Tata Steel- Multiple Positive Drivers falling in place for H2FY12E; JPMorgan

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Tata Steel Ltd Overweight
TISC.BO, TATA IN
Multiple Positive Drivers falling in place for H2FY12E;
Re-iterate OW


High-margin India expansion by Dec-11, continued high elevated iron ore
prices (which aid India profitability), long product exposure in India, and
reduction in net debt post the recent asset sales (c.$1.7bn) positions TATA
attractively for a meaningful re-rating in H2FY12E, in our view. We view
current levels as a good entry point for an H2FY12E rebound as catalysts play
out.
 Global Steel- Stronger scrap and long product prices driven by China and
Japan: JPM European steel analyst Alessandro Abate (click here for report)
highlights that reconstruction demand in Japan and social housing in China are
likely to lead to lower exports out of China and Japan in long steel, while scrap
imports by China would increase while scrap exports from Japan are likely to
decline. A pick up in RM costs, low inventory and IP rebound should drive a
steel price recovery by Q4 CY11. While Q2-Q3FY12E are likely to be weak
quarters as the ASP-RM mis-match is against Tata Steel Europe, given a) restructuring
in Europe and b) price recovery in Q4CY11E, we expect
$0.8/$1.05bn European EBITDA for FY12/13E.
 Stronger iron ore prices positive for TATA India: Domestic steel demand is
likely to remain depressed in the near term. However, continued high spot iron
ore prices (click here for report) is positive for TATA India’s profitability (we
increase India Steel EBITDA/MT to $376$/314/MT for FY12/13E). High spot
thermal coal, scrap and iron ore prices are likely to lead to continued elevated
DRI prices, which should in turn lead to continued higher long product prices
(~3MT TATA India sales).
 Leverage- Expect headline net debt to come off from $10.4bn of March-11.
The recent asset sales (Riversdale, Teeside), combined with working capital
pressures easing off, should result in net debt declining from March-11 levels
(we expect $9.7bn, March-12E). Orissa project capex is likely to pick up pace
once the Jamshedpur expansion spending declines, and thus a material pick up
in leverage would only be driven by any ‘corporate activity' .
 India expansion by Dec-11, another positive: The high-margin India capacity
commissioning by Dec-11E in our view would allow investors to start
discounting FY13E earnings (trades at 6.2x FY13E P/E). Key risks remain a
sharp decline in spot iron ore prices. We adjust our India multiple down by 4%
to adjust for the Mining bill overhang (worst case EPS impact 7%).


Price target and valuation analysis
Our Jun-12 PT of Rs785 is based on sum of the parts based on FY13E
estimates. We lower our valuation multiple for the India operations to
6.3x, but maintain Asia at 5x and European operations at 5x FY13E
EBITDA.
Aside from generic risks of steel prices, steel demand and the proposed
Indian mining bill, the company specific risks for TATA are as follows:
a) Large deficit in pensions in Europe
b) Sharp decline in spot iron ore prices as it could erode India
profitability
c) Delay in India capacity commissioning