Deep value play, reiterate Buy
We see deep value in Tata Sponge (TSL) with cash at ~90% of current mcap and
core sponge iron business generating positive free cash flow along with robust
return ratios on account of high utilization, superior quality product and captive
waste heat power. We see valuations at 0.8x FY14E EV/EBITDA as unduly
overstating concerns on core business profitability and usage of free cash on
books. Even our highly stressed bear case throws a fair value of Rs380 for the
stock, an upside of ~20%. We reiterate Buy on the stock with a TP of Rs490, an
upside of ~55% (based on 60:40 probabilities for our base and bear cases).
Higher sponge iron price drives strong earnings show in Q3 despite one-offs:
During Q3FY14, TSL’s sponge iron realizations went up by ~10% QoQ and coupled
with lower iron ore costs resulted in strong EBITDA of Rs403mn (up ~84% QoQ),
margin of 20.3%. TSL incurred one-off expense of ~Rs140mn (Rs80mn in interest
costs and Rs60mn in other expenses) related to inter-state tax demand from income
tax department during the quarter and posted PAT of Rs243mn (up 33% QoQ).
Coal block faces de-allocation threat; to remove market concern on cash use:
TSL’s coal block (Radhikapur East) is faced with a real threat of de-allocation post
recent developments which indicate that blocks without any major clearances
could be de-allocated by the Supreme Court. TSL has spent ~Rs1.9bn for coal block
development (Rs1.7bn paid as advance to state government for land acquisition)
but does not have any major clearance yet. We believe that possible de-allocation
of coal block will help in removing investor concerns on usage of high cash on
books (~Rs4.3bn) to a large extent. Management expects return of advance paid in
some form in the event of de-allocation which will increase its cash pile further.
Return ratios adjusted for coal block investment robust: Return ratios for the
company (refer exhibit 2) remain strong (after adjusting for ~Rs1.7bn of advances
paid for the coal block) despite the very large cash pile (~Rs290/share as on Dec’13).
TSL’s core business of sponge iron manufacture is very robust in our view (no
PAT/EBITDA loss in the past 15 years across steel down cycles). Strength in import
landed scrap prices augurs well for sponge iron business of TSL which is expected
to continue generating positive free cash flows and earnings.
Valuations and risks: The stock trades at extremely low valuation of 0.8x FY14E
EV/EBITDA and 5.9x FY14E P/E. The core business has sound fundamentals and
generates positive free cash flows. Current cash at ~90% of mcap along with
dividend yield of ~3% are added positives. We reiterate Buy with a target price of
Rs490 and view Tata Sponge as an ideal investment for long term value investors.
Key risks include higher iron ore costs and drop in sponge iron prices.
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We see deep value in Tata Sponge (TSL) with cash at ~90% of current mcap and
core sponge iron business generating positive free cash flow along with robust
return ratios on account of high utilization, superior quality product and captive
waste heat power. We see valuations at 0.8x FY14E EV/EBITDA as unduly
overstating concerns on core business profitability and usage of free cash on
books. Even our highly stressed bear case throws a fair value of Rs380 for the
stock, an upside of ~20%. We reiterate Buy on the stock with a TP of Rs490, an
upside of ~55% (based on 60:40 probabilities for our base and bear cases).
Higher sponge iron price drives strong earnings show in Q3 despite one-offs:
During Q3FY14, TSL’s sponge iron realizations went up by ~10% QoQ and coupled
with lower iron ore costs resulted in strong EBITDA of Rs403mn (up ~84% QoQ),
margin of 20.3%. TSL incurred one-off expense of ~Rs140mn (Rs80mn in interest
costs and Rs60mn in other expenses) related to inter-state tax demand from income
tax department during the quarter and posted PAT of Rs243mn (up 33% QoQ).
Coal block faces de-allocation threat; to remove market concern on cash use:
TSL’s coal block (Radhikapur East) is faced with a real threat of de-allocation post
recent developments which indicate that blocks without any major clearances
could be de-allocated by the Supreme Court. TSL has spent ~Rs1.9bn for coal block
development (Rs1.7bn paid as advance to state government for land acquisition)
but does not have any major clearance yet. We believe that possible de-allocation
of coal block will help in removing investor concerns on usage of high cash on
books (~Rs4.3bn) to a large extent. Management expects return of advance paid in
some form in the event of de-allocation which will increase its cash pile further.
Return ratios adjusted for coal block investment robust: Return ratios for the
company (refer exhibit 2) remain strong (after adjusting for ~Rs1.7bn of advances
paid for the coal block) despite the very large cash pile (~Rs290/share as on Dec’13).
TSL’s core business of sponge iron manufacture is very robust in our view (no
PAT/EBITDA loss in the past 15 years across steel down cycles). Strength in import
landed scrap prices augurs well for sponge iron business of TSL which is expected
to continue generating positive free cash flows and earnings.
Valuations and risks: The stock trades at extremely low valuation of 0.8x FY14E
EV/EBITDA and 5.9x FY14E P/E. The core business has sound fundamentals and
generates positive free cash flows. Current cash at ~90% of mcap along with
dividend yield of ~3% are added positives. We reiterate Buy with a target price of
Rs490 and view Tata Sponge as an ideal investment for long term value investors.
Key risks include higher iron ore costs and drop in sponge iron prices.
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