Tata Steel reported consolidated Ebitda of R32.4 bn, up 21% y-o-y and 24% ahead of our estimate. The beat was owing to better performance in the international business, both the UK and South East Asia. Key positive surprises were higher than expected realisation in European business and improvement in the South East Asia business’ profitability. Consolidated PBT (ex-extraordinary items) was R10.7 bn (vs. R2.6 bn in Jun-16), ahead of our estimate, largely helped by the higher Ebitda. We continue to believe that with higher volume growth in domestic business, stable profitability in domestic business and the improving performance in the international operations, Tata’s near-term earnings trajectory will remain strong. OW.
Strong Indian operations — in-line quarter
Revenue of R91.2 bn was flat y-o-y and 3% below our estimate. Volumes were flat y-o-y and down 13% q-o-q on account of a scheduled maintenance shutdown at some of its finishing lines. Blended realisations were flat y-o-y, but improved by 10% sequentially and were in-line with our estimate. Ebitda grew a robust 19% y-o-y, helped by lower per ton cost. The key driver of lower costs was a
decline in raw material costs (on a production basis), which was down by 6% y-o-y, to R9,876 (vs. R10,452 in F1Q16). Ebitda per ton improved to R10,351 as per our calculation, which implies a 19% y-o-y improvement, 3% ahead of our estimate. In FY17, while the company will gain from the strength in domestic steel prices, this could be partly offset by a ramp-up in production at the new Kalinganagar unit, given our view that profitability at the unit in the early phase of ramp-up will be lower vs. the company’s current standalone Ebitda per ton. In addition, the recent increase in global coking coal prices could hurt margins, though the management indicated that this is not likely to impact them before December, given the current inventory levels.
TSE reported robust Q1FY17 earnings
Tata Steel Europe (TSE) reported Ebitda of £89 m in Q1FY17, vs a loss of £60 m in Q4FY16 and profit of £33 m in Q1FY16, and this was significantly higher than our estimate of £31 m. The beat was partly helped by the earnings of the loss-making long product business (that was sold in Jun-16) being reported under ‘earnings of discontinued operations’. On per ton basis, Ebitda at £35 marked a significant improvement vs. £12 in Q1FY16 and a loss of £21 in Q4FY16. This was ahead of our estimate of £10/ton and was helped by better than expected realisation and some improvement in per ton cost. Volumes declined 12% y-o-y, to 2.5 mnt, given the focus on profitable and value-added products. Management is focused on restructuring of the European business and discussions are at an advanced stage for potential JV with strategic players including Thyssenkrupp; a focus on higher-value-added products, including in the auto market; further cost reductions.
Other businesses aided the beat
Other subsidiaries reported Ebitda of R1.6 bn vs. our expectation of R0.7 bn and vs. R4.7 bn in Q1FY16. This was helped by improvement in South East Asian operations’ profitability. Ebitda for this business has been volatile in the past, though management highlighted that the improved performance in some subsidiaries is sustainable.
Key conference call takeaways
The reported net debt of the company as of Mar-16 reduced from R74.6 bn to R71.1 bn owing to a change in accounting standards — primarily on account of a joint venture being accounted as equity now, in our view. Relative to the net debt of R71.1 bn as of Mar-16, its net debt as of Jun-16 increased to
R75.3 bn—this factors debt towards capex, accounting of certain commitments as finance lease (under debt) and other impact related to change in accounting standards. Management reiterated its guidance of 1 mnt of volumes from its newly commissioned Kalinagangar plant, which coupled with its existing plant volume will lead to total volume of 10.5 mnt for FY17. This is in-line with our estimate for FY17. It expects realisation to soften in Q2FY17 by more than R1,000/ton, given easing in global steel prices and seasonal weakness in India. The company has planned capex of R90 bn for F17, which
includes R45 bn in India and R35 bn in Europe. Management highlighted that 50-60% of the improvement in spread in Europe has flowed into the earnings during this quarter and the balance will be reflected with a lag owing to the nature of contracts. The company expects its Southeast Asian operation to do well in coming years, in view of improved demand and focus on value-added products.
Our PT of R417 is our base case scenario value, derived by using SOTP methodology. We value Tata Steel’s standalone business using a residual income (RI) model. For our RI model, we assume a terminal RoE of 15.5%, terminal growth rate of 3%, and cost of equity of 14.6% (risk-free rate of 7.5%, equity risk premium of 6%, and beta of 1.19). We value its international business at 7.7x 2017e EV/Ebitda, as implied by our base-case value for the standalone business.
Key downside risks to our price target
Delays in commissioning of the new plant and slower ramp-up, leading to weaker than expected cash flows. Weaker-than-expected cash flows in the international business resulting in increased international balance sheet risks.