India business growing, but medium-term Europe outlook is uncertain

The profitable India business is growing (volumess +16% in FY13/14), but medium-term Europe outlook is uncertain. Demand is weak; passenger car sales are falling; construction should recover only in 2013. At 5.7x (times) Sep13e (estimates) EV/Ebitda, (enterprise value/earnings before interest, taxes, depreciation, and amortisation) the stock trades at a premium to global peers (5x). It has outperformed domestic/global peers over the past three months, but underperformed the broader market and discounts the uncertainty to an extent. With no near-term triggers, we maintain Neutral.

We cut FY13e/14e consolidated PAT (profit after tax) by 21-23% as we lower Ebitda across operations and hike interest costs based on FY12 trends. Roll forward to Sep13e from Mar13e, but continue to use 6x EV/Ebitda for TP (target price) of R446.

Q4FY12 adjusted consolidated PAT down 77% y-o-y?Tata Steel?s consol. adj PAT came in at R4.3bn, +6% vs. estimate. India?s Ebitda/tonne ($333) was in line but Europe ($8/t) did better. Volumes/margins/PAT were better for all businesses q-o-q (quarter-on-quarter), but PAT was lower y-o-y (year-on-year) on higher coking coal, interest expense and tax rate. Net D/E (debt-equity) is 1.1x vs. 1.5x as of March?11.

Q4 India highlights?Adjusted PAT at R5.6bn fell 8% y-o-y, 9% below Citi estimate. Ebitda margin was 32% vs 37% last year. Ebitda/t was $333 vs $353 in Q4FY11 and $316 in Q3. Sales volumes rose to 1.77mt. Avg. realisations rose 11% y-o-y and 4% q-o-q. Margins declined y-o-y on higher raw material, power, labour costs. The Jamshedpur 3mtpa (million tonnes paer annum) project is complete and should add 1mt in FY13 and 2.5mt in FY14.

Europe Ebitda improves q-o-q ?Ebitda/t was $8 in Q4 vs $85 last year and -$44 in Q3. Q4 gained from a q-o-q improvement in volumes at 3.6mt and lower coking coal prices. Realisations fell q-o-q as Europe could not cater to additional orders beyond the existing order book. They continue to upgrade/rationalise and focus on high-margin products. Pension surplus was ?211m in Mar12 .

Estimate revisions

Our global HRC (hot-rolled coil) forecasts have been revised down by 8-10% for FY13 and FY14. The impact of lower prices has been offset by a weakening rupee. Citi?s Rs/$ forecast is at 54.5 for FY13 (vs 49.2) and 53 for FY14 (vs 47.3). We have raised Tata Steel India?s average realisations by 10% for FY13 and 9% for FY14.

We cut FY13 domestic steel sales volumes by 4% to 7.7mt. Tata Steel has commissioned the 2.9mtpa expansion and expected to produce an additional 1mt in FY13. We lower FY14 volumes marginally to 8.9mt.

We cut FY13/14 Ebitda for Tata Steel India by 6-8% to account for higher costs. Raw material costs are higher than earlier expected. We expect coking coal integration to decline to 45% in FY13 and 42% in FY14 (vs 50% earlier).

Valuation & risks

We use EV/Ebitda as our preferred valuation metric for Tata Steel largely due to its high leverage. We use a target EV/Ebitda of 6x on September 2013e earnings to arrive at our target price of R446. At this price, the stock would trade at a consolidated Sep13E P/E of 9.8x and P/B (price-to-book ratio) of 1.5x.

Key upside risks to our investment thesis on TSL include: (i) improved demand; (ii) higher steel prices and (iii) lower raw material costs which would benefit Tata Steel Europe.

Downside risks include: (i) weaker steel prices; (ii) higher raw material prices and (iii) FX trends. Any of these risks could cause the shares to deviate from our target price.