Tata Steel’s EBITDA was materially ahead of our estimate—98% q-o-q jump to Rs 70.2 bn. (i) Improved spreads in a supportive Q4FY17 steel market, and (ii) positive factors such as higher realised selling price but delay in higher cost booking on coal inventories aided earnings besides one-offs and internal improvements. Internal restructuring of European operations is helping operating margins as well, led by trimming of loss-making operations and cost rationalisation. Maintain Add with a revised target price of Rs 525.
Strong across operations; supportive steel market, internal improvements, other factors help Tata Steel’s consolidated Ebitda increased by 98% q-o-q to Rs 70.3 bn and was materially ahead of our estimate. Ebitda outperformance was across operations as, (i) India standalone Ebitda increased 29% q-o-q to Rs 43.6 bn, (ii) Europe Ebitda increased 2x q-o-q to Rs 19.7 bn (Ebitda loss of Rs 3.5 bn in Q4FY16); Europe Ebitda/ton of $103/ton ($38/ton in Q3FY17) was the highest in the past many years. Moreover, other smaller subsidiaries (including SE Asia operations) reported Ebitda of Rs 6.8 bn against Ebitda loss of Rs 4.5 bn in Q3FY17 resulting in a fillip of Rs 11.4 bn q-o-q to Ebitda. Supportive steel markets in Q4FY17 (strong spreads), internal improvements at Tata Steel and a few favourable factors aided Ebitda inthe quarter.
You May Also Want To Watch:
The improvement in Europe earnings was accentuated by positive selling result of higher steel prices while the full impact of coking coal cost increase (brought over last 3-4 months) is yet to hit earnings. In India, Rs 5.7 bn contribution from deferred income release on higher exports (for full year) and lower employee cost due to actuarial changes aided earnings. The company reported adjusted net income of Rs 33.5 bn and exceptional charge of Rs 40.7 bn.
UK Pension development will help quicken long drawn out restructuring but has costs
The exceptional charge during the quarter mainly relates to Rs 36.3 bn towards BSPS curtailment charge—this has to do with the closure of defined benefit section of BSPS to future accruals for employees in March 2017. Also, the company is in discussion with Trustee and regulators so that Tata Steel UK can sponsor a new closed pension scheme with an option to members of BSPS to transfer to the new scheme —this scheme will have improved funding as it would have lower future annual increases for pensioners/deferred members thereby reducing risk. However, the new settlement will come at a cost of £550m and 33% equity stake in TSUK.
Restructuring of European operations will be positive; Maintain ADD with TP of Rs 525
The settlement of UK pension issues will lead to strategic restructuring of European operations including a potential deal with Thyssen Krupp, in our view. Net debt declined by Rs 43 bn q-o-q to Rs 746 bn owing to strong earnings. We raise our Ebitda estimate by 0-2% for FY2018-19e and raise target price to Rs 525. The increase in our TP is led by rollover to March 2019 and higher Ebitda, partially offset by potential payout of £550m towards pension settlement.
Changes in our estimates
We raise our FY2018e, FY2019e India volumes by 3% to 12.3m, 12.5m tons based on management guidance of 12.3–12.4m tons for FY2018e. We also incorporate our economist’ revised Fx rate assumption. We retain our Ebitda/ton estimate for India at broadly the same level of Rs 11,100/ton for FY2018e and Rs 11,300/ton for FY2019e. We also change our presentation of European earnings. Earlier we had assumed only Netherlands operations as continuing (due to stake sale discussions in UK). UK operations anyways were hardly earning any substantial Ebitda. However, we now model UK volumes as well—though this does not change Ebitda much as we believe most of the profitability in Europe is attributable to Netherlands operations. We estimate consolidated Ebitda of Rs 181 bn, Rs 193 bn and Rs 198 bn for FY2018e, FY2019e and FY2020e and EPS of Rs 51.3, Rs 60.9 and Rs 66.4, respectively.
Analysing Q4FY17 results
Standalone results — support from ferro-alloys, one-offs: Q4FY17 realisation increased by Rs 2,600/ton q-o-q. However, the company did not benefit from positive selling result as the coking coal cost increase took all the gains from steel price increase away. Despite this, Tata Steel’s Ebitda/ton increased 20% q-o-q to Rs 13,586/ton. A few one-offs/other favourable factors also helped in posting better operating margins (i) Ferro alloy division reported increase in Ebitda by Rs 2.7 bn q-o-q (Rs 5.7 bn Ebitda) from better prices, (ii) Rs 5.7 bn gains from deferred income release on higher exports and lower employee cost on changes in actuarial assumptions helped.
As per management, the steel prices have declined by Rs 700-800/ton q-o-q in Q1FY18 (until now), though export prices have declined more—the difference between domestic prices and export prices (HRC) is about Rs 3,000-4,000/ton. The management expects steel volumes in India to increase to 12.3-12.4 million tons in FY2018e. The company exported 400-450 kt in FY2017 which is expected to increase to 1.2 million tons in FY2018e.
KPO delivers 1.5 mn tons of HR Coils since it started production in May 2016: The Kalinganagar project delivered total hot metal volumes of 2.2 million tons and HR coil production of 1.5 million tons since it started production in May 2016. Note that of the 10.9 million tons of Tata Steel’s India sales in FY2017, Jamshedpur operations contributed 9.4 million tons while KPO accounted for the balance volumes. The management also expects Jamshedpur capacity to expand by 1 mtpa over next three years given that EC has already