India in line, Europe surprises positively: Tata Steels (TS) consolidated Ebitda at R42.1 bn (+18% year-on-year) came in line with DBe (Deutsche Bank estimate) and consensus. While performance of Indian operations was in line with Ebitda at R32.6 bn (+15% y-o-y), the performance of TS Europe was better than expected with Ebitda/t (earnings before interest, taxes, depreciation and amortisation/tonne) rising by 26% y-o-y to a three- year high of $49/t (vs DBe at $45/t) reinforcing our positive view. Recurring earnings at R6.4 bn (-37% y-o-y) were 10% below DBe on higher depreciation and interest costs. Reported earnings were impacted on account of net exceptional loss of R2.6 bn related to non-cash write down at Benga coking coal project. We raise our target price by 11% to R665 as we roll forward to FY16.
Tata Steel Europe
Tata Steels European operations reported a better than expected operating performance in Q1FY15Q with Ebitda/t expanding by $15/t q-o-q to $49/t, which was 7% above DB expectations of $45/t. While steel deliveries at 3.2 mn tonnes (+2% y-o-y) were in line with DBe, blended steel realisations increased 8% q-o-q supported by a combination of lagged impact of improved spot prices and higher proportion of differentiated steel product sales (+20% vs FY14) and drove the earnings surprise.
Outlook: The steel demand environment outlook in Europe is continuing to improve. Eurofer has increased its CY14 apparent steel consumption forecast to +3.7% (vs 3.4% earlier) and expects the demand recovery to continue in CY15 with a demand forecast of +2.9%. We believe that Tata Steel is well positioned to benefit from the improving profitability outlook for European steel makers as the benefits of its operating cost saving initiatives should begin to reflect in its profitability numbers as its utilisation rate increases. European HRC spreads have been normalising as we approach a seasonally weak period. However, the spreads are still higher than historical (24 month) average and should find support from improving demand outlook in Europe.
Tata Steel India
Tata Steels Q1FY15 standalone Ebitda at R32.5 bn (+15% y-o-y) came in line with DBe. Saleable steel sales volumes were up 5% y-o-y to 2.1m tonnes while Ebitda/t at R15,504 was marginally (-2%) below DBe on account of higher employee costs related to provisioning over employee retrials. Tata Steel India's value added product mix has insulated the company from a weak demand environment in India and allowed it push volumes in the domestic market despite a weak demand environment. The company confirmed that the mining operations at two of its iron ore mines and two manganese mines in Odisha has resumed following the Express Order by the state government and these mines are supplying all of their captive iron ore requirements. Iron ore imports (0.5mt till now) had been done primarily in anticipation of mining restrictions and as a risk mitigation strategy.
Outlook: The earnings outlook for Indian operations remains constructive with Jamshedpur expansion ramping up well. The company remains confident of commissioning the 3mt Kalinganagar steel plant in Odisha by FY15 end which should drive volume growth FY16 onwards.
Jamshedpur profitability, Odisha expansion on track: Following the full commissioning and synchronisation of the expanded capacity at Jamshedpur, we see the TS Indias profitability sustaining around current levels over the course of FY15 on the back of an improving outlook for automobile sector and general economic recovery. We expect TS Indias FY15 operating cash flows to rise by 16% y-o-y to a record R95 bn.
FY15 capex guidance revised downwards: TS has incurred R30 capex in Q1FY15 is guiding for full year capex of R120-140 bn, which is lower than its earlier guidance of R160 bn and likely to decline further in FY16. The outlook for the companys net debt position is improving driven by a combination of (i) improving operating cash flows from Jamshedpur, (ii) reducing capex trajectory post-completion of Kalinganagar capex, (iii) divestment of non-core assets (Dhamra and Borivali land parcel sale already completed). We expect Tata Steels consolidated net debt to equity to decline to 1.18x by FY17 from a high of 1.72x in FY14.