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We met with Tata Steel Management recently. The company is increasing its
focus on raw material integration and expects the Riversdale offtake to stand –
Tata Steel has 24.2% stake in Riversdale, which received a bid of US$3.9bn
from mining giant Rio Tinto. We also learn that the capital spends in the
European division should increase with the company’s increasing focus on the
region’s profitability. The debt refinancing of GBP3.5bn and board approval for
increasing capital of US$1.5bn, we believe will release cash for capital spend
needs.
Raw Materials Integration:
With rising raw material prices, we see integration critical for profitability and see Tata
Steel’s integration plans as a step in the right direction. Currently the domestic
operations are integrated fully on iron ore and 50% on coking coal. Post Jamshedpur
Brownfield expansion, increasing the capacity to 10m tonnes (currently at 6.8mt), the
domestic operation would still be 100% integrated on iron ore and 35% integrated on
coking coal. However the company expects to increase the coking coal integration to
50% within 18 months, mostly through the Riversdale offtake. We believe that this
would help the company contain the raw material costs while expanding production and
see this as a huge advantage for the company compared to peers. We also note two
other iron ore projects a) The Canadian iron ore – to increase production to 4mt from
the current 2mt by CY 2012 and b) African iron ore – to start production of 1-2mt from
FY 2013. This should contribute to the Tata Steel Europe’s iron ore integration.
Riversdale off take - strategic:
While there are various options for Tata Steel on Rio’s bid for Riversdale for US$3.9bn,
we note the strategic significance of the stake and the existing offtake agreement of
40%. While the management is assessing its options, they are confident that the off
take agreement would stand and also see Rio’s current offer to be undervalued. We
believe the company’s view to be justified due to the project’s reserve base of 502mt
with a quality equal to Bowen basin of Australia (known for the high quality hard coking
coal).
Focus on Tata Steel Europe (TSE) profitability
With EBITDA turning positive in the first half of FY2011, Tata Steel is focusing on
maintaining the trend. The closure of Aluminium plant and sale of Teesside Cast Plant
(for US$ 500m) reiterates the company’s focus on profitability. The “Weathering the
storm” programme reduced costs by GBP866mn in FY2010. While this is a temporary
reduction, with costs coming up again, once capacity starts picking up, the management
expects to permanently reduce 10% of the costs in future. TSE reduced 7300 of
manpower and would look at any possible reduction in order to increase efficiency. The
company expects US$70-100 EBITDA / ton in three years time, primarily through their
new operating model - establishing manufacturing hubs around the steel production
sites with a centralized sales and marketing channel. The company would aim at a
capital deployment of GBP400mn in Europe.
Refinancing and capital raising
Tata Steel underwent a refinancing of its loan portfolio amounting to GBP 3.5bn, which
would result in a maturity of just GBP350m in the next three years. The new loans do
not attach any EBITDA linked covenants. We believe that this would release cash for
both organic and inorganic expansion. We however think that the cash would be focused
on raw material linked acquisitions. On the equity side, the board approved a capital
increase of US$1.5bn. While there have been rumours of a possible DVR of US$1bn, the
company is still undecided on the instrument. The management expects to use the
proceeds for the Jamshedpur Brownfield expansion, the raw material projects in Canada
and Mozambique and for the capital spends in Europe.
View on Indian steel
The company agrees with our view of a possible import threat from Russia going on
next year and attaches less probability of imports from Ukraine and other CIS countries
(focus to be more on the European region) and China (no cost advantage). Refer our
notes “Impact of Chinese steel exports on Indian Steel Pricing” dated 7 December 2010
and “CIS Exports – Destination Asia / India?” dated 14 December 2010.
Valuation
The stock currently trades at an EV/EBITDA of 6.0x on consensus FY12EBITDA of
Rs.176.895bn. We believe these valuations are at attractive levels given the company’s
potential EBITDA growth resulting from high domestic demand, raw material integration
and a reduced cost-European base.
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