Tata Steel: Bottoming out

Last Updated: Fri, Jun 21, 2013 04:01 hrs

Despite a better-than-expected performance reported by Tata Steel in the March 2013 quarter, the stock continued trending downwards to its four-year low of Rs 264.60 on 13 June. This can be attributed to the JPC (Joint Plant Committee) data that showed a fall in domestic steel demand during the first two months of the current financial year.

Since India operations accounted for 90 per cent of FY13 profits, the market reaction wasn't surprising. The recent Chinese manufacturing data, too, was not encouraging.

Going ahead, though the demand remains sluggish, analysts are hopeful of some recovery in domestic demand after monsoon. Tata Steel's domestic volumes are expected to increase with benefits of capacity expansions. Margins in its European operations that marked good improvement in March quarter should also benefit from increase in captive raw material supplies.

Citing these improvements, many analysts are positive on the stock, though they would be watching the trend in European operations' margins, as well as cash flows essential to support the ongoing capital expenditure.

Analysts at Credit Suisse still continue to be cautious looking at the increasing debt and negative free cash flow. For the stock trading at Rs 272.40, the consensus target price, according to Bloomberg, is Rs 397. Of the 16 analysts polled in June, nine have a buy rating, five have a hold and two have a sell.

India steel demand
According to the Joint Plant Committee (JPC), India, domestic demand contracted 4.4 per cent year-on-year in May; for the first two months of FY14, demand is down 0.8 per cent year-on-year. This weakness in demand has put pressure on the steel stocks. The pressure is likely to persist till monsoon-end. Even Credit Suisse' analysts feel it is at their bottom of consensus target price and after monsoon recovery in demand will start getting priced in.

Domestic steel realisations are up thanks to rupee depreciation. While during February, steel prices were at 8-10 per cent discount to import parity prices, those are now trading on a par with the latter. For FY14, analysts at Nomura expect domestic prices to remain at a discount of one-two per cent on an average and demand-supply scenario to stay balanced.

Lower input costs, volume gains
For Tata Steel Europe (TSE), the impact of the decline in the steel prices will be mitigated by the lower coal and iron-ore prices. Per tonne iron ore spot prices have fallen from $157 in February 2013 to $115 in May and are at $120.

Coking coal prices, too, have fallen from $170 a tonne to $145 correspondingly. Analysts say this decline in prices will support margins.

On the domestic front, Tata Steel is confident of selling 8.6 million tonnes (mt) in FY14 compared 7.6 mt in FY13, while for Europe it expects flat sales (13.5 mt in FY14 vs 13.1 mt in FY13). While the 2.9-mt-an-annum Jamshedpur brownfield expansion project has been commissioned, the full benefits should come in FY15.

For TSE, the gains from Port Talbot Blast Furnace-4, rebuilt recently, would start flowing from March 2014 quarter in the form of higher volumes of value-added products. Operating costs should also decline with captive coal supplies increasing from Mozambique (1 mt in CY13 compared to 0.3 mt in CY12).

The Canadian iron-ore project is also likely to provide 1 mt iron-ore in CY14. These should help improve TSE's Ebitda margins further. TSE had already seen Ebitda per tonne improve to $33 in March 2013 quarter compared to $8 in March 2012 quarter (loss of $26 in December 2012 quarter) due to better cost control.

Debt concerns
Continuing expansions have led to rise in debt which comes at a time when profitability has been low. While net debt stood at $10.2 billion at end-FY13, the same can rise by $1.8 billion cumulatively looking at planned $2.5 billion capex during FY14 and FY15, say analysts at Credit Suisse. They add that debt/Ebitda levels would rise to five times and believe that the market will start pricing in profits from new expansion towards end-FY15 and not through FY14. This leads them to remain underweight on the stock.

However, even after considering the debt position, other analysts remain positive. Analysts at Citi use EV/Ebitda to value the company largely due to its high leverage. They arrive at a target price of Rs 420 based on June 2014 estimated EV/Ebitda. Bhavesh Chauhan, analyst at Angel Broking, too, has a sum-of-the-parts based target price of Rs 378.

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