulatory landscape,
European steel makers will be compelled to cede market share in low margin
commodity grade steels to China and other emerging markets and focus on high margin,
value added and niche steel products.
A relentless and focused quest to close the productivity and efficiency gap between
Ijmuiden and other more efficient steel plants and between Ijmuiden and UK
operations: We understand that Port Talbot and Scunthorpe’s operating costs could be
16-20% higher on average than the corresponding operating costs of the Ijmuiden
operations. We believe that this pillar will form the hallmark of the company’s strategic
intent to close the efficiency and cost gap. This will include focusing on energy
optimization, enhancement of blast furnace steelmaking efficiency through injecting
pulverized and granulated coals, enriching the UK iron and steel making facilities with
more oxygen (UK operations are oxygen constrained; company is bringing on new
oxygen plants to eliminate these constraints ) and building new power plants to reduce
dependence on the grid.
We were surprised to discover that the Port Talbot plant flares gases generated
from the steel making operations. Most efficient steel plants including Tata Steel’s
Jamshedpur plant recycle the blast furnace and coke oven gases which are used as
a fuel either for captive power plants or reheating furnaces. We understand that Tata
Steel will now be transferring some of its best practices from its Indian operations
where it recycles the gases. The UK operations should be able to bring down its
energy costs sharply once it has successfully recaptured its waste gases. While this
will entail an investment in new power plants (could these be set up in partnership
with group company Tata Power?), it has the potential to bring down the operating
cost per tonne in a range of USD20-25/tonne. Increasing levels of coal injection will
increase the level of gas generation as well. The company also plans to fully revamp
its BF-4 at a total investment of GBP185 mn in 2012. This is also likely to help
improve the operating parameters at the Port Talbot Plant and bridge the efficiency
gap with Europe’s more efficient plants.
Tata Steel also plans to raise its blast furnace efficiency in UK (Port Talbot) by
increasing coal injection. Pulverized (In the case of Port Talbot, it will be granulated
coal injection) coal injection has assisted the steel industry to lower operating costs,
extend coke oven life and lower greenhouse emissions. Hot metal production is the
most energy intensive stage of the steel making process. The aspiration to increase
granulated coal injection at Port Talbot from the current level of about 180kgs/thm to
levels close to Ijmuiden (PCI of 220-240/thm) will be yet another determinant of
bridging the cost gap between Ijmuiden and UK operations. The increased thrust on
coal injection will help reduce the total energy costs and also aid the quest for lower
energy emissions. Incremental coal injection also results in higher gas generation,
which can be used as a fuel for captive power plants.
Increasing customization and reorienting product mix towards Original
Equipment manufacturers (OEMs): Tata Steel Europe will integrate its
technological improvements with the needs of its customers allowing it to offer
optimally customized products and solutions, deepening its association with its end
users and emerging as a “preferred” long term supplier. This strategy has been
deployed by Japanese steel producers successfully. This is aimed at increasing the
composition of high margin steel products and reducing dependence on low margin
commodity grades. The company plans to increase direct sales to the OEM
segment from 40% to 65-70% over the next 3 years.
Tata Steel’s regeneration strategy is also premised on the changing composition of
end use steel demand in Europe. European demand for construction is expected to
remain sedate while demand for automotive mechanical engineering products and
tubes is expected to accelerate. Consequently, the company is focused on
realigning its product portfolio towards the faster growing sectors.
The foundations of this pillar will rely on a combination of developing close relationships
with end users including the early vendor relationship with auto manufacturers. Tata
Steel Europe has developed its strongest relationship with Nissan and is now working
with most other European auto producers including Volkswagen and BMW. The
company has already realigned its product mix in strips from the construction sector to
the auto sector. In UK the company is now selling 0.4mn tonnes of strips to the auto
sector (up twice from two years ago) and plans to take this to 0.7mn tonnes. A
continued thrust on value addition will mean additional investments in new galvanizing
lines and balancing investments in downstream units including rolling and finishing mills.
Improvement in raw material integration: The company is also exploring the option the
supplying a part of its coking coal requirements from the Margan coal mine, which is
located in close proximity to Tata’s Port Talbot plant. The feasibility studies are currently
underway at this mine and the resources are estimated to be 37 mn tonnes. The coal
supplies from this mine can potentially provide a coal value in use benefit of GBP 5/thm.
Capex on a treadmill but Jamshedpur expansion to assuage
concerns on balance sheet
Following our visit to Tata Steel Europe’s plants and listening to the company’s articulation of
its regeneration strategy for Europe, we are revising up our annual capex assumptions for the
European operations by USD300mn tonnes to USD650mn per annum. We believe that the
increase in capex at the European operations is well justified as it is integral to company
raising its sustainable EBITDA by ~80% to USD100, over the next 3-4 years. Consequently,
our total annual capex for the consolidated entity for FY12 and FY13 stands revised to
USD2.5bn and USD2.4bn, respectively.
While we believe that the capex is heavy, we are encouraged by the strong cash flow
generation in FY13 from company’s 2.9mn tonnes expansion at Jamshedpur, expected to be
commissioned by 3Q’FY12. Despite the increased capex assumptions, we forecast a gradual
improvement in the net debt/equity ratio for the consolidated entity over FY11-13.
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.
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. 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 INR708/share.
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 CY11 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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