Tata Steel reported consolidated EBITDA of Rs170 billion in FY17, up c120% y-o-y. The earnings improvement was broad-based but led by a turnaround at its European operations (TSE), which reported FY17 EBITDA of Rs47 billion compared to a loss of Rs7 billion (including long and speciality steel) in FY16. Sales for the long product division in Q1FY17 and speciality steel recently, coupled with better demand conditions, led to the sharp recovery. With the sale of pipe mills recently, Tata has largely completed its portfolio restructuring in the UK. After significantly underperforming its European peers over recent years, TSE reported an EBITDA/t of $103 in the January-March 2017 quarter, second only to Voestalpine.
The domestic operations have benefited from increased trade barriers, a strong ramp-up at Kalinganagar and recovery in the Ferro alloy divisions (FAMD). FY17 stand-alone EBITDA of Rs120 billion was up 65% y-o-y, while blended EBITDA/t of Rs13,586/t was the highest for ten quarters. Q1FY18 domestic sales of 2.75mt are already up by c28% y-y and ahead of management’s annual guidance of 12-13% volume growth.
We estimate Tata’s Q1 growth will be the highest amongst domestic peers.Tata is closer to resolving its UK pension issue, which could pave the way for the proposed merger with thyssenkrupp (TKA GR, EUR26.47, Buy). The potential merger with TKA should further aid consolidation in the European steel industry, making the combined entity the second largest in Europe (behind Arcelor Mittal, MT NA, EUR20.90, not rated) and help derive synergies. Although the companies have not provided any guidance, media reports (eg Reuters, 4 July 2017) suggest the synergies could be cEUR500m. We believe this could come from increased pricing power, better product mix, lower procurement and operating costs and asset optimisation.
We have raised our EBITDA estimates by 9/26% for FY18/19 to account for improved profitability across the operations and higher domestic volumes. We do not yet account for the TKA merger in our model, however, we estimate further upside of Rs117-167 to our target price assuming EUR400-600m of annual synergies are realised. We reiterate our ‘buy’ rating on Tata with a higher TP of Rs750 vs Rs540 on our higher earnings and as we move our valuation base to FY19e from FY18e, valuing Tata steel at 6.5x EV/EBITDA.