Q2 EBITDA grew 7% q-o-q, 12% below our est., as India and TSE Ebitda disappointed. Net debt rose q-o-q. We lift our FY18-19E Ebitda by 8%. We expect Q3 margins to be better q-o-q, but this is widely expected. Steel prices/spreads have surprised positively and while markets appear to be extrapolating these, we believe spreads/steel prices will moderate. Potential downgrades to consensus FY19 earnings could weigh on valuation multiples. Maintain Underperform. Q2 Ebitda below expectation: Reported Ebitda was Rs 47.2 bn, below our Rs 53.4 bn estimate. Ebitda included Fx gain of ~ Rs 3.2 bn. India Ebitda rose 14% q-o-q to Rs 33.7 bn, 13% below our estimate. TSE Ebitda surprisingly fell 39.7% q-o-q, 42% below our estimate. Net debt jumped to Rs 783 bn from Rs 717 bn in Q1 led by payment of £550 mn towards pension settlement. India Ebitda disappoints on softer ASP: Ebitda/ton rose Rs 172/ton q-o-q to `10,959/ton vs. our est. of Rs 12,346/ton. Underlying ASP fell Rs 200/ton q-o-q (Jeff est. Rs 600/ton q-o-q) despite higher flat product ASP (`2000/ton.) due to weak long product prices. Lower ferro alloy prices also impacted India Ebitda. We understand recent price hikes by steel mills have been only been partly absorbed in the domestic market. Tata expects ASP to improve by Rs 1,000/ton q-o-q in Q3.
TSE margins surprise negatively: Volume grew 8% q-o-q to 2.6mn tons as expected, but TSE Ebitda/ton fell $36/ton q-o-q (Jeff est. $76/ton). Management attributed this to fall in spreads due to lower ASP. EU steel spreads have expanded sharply in the last few months. This should support better margins in H2. Tata expects slight improvement in Q3 as higher spreads may be offset by seasonal weakness (in terms of volume) during winter.
Steel prices, spreads are near peak: Potential winter cuts could impact demand/prices for steel making inputs (iron ore, coking coal). This could weigh on regional/domestic steel prices. Current spreads are near multi-year highs (near pre GFC levels). This appears unsustainable. Besides capacity cuts, strong Chinese demand led by stimulus (apparent demand ~5% y-o-y YTD) has supported higher spreads YTD, but this could moderate.
Valuation/Risks: We lift our FY18-19E Ebitda est. by 8% as we lift our India/TSE Ebitda factoring better domestic prices and higher EU spreads. Our multiples are unchanged, but we rollover our PT to Dec 18E (Sept 18E). Our new PT of Rs 536 (from Rs 424) is based on SOTP valuation. Upside risks: Higher prices, higher TSE margins. Downside risks: Lower steel prices, higher BS stress.