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Growth in high margin business to drive RoCE
D/E lowest since TSE acquisition and to fall further
Outperforms other steel stocks after four years of weak stock performance.
RoCE to improve by FY13 as most capital is employed in its core business and
CWIP/CE will decline.
TATA will reduce debt by USD2b, despite using ~USD4b on capex, over two years. It
will generate cash flow of USD8b.
Pension fund deficit concerns unfounded.
Despite an uncertain European outlook, Tata Steel Europe is better equipped to
cope with a downturn.
The stock trades at attractive valuations and at a 58% discount to NAV.
Reiterate Buy.
RoCE to improve as CWIP/CE will decline in FY13
Tata Steel (TATA) has been one of worst performing stocks over FY07-11, delivering
just 4% annualized total stock returns (ASR). This trend has changed over past 12
months as the stock outperformed its peers in the sector as it reversed a declining
trend in RoIC.
Volume growth in the high margin Indian business will boost RoIC hereon as TATA
expands its capacity by 3mtpa to 10mtpa in Jamshedpur by the end of FY12. Since
TATA is among the few metals companies with most of its capital employed in its core
business, RoCE will improve in FY13. The CWIP/CE will be the smallest for TATA in
FY13. We expect TATA to outperform other metals stocks because sector RoCE will
keep declining.
Net debt reduction of USD2b despite huge capex
TATA will reduce debt by USD2b to USD8.6b, despite using ~USD4b on capex, over two
years. USD6.2b of operating cash flow and USD1.7b from liquidation of investment,
interest and dividend will generate USD8b in cash flow. After incurring capex of USD4b
and USD2b as payment of interest and dividend, net debt will fall by USD2b. This will
strengthen the balance sheet significantly as net worth will rise to USD11.3b and debt-toequity
will fall to 0.8x. After adjusting for goodwill of INR153b from net worth, net debtto-
equity ratio will be 1.1x.
Pension fund deficit concerns unfounded
Pension fund surpluses were USD556m and USD401m at the end of March 2011 and
June 2011 respectively. TATA invested 29% of its total BPSP assets of GBP11.3b in
equities and 63% in bonds and the rest of the funds were invested in cash and properties.
Since the end of March 2011 the FTSE fell 10% and bond yields fell 30-70bp.
Although it is difficult to accurately gauge the movement of surpluses, it is possible to get
a sense of the possible direction of the movement. We have assumed average duration of
the bond portfolio and pension liabilities to be 10 years each. According to our calculations,
the mark to mark valuation of equities will be down by 10%, or about GBP317m, assuming
similar returns as the FTSE. On the other hand, the valuation of the bond portfolio may
have risen by GBP856m assuming 70bp decline in yield. Pension liabilities would have
risen by GBP329m assuming AA bond yield decline by 30bp. So, on a net basis, the surplus
would have increased by GBP209m. We would also like to highlight that pension funds
have passed the litmus test of the 2008 financial crisis without requiring additional
contribution from TSE.
European outlook uncertain but TSE now better equipped
The earnings outlook for TSE (Tata Steel Europe) is uncertain due to economic problems
in Europe and other western countries. Weaker demand may force some production cuts
and margins will come under pressure for a couple of quarters. It is worth noting here that
TSE operates as a converter though margins are thin. The structure of finished products
and raw material contracts has undergone major change to better withstand volatility in
commodity prices since the financial crisis of 2008. Finished steel contracts have now
moved closer to spot prices and quarterly pricing. Similarly, iron ore and coking coal contracts
moved from annual pricing to quarterly and monthly pricing.
Operation restructuring at several units reduced fixed costs significantly. On our recent
visit to TSE, we learned the company is now moving towards value-added products to
move up the value chain and reduce earnings volatility. The Ijmuiden plant has the best
operating efficiencies and product mix in the world. TCP (Teesside Cast Products) has
been sold. Therefore, we understand TSE is now better equipped to withstand a financial
crisis. After achieving significant fixed-cost reduction, TSE aims to improve margins and
has stepped up investment. Recently, TSE announced USD1.1b capex for the Imjuiden
unit to expand saleable steel capacity and further improve operating efficiencies. We
believe TSE will be able to improve productivity and capital efficiencies year after year as
it replicates its best practices across the group.
Valuations attractive
TATA's earnings will grow 29% in FY13 driven by 33% volume growth in the high margin
Indian business as capacity expansion at Jamshedpur is completed by the end of March
2012. RoIC and RoCE will improve. The balance sheet is stronger now due to generation
of USD2.65b over nine months by way of sale of TCP (USD470m), settlement (USD130m)
of arbitration for breach of off-take agreement, stake sale in the Riversdale parent company
(USD1.1b) and TRF (USD150m) and rights issue (USD800m). Despite USD4b of capex
over 2 years, net debt will come down by USD2b by the end of FY13. Net debt-to-equity
(less goodwill) ratio will fall from 2.4x at the end of FY11 to 1.1x by the end of FY13.
TATA has investments in Tata Motors (TTMT) worth USD526m, coking assets in
Mozambique worth USD1b and iron ore assets in Canada worth USD367m, totaling nearly
USD2b. These assets will start generating cash flow over 6-12 months, yielding RoIC of
20-25% (ex-TTMT).
TATA traded at premium to NAV (taking into account replacement cost for fixed assets)
until FY07. After the acquisition of Corus, the stock traded at a discount to NAV because
of low margins in the international business. At CMP of INR433, the stock trades at a
deep discount of 57% to NAV. Such discounts to NAV were only seen in 2009 (~51%).
sector report and other companies
India Equity Research Reports, IPO and Stock News
Visit http://indiaer.blogspot.com/ for complete details �� ��
Growth in high margin business to drive RoCE
D/E lowest since TSE acquisition and to fall further
Outperforms other steel stocks after four years of weak stock performance.
