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Tata Steel
Enhanced Macro Risks but
Company Transformation
Accelerating: Stay OW
What's Changed
Price Target Rs733.00 to Rs603.00
EPS for F2012-14E Down 18-31%
Tata is a good way to gain from transformation and
growth. We see the stock meaningfully higher in
one year notwithstanding near-term volatility.
Macro risks have risen, but Tata’s moves the over
last two years to transform itself should be
rewarded in the medium term as fears of extreme
earnings volatility fade with structural gains. Likely
catalysts: commissioning of steel project and coal
mine, validation of gains from cost cutting at TSE.
What is in the price…: 1) A significant slowdown in DM,
even if not a prolonged recession, which suggests steel
prices falling 10-15% in the next three quarters. 2) Fixed
costs decline about US$20/t vs. our assessment of
US$44/t at Tata Steel Europe (TSE) in the last three
years. ….and what is not: 1) New 3mnt steel capacity
likely to be commissioned in two to three quarters. 2)
Growing raw materials self-sufficiency at TSE. The
market is overlooking these because of near-term fears
regarding TSE, which in our view will abate as new
projects come closer to completion. Accordingly, Tata
Steel is our top pick in the Indian metals space.
Our earnings projections have fallen by 18-31% for
F2012-14: We have trimmed our TSE steel price
forecasts by 4-7% due to muted demand in Europe
owing to the economic weakness in developed markets.
3mnt commissioning in C1H12 – A watershed event
for Tata: 1) Largest-ever capacity addition in Tata’s
history; 2) one of the few large projects in Indian steel
sector coming up without issues (e.g., delays, materials
sourcing, etc.); 3) focus to shift from TSE to India with
latter’s proportion crossing 75% of total EBITDA.
We Retain Our Overweight Rating
Summary & Conclusions
Tata stock seems to be reflecting a significant slowdown in the
developed markets (DM), even if not a prolonged recession–
which does not seem unfair to us. However, we think the
market is exaggerating the potential impact of a recession on
Tata’s earnings. The company’s initiatives to enhance its
competitive advantages and to scale up its high profit divisions
at low costs are also being overlooked.
Taking into account a slackened macroeconomic situation, we
have curtailed our earnings forecasts by 18-31% for F2012-14
and our price target by 18%. Our new price target of Rs603
suggests 21% upside from current levels.
We have incorporated the risks of a developed market
recession in our PT by assigning a 20% weighting to our bear
case. Our bear case takes into account a scenario of
double-dip recession in the developed markets.
As we detail on the next page, while we acknowledge that risks
of the developed markets falling into recession have grown, in
our view Tata Steel offers a good entry opportunity here.
1) It is close to its most exciting growth phase ever.
2) TSE’s RM self sufficiency is improving.
3) Valuations are pricing in some part of the macro risks, but
only a small portion of the company-specific
improvements.
What’s Changed
1) Revenues, EBITDA, adjusted PAT. (Exhibits 1-2)
2) Steel prices – Indian average, European average. (Exhibits
3-4)
3) Sales volumes
Why aren’t we worried about Tata’s ability to sell its
incremental production?
• We expect steel demand growth in India, where Tata
is adding capacity, to be much better than in the rest
of the world and upward of 5.5-6% in the next two
years. MS economists’ bear-case growth forecasts for
C2011 and C2012 are 6.5% and 6.2%, respectively,
for India and 3.4% and 2.2%, respectively, for the
world.
• Tata’s 3mnt capacity will not start producing at a
utilization rate of 100% overnight. Full benefits will be
spread over F2013-14.
• Contrary to the general notion that massive new steel
supply is being added in India near term, we reckon
that Indian steel sector will continue to be underfed in
the next two years. Medium-term steel capacities are
either being overstated (JSPL, Jai Balaji, Adhunik,
etc.) or delayed (SAIL, Tata Steel Orissa, JSW
Bengal), or are suffering problems in ramp up due to
regulatory confusion ( JSW Karnataka) or are being
assigned an overly optimistic ramp up schedule
(Essar, JSW Karnataka).
• Being a cost leader not just in Asia but globally, Tata
may not find it difficult to sell its incremental output
even in an extremely poor steel market.
Improving Raw Material Self-sufficiency at TSE
We expect the market to award the Mozambique coking
coalmine better valuations as we come closer to
commissioning by early C2012. This is not a big earnings driver.
Assuming Tata’s share of 0.5mnt output in F2013 and a profit
of US$125/t, the mine will represent about 11% of TSE’s
EBITDA in F2013E. Even so, we think it may boost sentiment
toward TSE. Output from the mine will allow for 6%
self-sufficiency in F2013E and 12% in F2014E for TSE’s coking
coal requirement from current levels of nil.
