Tata Steel- Leverage cuts both ways ::Macquarie Research,

Tata Steel
Leverage cuts both ways
Event
 Lower sales volume hits earnings: As was well expected given the
slowdown in sales volume, Tata Steel Q1 earnings missed expectations. We
have cut our earnings estimates for FY13 and FY14 by 23% and 13%,
respectively, to build in lower sales volume for both Europe and India. We cut
our target price to Rs306 based on 7x PER (earlier Rs404) and downgrade
to Underperform from Neutral.

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Impact
 Weak results – hit by lower volume and price: Consolidated turnover at
US$6.2bn was down 20% YoY as volumes shrunk by 15% and realisation
dropped by 6%. EBITDA at US$644mn was down 39% as costs eased
marginally. Net Profit at US$111mn was down 58% adjusted for exceptional.
 Indian operations – slow start: This business reported annualised sales
volume of 6.36mnt and EBITDA/t of US$313. We are now building in the full
year volume of 7.8mnt and EBITDA/t of US$290. We expect some reduction
in steel prices in India, also we expect lower profitability of its new capacity
due to lower raw material integration and lower value addition.
 European operations – demand visibility low: As expected this division
reported EBITDA/t of US$35 and annualised volume of 12.8mnt. We are now
building in 13.7mnt and EBITDA/t of US$31. Here we expect lower steel
prices to be compensated by lower raw material costs. However, demand
visibility remains poor and one-off restructuring costs can’t be ruled out.
 Cutting estimates: We have reduced EPS estimates by 23% and 13%,
respectively, for FY13 and FY14. The main factor leading to our cuts is the
reduction in sales volume assumptions for both India and Corus. Also, we are
now building in higher depreciation and interest costs given the depreciation
of the rupee.
Earnings and target price revision
 We have cut our earnings estimates for FY13 and FY14 by 23% and 13%,
respectively, and cut our TP from Rs404 to Rs306. Downgrade to
Underperform.
Price catalyst
 12-month price target: Rs306.00 based on a PER methodology.
 Catalyst: Stability in European Union, visibility of production from its new
capacities.
Action and recommendation
 Downgrade to Underperform: Tata Steel on a P/B adjusted for goodwill is
trading at 1.4x which looks high with ROEs at14-15%. Secondly, the sharp
drop in raw material prices has posed significant risk for Tata Steel’s Indian
operations profits. On our target price, Tata Steel would be trading closer to
adjusted book value and at around 5x EV/EBITDA.