RoCE to improve by FY13 as most capital is employed in its core business and
CWIP/CE will decline.
TATA will reduce debt by USD2b, despite using ~USD4b on capex, over two years. It
will generate cash flow of USD8b.
Pension fund deficit concerns unfounded.
Despite an uncertain European outlook, Tata Steel Europe is better equipped to
cope with a downturn.
The stock trades at attractive valuations and at a 58% discount to NAV.
Reiterate Buy.
RoCE to improve as CWIP/CE will decline in FY13
Tata Steel (TATA) has been one of worst performing stocks over FY07-11, delivering
just 4% annualized total stock returns (ASR). This trend has changed over past 12
months as the stock outperformed its peers in the sector as it reversed a declining
trend in RoIC.
Volume growth in the high margin Indian business will boost RoIC hereon as TATA
expands its capacity by 3mtpa to 10mtpa in Jamshedpur by the end of FY12. Since
TATA is among the few metals companies with most of its capital employed in its core
business, RoCE will improve in FY13. The CWIP/CE will be the smallest for TATA in
FY13. We expect TATA to outperform other metals stocks because sector RoCE will
keep declining.
Net debt reduction of USD2b despite huge capex
TATA will reduce debt by USD2b to USD8.6b, despite using ~USD4b on capex, over two
years. USD6.2b of operating cash flow and USD1.7b from liquidation of investment,
interest and dividend will generate USD8b in cash flow. After incurring capex of USD4b
and USD2b as payment of interest and dividend, net debt will fall by USD2b. This will
strengthen the balance sheet significantly as net worth will rise to USD11.3b and debt-toequity
will fall to 0.8x. After adjusting for goodwill of INR153b from net worth, net debtto-
equity ratio will be 1.1x.
Pension fund deficit concerns unfounded
Pension fund surpluses were USD556m and USD401m at the end of March 2011 and
June 2011 respectively. TATA invested 29% of its total BPSP assets of GBP11.3b in
equities and 63% in bonds and the rest of the funds were invested in cash and properties.
Since the end of March 2011 the FTSE fell 10% and bond yields fell 30-70bp.
Although it is difficult to accurately gauge the movement of surpluses, it is possible to get
a sense of the possible direction of the movement. We have assumed average duration of
the bond portfolio and pension liabilities to be 10 years each. According to our calculations,
the mark to mark valuation of equities will be down by 10%, or about GBP317m, assuming
similar returns as the FTSE. On the other hand, the valuation of the bond portfolio may
have risen by GBP856m assuming 70bp decline in yield. Pension liabilities would have
risen by GBP329m assuming AA bond yield decline by 30bp. So, on a net basis, the surplus
would have increased by GBP209m. We would also like to highlight that pension funds
have passed the litmus test of the 2008 financial crisis without requiring additional
contribution from TSE.
European outlook uncertain but TSE now better equipped
The earnings outlook for TSE (Tata Steel Europe) is uncertain due to economic problems
in Europe and other western countries. Weaker demand may force some production cuts
and margins will come under pressure for a couple of quarters. It is worth noting here that
TSE operates as a converter though margins are thin. The structure of finished products
and raw material contracts has undergone major change to better withstand volatility in
commodity prices since the financial crisis of 2008. Finished steel contracts have now
moved closer to spot prices and quarterly pricing. Similarly, iron ore and coking coal contracts
moved from annual pricing to quarterly and monthly pricing.
Operation restructuring at several units reduced fixed costs significantly. On our recent
visit to TSE, we learned the company is now moving towards value-added products to
move up the value chain and reduce earnings volatility. The Ijmuiden plant has the best
operating efficiencies and product mix in the world. TCP (Teesside Cast Products) has
been sold. Therefore, we understand TSE is now better equipped to withstand a financial
crisis. After achieving significant fixed-cost reduction, TSE aims to improve margins and
has stepped up investment. Recently, TSE announced USD1.1b capex for the Imjuiden
unit to expand saleable steel capacity and further improve operating efficiencies. We
believe TSE will be able to improve productivity and capital efficiencies year after year as
it replicates its best practices across the group.
Valuations attractive
TATA's earnings will grow 29% in FY13 driven by 33% volume growth in the high margin
Indian business as capacity expansion at Jamshedpur is completed by the end of March
2012. RoIC and RoCE will improve. The balance sheet is stronger now due to generation
of USD2.65b over nine months by way of sale of TCP (USD470m), settlement (USD130m)
of arbitration for breach of off-take agreement, stake sale in the Riversdale parent company
(USD1.1b) and TRF (USD150m) and rights issue (USD800m). Despite USD4b of capex
over 2 years, net debt will come down by USD2b by the end of FY13. Net debt-to-equity
(less goodwill) ratio will fall from 2.4x at the end of FY11 to 1.1x by the end of FY13.
TATA has investments in Tata Motors (TTMT) worth USD526m, coking assets in
Mozambique worth USD1b and iron ore assets in Canada worth USD367m, totaling nearly
USD2b. These assets will start generating cash flow over 6-12 months, yielding RoIC of
20-25% (ex-TTMT).
TATA traded at premium to NAV (taking into account replacement cost for fixed assets)
until FY07. After the acquisition of Corus, the stock traded at a discount to NAV because
of low margins in the international business. At CMP of INR433, the stock trades at a
deep discount of 57% to NAV. Such discounts to NAV were only seen in 2009 (~51%).
sector report and other companies
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