Similarly, by F2014, TSE will likely become about 10-12% self
sufficient in iron ore as the Canadian iron ore project starts
production vs. nil currently. TSE’s lack of raw materials (RM)
integration has been a consistent cause of concern for
investors, and as it gets closer to mitigating this fear, sentiment
should improve.
We View the Risk-Reward Situation Favorably
The stock is pricing in an economic slowdown but only a
small portion of the company-specific improvements: The
stock is trading at P/BV of 1.1x and 0.9x based on our F2012
and F2013 forecasts, respectively, versus comparable global
averages of 1.5x and 1.2x and Tata’s eight-year historical
average one-year forward multiple of 2.6x. In the trough
(achieved in C2008), the P/BV hit 0.50x, and some investors
are fearful of a repeat of that situation. However, we highlight
the substantially improved balance sheet and much better
positioning on earnings.
On EV/EBITDA, the stock is trading at 5.3x and 4.4x based on
F2012E and F2013E, respectively, versus comparable global
peer group averages of 5.7x and 4.5x. We also note that versus
many of its peers, Tata’s earnings growth is driven more by its
volume growth, growing raw materials self-sufficiency, and
improving operational parameters.
Because of TSE’s inferior cost structure and because about
25% of Tata’s EBITDA comes from Europe, there is a lot of
skepticism around the stock .We acknowledge that risks of a
full-blown recession in the developed world have grown and
hence we assign a 20% weighting to our bear-case scenario
value in deriving our price target.
However, we disagree with the widespread view that in the
event of further macro deterioration, the stock could sink to the
levels it reached during the global financial crisis (GFC).
Our bear case, which factors in a full-blown recession in
the developed world, implies 25% downside from current
levels: At our bear case value of Rs375 per share, the stock
would imply P/BV of 0.8x on our bear case F2012 book value
forecast. Also, at our bear case, the EV would be just 13%
higher than the trough EV of US$14.9b achieved in C2008.
The proportion of Indian operations (whose EBITDA in
F2013 will likely be >9.9x TSE’s) will likely see a step up by
C1H12. This is one of the most important change factors
for the company, in our view.
Valuation and Price Target
We value Tata Steel by assigning weightings of 80% and 20%
to our base case and bear case scenario values, respectively.
Earlier we used our base case alone as our price target. The
change is to reflect our economists’ view that developed
markets may be close to falling into recession, superimposed
on our assessment of the probabilities of recession taking
place in the steel markets of India and Europe.
Our base and bear case scenario values are derived by the
SOTP method from our DCF model, where we take separately
the following three businesses:
i) Jamshedpur plant;
ii) Orissa project
iii) Tata Europe (Corus) and other operations, separately.
Exhibit 14
Tata Steel PT of Rs603
New
Old Base case Bear case
Jamshedpur 597 593 415
Orissa 65 68 45
Corus 71 0 (85)
Total 733 660 375
Weighting for PT (%) 100 80 20
PT 733 603
Source: Company data, Morgan Stanley Research
Note that our new base case scenario value of Rs375 per
share is down just 2.6% from our previous value of Rs385 per
share. Our old bear case scenario also built in a scenario of
recession in the developed markets.
Our other key assumptions of a WACC of 12.8% and terminal
growth rate of 2% are unchanged.
Exhibit 15
Base case scenario Value of Rs660
(A) Present value of the explicit phase (F2010-16) 264,012
Terminal value 588,079
Terminal growth rate (%) 2
(B) Present value of the terminal value 374,008
(A+B) Total present value 638,020
Net present value 665,598
Net debt without Corus 90,000
Equity Value Rs mn 575,598
Shares (mn) 971
Implied DCF value per share (Rs) Jamshedpur 593
Orissa Plant's value per share (Rs) 68
Corus value per share (Rs) 0
Total (Rs/Share) 660
Source: Company data, Morgan Stanley Research
Exhibit 16
WACC of 12.8%
WACC Calculation: Percent
Risk Free Return (Rf) (%) 7.9
Market Premium (Rm-Rf) (%) 6.5
Assumed Beta 1.21
Cost of Equity (Re) (%) 15.7
Equity (%) 70
Cost of Debt (Rd) (%) 9.0
Tax rate (%) 33.1
After-tax cost of debt (Rd [1-t]) (%) 6.0
Debt (%) 30
WACC (%) 12.8
Source: Company data, Morgan Stanley Research
India Equity Research Reports, IPO and Stock News
Visit http://indiaer.blogspot.com/ for complete details �� ��
Tata Steel
Enhanced Macro Risks but
Company Transformation
Accelerating: Stay OW
What's Changed
Price Target Rs733.00 to Rs603.00
EPS for F2012-14E Down 18-31%
Tata is a good way to gain from transformation and
growth. We see the stock meaningfully higher in
one year notwithstanding near-term volatility.
