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Tata Steel (TATA IN; Last Price: INR447; DB Rec: Buy)
Stock down 16% since S&P downgrade, trading at 24% discount to past eighteen year
average valuations. Following fears of a sharp slowdown in Europe, Tata Steel has come
off sharply. Stock is currently trading at FY12 P/BV of 1.5x, - 24% discount to its last 18
year average and close to levels seen in the aftermath of the Lehman event in FY09.
With a recession in Europe not our central assumption, we reiterate that these fears are
exaggerated and consequent stock weakness is overdone.
European operations trading at 90% discount to European peers: At the current stock
price, the residual valuation of company’s European operations implies a discount of
90% to corresponding valuations of its peers in Europe – Arcelor Mittal and Thyssen
Krupp.
Concerns over pension fund deficit – though legitimate - seem exaggerated: With a total
pension fund corpus of GBP12bn, investor fears of volatile markets creating pension
shortfalls are legitimate. in a highly adverse scenario where we assume a 15% decline
(400bps underperformance versus FTSE) in the value of equity assets (29% of total
pension fund assets) and no gains in the debt and government securities portfolio (61%
of pension assets), we estimate a deficit of GBP400mn in the pension fund (which would
impact stock by only Rs28/share).
Triggers for near term outperformance: Stabilization/rebound of European steel prices.
Also, timely commissioning of the 3mt brown-field expansion at its highly profitable
Indian operations (normalized EBITDA/t is ~2.5x of global peers) which will further de-risk
Tata Steel's earnings from the vagaries of volatile raw material prices (with Indian
operations contributing 76-77% of the consolidated EBITDA.) and any statement from
company assuaging investors that its pension fund concerns are overdone.
Strong operating cash flows from India to provide support: With the commissioning of
Jamshedpur brownfield expansion by FY12 end,, we expect the Indian operations to
constitute 76-77% of consolidated EBITDA over FY12-13, thus, reducing the company's
earnings dependence on its low margin international operations.
Stock trading at modest premium to our mild stress case scenario In our base case, we
estimate the fair value of the stock to be ~INR620/share implying 45% upside from
present stock price levels. In a mild stress scenario (India GDP grows by 7.5%;
Developed Market just skirts recession), we estimate the fair value to be ~INR402/share
and in the extreme stress scenario (India GDP grows by 6.5%; Developed Market move
into recession, which is not our central assumption), the fair value comes to
INR260/share, as per our calculations.
Key Risks: 1) Higher than anticipated increase in steel making raw material prices, (2)
Delay in capacity expansions in India,(3) Steel demand environment remaining
challenging in Europe especially in the long product segment into CY11 and delay in steel
demand recovery,(4) The overhang of an inflation wary government of India. In case, an
inflation wary government of India begins frowning on the price hikes, sentiment for all
steel stocks, including Tata Steel may be impacted negatively.
India Equity Research Reports, IPO and Stock News
Visit http://indiaer.blogspot.com/ for complete details �� ��
Tata Steel (TATA IN; Last Price: INR447; DB Rec: Buy)
Stock down 16% since S&P downgrade, trading at 24% discount to past eighteen year
average valuations. Following fears of a sharp slowdown in Europe, Tata Steel has come
off sharply. Stock is currently trading at FY12 P/BV of 1.5x, - 24% discount to its last 18
year average and close to levels seen in the aftermath of the Lehman event in FY09.
With a recession in Europe not our central assumption, we reiterate that these fears are
exaggerated and consequent stock weakness is overdone.
European operations trading at 90% discount to European peers: At the current stock
price, the residual valuation of company’s European operations implies a discount of
90% to corresponding valuations of its peers in Europe – Arcelor Mittal and Thyssen
Krupp.
Concerns over pension fund deficit – though legitimate - seem exaggerated: With a total
pension fund corpus of GBP12bn, investor fears of volatile markets creating pension
shortfalls are legitimate. in a highly adverse scenario where we assume a 15% decline
(400bps underperformance versus FTSE) in the value of equity assets (29% of total
pension fund assets) and no gains in the debt and government securities portfolio (61%
of pension assets), we estimate a deficit of GBP400mn in the pension fund (which would
impact stock by only Rs28/share).
Triggers for near term outperformance: Stabilization/rebound of European steel prices.
Also, timely commissioning of the 3mt brown-field expansion at its highly profitable
Indian operations (normalized EBITDA/t is ~2.5x of global peers) which will further de-risk
Tata Steel's earnings from the vagaries of volatile raw material prices (with Indian
operations contributing 76-77% of the consolidated EBITDA.) and any statement from
company assuaging investors that its pension fund concerns are overdone.
Strong operating cash flows from India to provide support: With the commissioning of
Jamshedpur brownfield expansion by FY12 end,, we expect the Indian operations to
constitute 76-77% of consolidated EBITDA over FY12-13, thus, reducing the company's
earnings dependence on its low margin international operations.
Stock trading at modest premium to our mild stress case scenario In our base case, we
estimate the fair value of the stock to be ~INR620/share implying 45% upside from
present stock price levels. In a mild stress scenario (India GDP grows by 7.5%;
Developed Market just skirts recession), we estimate the fair value to be ~INR402/share
and in the extreme stress scenario (India GDP grows by 6.5%; Developed Market move
into recession, which is not our central assumption), the fair value comes to
INR260/share, as per our calculations.
Key Risks: 1) Higher than anticipated increase in steel making raw material prices, (2)
Delay in capacity expansions in India,(3) Steel demand environment remaining
challenging in Europe especially in the long product segment into CY11 and delay in steel
demand recovery,(4) The overhang of an inflation wary government of India. In case, an
inflation wary government of India begins frowning on the price hikes, sentiment for all
steel stocks, including Tata Steel may be impacted negatively.
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