Tata Steel -Good results but doubts linger on :: Macquarie Research,

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Tata Steel
Good results but doubts linger on
Event
 In line results on operating line: Tata Steel reported in line results for 1Q
FY12, though profit was distorted with one-offs. We are worried about the
European markets, and have cut volume and margins assumptions for its
European business, leading to reduced earnings by 15-19% over the next
three years. However, we had already introduced a 20% discount to our target
PE multiple and hence are maintaining our Rs688 target price and Outperform
recommendation.
Impact
 Strong results – Tata Steel reported Net Sales of Rs328bn up 22%YoY
driven by 25% increase in realisation. EBITDA at Rs43bn is flat as higher raw
material costs also increased. PAT at Rs52bn was helped by Rs38bn of sale
of assets.
 Indian operations – cyclical peak: Indian operation reported US$420/t of
EBITDA. We have increased our full-year estimate to US$409 from US$382
earlier. This has resulted in upgrade to Indian earnings by 7%. However, we
do note that any reduction in raw material prices due to slackness in global
demand can actually push steel prices down and thereby risk on margins.
 European operations – highly susceptible: We are now assuming flat
volume at 14.9mnt and reduced EBITDA per ton to US$56 against earlier
15.6mnt volume and US$65/t EBITDA estimate. Clearly, the demand situation
is very fluid at the moment and sensitivity to earnings is very high. Every $10/t
reduction in margins wipes out 10% of profits from Tata’s consolidated
earnings.
 Balance sheet – now less of concern: After a spate of asset sales, net debt
has reduced to just US$8.4bn and debt: equity to 1.06x. We will be more
comfortable if company reduces its gross debt.
Earnings and target price revision
 We have reduced earnings by 15-19% over FY12-14 largely driven by cut in
its European business margins and volume.
Price catalyst
 12-month price target: Rs688.00 based on a PER methodology.
 Catalyst: Reduction in economic uncertainty in Europe.
Action and recommendation
 Maintain Outperform: Tata Steel appears to be attractively valued, but high
leverage and a fragile recovery in Europe make it a bit risky, in our view. We
recommend that long-term investors wait for the seasonal dip in the steel
market to make an entry