Macro risks have risen, but Tata’s moves the over
last two years to transform itself should be
rewarded in the medium term as fears of extreme
earnings volatility fade with structural gains. Likely
catalysts: commissioning of steel project and coal
mine, validation of gains from cost cutting at TSE.
What is in the price…: 1) A significant slowdown in DM,
even if not a prolonged recession, which suggests steel
prices falling 10-15% in the next three quarters. 2) Fixed
costs decline about US$20/t vs. our assessment of
US$44/t at Tata Steel Europe (TSE) in the last three
years. ….and what is not: 1) New 3mnt steel capacity
likely to be commissioned in two to three quarters. 2)
Growing raw materials self-sufficiency at TSE. The
market is overlooking these because of near-term fears
regarding TSE, which in our view will abate as new
projects come closer to completion. Accordingly, Tata
Steel is our top pick in the Indian metals space.
Our earnings projections have fallen by 18-31% for
F2012-14: We have trimmed our TSE steel price
forecasts by 4-7% due to muted demand in Europe
owing to the economic weakness in developed markets.
3mnt commissioning in C1H12 – A watershed event
for Tata: 1) Largest-ever capacity addition in Tata’s
history; 2) one of the few large projects in Indian steel
sector coming up without issues (e.g., delays, materials
sourcing, etc.); 3) focus to shift from TSE to India with
latter’s proportion crossing 75% of total EBITDA.
We Retain Our Overweight Rating
Summary & Conclusions
Tata stock seems to be reflecting a significant slowdown in the
developed markets (DM), even if not a prolonged recession–
which does not seem unfair to us. However, we think the
market is exaggerating the potential impact of a recession on
Tata’s earnings. The company’s initiatives to enhance its
competitive advantages and to scale up its high profit divisions
at low costs are also being overlooked.
Taking into account a slackened macroeconomic situation, we
have curtailed our earnings forecasts by 18-31% for F2012-14
and our price target by 18%. Our new price target of Rs603
suggests 21% upside from current levels.
We have incorporated the risks of a developed market
recession in our PT by assigning a 20% weighting to our bear
case. Our bear case takes into account a scenario of
double-dip recession in the developed markets.
As we detail on the next page, while we acknowledge that risks
of the developed markets falling into recession have grown, in
our view Tata Steel offers a good entry opportunity here.
1) It is close to its most exciting growth phase ever.
2) TSE’s RM self sufficiency is improving.
3) Valuations are pricing in some part of the macro risks, but
only a small portion of the company-specific
improvements.
What’s Changed
1) Revenues, EBITDA, adjusted PAT. (Exhibits 1-2)
2) Steel prices – Indian average, European average. (Exhibits
3-4)
3) Sales volumes
Why aren’t we worried about Tata’s ability to sell its
incremental production?
• We expect steel demand growth in India, where Tata
is adding capacity, to be much better than in the rest
of the world and upward of 5.5-6% in the next two
years. MS economists’ bear-case growth forecasts for
C2011 and C2012 are 6.5% and 6.2%, respectively,
for India and 3.4% and 2.2%, respectively, for the
world.
• Tata’s 3mnt capacity will not start producing at a
utilization rate of 100% overnight. Full benefits will be
spread over F2013-14.
• Contrary to the general notion that massive new steel
supply is being added in India near term, we reckon
that Indian steel sector will continue to be underfed in
the next two years. Medium-term steel capacities are
either being overstated (JSPL, Jai Balaji, Adhunik,
etc.) or delayed (SAIL, Tata Steel Orissa, JSW
Bengal), or are suffering problems in ramp up due to
regulatory confusion ( JSW Karnataka) or are being
assigned an overly optimistic ramp up schedule
(Essar, JSW Karnataka).
• Being a cost leader not just in Asia but globally, Tata
may not find it difficult to sell its incremental output
even in an extremely poor steel market.
Improving Raw Material Self-sufficiency at TSE
We expect the market to award the Mozambique coking
coalmine better valuations as we come closer to
commissioning by early C2012. This is not a big earnings driver.
