Performance review: Tata Steels Q1FY14 standalone Ebitda at Rs 28.3 bn (+2% y-o-y, -14% q-o-q) and PAT at Rs 13.56 bn (0% y-o-y, -32% q-o-q) came in line with DBe. While the blended steel realisations came in 2% below our expectations, the adverse impact was more than offset by higher than expected volumes at 2.01 mn tonnes. Ebitda/tonne declined by 2% q-o-q to Rs 14,136/tonne.
Outlook: The ramp up of the newly commissioned facilities at Jamshedpur is progressing well. While the steel price outlook in India remains subdued on a weak domestic environment, Tata Steel India should benefit from improved volumes during the year. Management has maintained its guidance of ~1mn tonne in incremental saleable steel volumes during FY14.
Performance review: The operating performance of Tata Steel Europe in Q1FY14 was significantly above DBe with the European operations reporting a recurring Ebitda of GBP 79m ($120m), against our expectations of $48m. The headline Ebitda numbers were amplified by GBP12m of one off related to provision write back. The positive surprise on recurring Ebitda was driven primarily by a 1% sequential improvement in pricing against our expectations of 3% decline. The conversion costs also declined on account of higher production levels - saleable steel producing jumped 16% q-o-q and improving operating parameters at recently revamped blast furnaces in Port Talbot and Ijmuiden.
Outlook: While the steel demand environment in Europe continues to be challenging, we are seeing some green shoots of recovery which can support a much more constructive outlook for H2FY14. Consequently, we are revising up our Ebitda/t forecasts for TS Europe to $23/tonne. We increase our profitability assumptions for TS Europe for FY14/15 by $3/$3 respectively. This should drive a 14.3%/9.6% increase in FY14/15 consolidated earnings for Tata Steel.
Valuation methodology and argument: We continue use EV/ Ebitda (enterprise value/earnings before interest, taxes, depreciation, and amortisation) as our primarily valuation methodology to value Tata Steel. We prefer to use a sum-of-the-parts (SOTP) valuation given the dynamics of the key regional geographies and divergent nature of individual steel assets.
We value the Indian operations at 6x FY14e EV/Ebitda. At our target multiple, Tata Steel India will be trading at a slight premium to its India peers, which is justified is its superior profitability and return profile. We have assigned a valuation of 5.4x to Tata Steels European operations. Given Tata Steel Europes lower profitability relative to the Indian operations and a weak steel pricing environment in Europe, we assign a 10% discount to the valuation multiple of Tata Steel India. Asian operations are converters and do not have upstream steel-making capacity.
Hence, we value them at 4x FY14 EV/Ebitda, at a marked discount to the integrated operations at India and Europe. We value the raw material assets at 4x FY14 EV/Ebitda. Our SOTP methodology leads to a target price of Rs 286/share.
* Higher-than-anticipated increase in steel-making raw material prices: In the case raw material price rise above our expectations, there could be a risk to our target price being achieved.
* Steel demand environment remaining challenging in Europe, especially in the long product segment and delay in steel demand recovery.
* Tata Steels sticky net debt remains a key area of investor concern, with consolidated FY14 net debt to equity at 1.68x and expected to rise further in FY15.
* Triennial valuation and contribution negotiations for Tata Steels pension fund in Europe have concluded. Tata Steel management maintains that the cash impact is likely to be limited over the next few years but it will continue to be an overhang.