Assuming Tata’s share of 0.5mnt output in F2013 and a profit
of US$125/t, the mine will represent about 11% of TSE’s
EBITDA in F2013E. Even so, we think it may boost sentiment
toward TSE. Output from the mine will allow for 6%
self-sufficiency in F2013E and 12% in F2014E for TSE’s coking
coal requirement from current levels of nil.
Similarly, by F2014, TSE will likely become about 10-12% self
sufficient in iron ore as the Canadian iron ore project starts
production vs. nil currently. TSE’s lack of raw materials (RM)
integration has been a consistent cause of concern for
investors, and as it gets closer to mitigating this fear, sentiment
should improve.
We View the Risk-Reward Situation Favorably
The stock is pricing in an economic slowdown but only a
small portion of the company-specific improvements: The
stock is trading at P/BV of 1.1x and 0.9x based on our F2012
and F2013 forecasts, respectively, versus comparable global
averages of 1.5x and 1.2x and Tata’s eight-year historical
average one-year forward multiple of 2.6x. In the trough
(achieved in C2008), the P/BV hit 0.50x, and some investors
are fearful of a repeat of that situation. However, we highlight
the substantially improved balance sheet and much better
positioning on earnings.
On EV/EBITDA, the stock is trading at 5.3x and 4.4x based on
F2012E and F2013E, respectively, versus comparable global
peer group averages of 5.7x and 4.5x. We also note that versus
many of its peers, Tata’s earnings growth is driven more by its
volume growth, growing raw materials self-sufficiency, and
improving operational parameters.
Because of TSE’s inferior cost structure and because about
25% of Tata’s EBITDA comes from Europe, there is a lot of
skepticism around the stock .We acknowledge that risks of a
full-blown recession in the developed world have grown and
hence we assign a 20% weighting to our bear-case scenario
value in deriving our price target.
However, we disagree with the widespread view that in the
event of further macro deterioration, the stock could sink to the
levels it reached during the global financial crisis (GFC).
Our bear case, which factors in a full-blown recession in
the developed world, implies 25% downside from current
levels: At our bear case value of Rs375 per share, the stock
would imply P/BV of 0.8x on our bear case F2012 book value
forecast. Also, at our bear case, the EV would be just 13%
higher than the trough EV of US$14.9b achieved in C2008.
The proportion of Indian operations (whose EBITDA in
F2013 will likely be >9.9x TSE’s) will likely see a step up by
C1H12. This is one of the most important change factors
for the company, in our view.
Valuation and Price Target
We value Tata Steel by assigning weightings of 80% and 20%
to our base case and bear case scenario values, respectively.
Earlier we used our base case alone as our price target. The
change is to reflect our economists’ view that developed
markets may be close to falling into recession, superimposed
on our assessment of the probabilities of recession taking
place in the steel markets of India and Europe.
Our base and bear case scenario values are derived by the
SOTP method from our DCF model, where we take separately
the following three businesses:
i) Jamshedpur plant;
ii) Orissa project
iii) Tata Europe (Corus) and other operations, separately.
Exhibit 14
Tata Steel PT of Rs603
New
Old Base case Bear case
Jamshedpur 597 593 415
Orissa 65 68 45
Corus 71 0 (85)
Total 733 660 375
Weighting for PT (%) 100 80 20
PT 733 603
Source: Company data, Morgan Stanley Research
Note that our new base case scenario value of Rs375 per
share is down just 2.6% from our previous value of Rs385 per
share. Our old bear case scenario also built in a scenario of
recession in the developed markets.
Our other key assumptions of a WACC of 12.8% and terminal
growth rate of 2% are unchanged.
Exhibit 15
Base case scenario Value of Rs660
(A) Present value of the explicit phase (F2010-16) 264,012
Terminal value 588,079
Terminal growth rate (%) 2
(B) Present value of the terminal value 374,008
(A+B) Total present value 638,020
Net present value 665,598
Net debt without Corus 90,000
Equity Value Rs mn 575,598
Shares (mn) 971
Implied DCF value per share (Rs) Jamshedpur 593
Orissa Plant's value per share (Rs) 68
Corus value per share (Rs) 0
Total (Rs/Share) 660
Source: Company data, Morgan Stanley Research
Exhibit 16
WACC of 12.8%
WACC Calculation: Percent
Risk Free Return (Rf) (%) 7.9
Market Premium (Rm-Rf) (%) 6.5
Assumed Beta 1.21
Cost of Equity (Re) (%) 15.7
Equity (%) 70
Cost of Debt (Rd) (%) 9.0
Tax rate (%) 33.1
After-tax cost of debt (Rd [1-t]) (%) 6.0
Debt (%) 30
WACC (%) 12.8
Source: Company data, Morgan Stanley Research
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