Tata Steel reported better-than-expected Q2FY11 results. While Tata Steel India?s results were in line with our estimates, Tata Steel Europe?s were a positive surprise with Ebitda (earnings before interest, taxes, depreciation and amortis-ation) of $55.8/tonne compared with our estimate of $40/t. While Q3FY11 may be subdued for Tata Steel Europe given the full impact of the price decline in Q2 will be felt in Q3, we expect Q4FY11 to be better since global steel prices are showing signs of bottoming out. Given the better-than-expected performance at Tata Steel Europe and the strength of the Indian operation, we raise FY11e earnings by 1.8% to Rs 62.
The Indian business performed on expected lines. While we had estimated Ebitda of Rs 15,859/tonne, it reported Rs 15,424/t. The decline in realisation was more or less in line with SAIL?s realisation decline at Rs 3,823/t. The ferro-alloys division did well with revenue of Rs 6 bn. Tata Steel India?s net profit was boosted by sale of investments, leading to exceptional income of Rs 7 bn. Adjusted for the one-time gain, net profit was Rs14.4bn.
Tata Steel Europe?s Ebitda was a positive surprise. While we had estimated an Ebitda/t of $40, the reported number was $55.8/t. The surprise was mainly because of the fact that the company was able to sell at near-peak prices until August. Note that European steel prices had started to decline in July 2010 and have recovered a bit in the past few days.
Tata Steel is planning to raise up to Rs70 bn in capital through an issue of securities, including ordinary shares, equity shares with differential voting rights, GDRs, debentures and FCBs. The company will use the capital to fund capital expenditure at its Jamshedpur plant, investment in raw material projects and investment in its European business.
While our models indicate the company can fund its capex plans via internal accruals, the willingness to raise capital may be because of the group?s long-term vision to maintain debt/equity ratio close to 1. Wide fluctuations in raw material and end product prices, which is raising the net current asset levels in the business. In YoY terms, the group?s net current assets is up by close to $1.1 bn.
The uneven steel demand and fluctuations in raw material prices might lead to liquidity drainage, which can be hedged by raising additional capital. The management indicated that this additional capital will help speed up the commissioning of raw material projects.
Tata Steel Europe received the benefit of relatively soft iron ore prices in the last quarter, but iron ore prices have started to harden again. The resumption of Chinese buying and also the very fact that iron ore is and will be in short supply for the next couple of years are the main reasons for the up move in iron ore prices.
While hardening iron ore prices may pinch Tata Steel, relatively lower coking coal prices can give it some respite. Coking coal contract prices have been signed at $205-210 by the miners for deliveries in the current quarter.
European steel prices, which were very strong till the end of July, have collapsed since then. The price collapsed from a high of $780/tonne to the present price of $690/t. Capacity utilisation at steel mills stood at 72% in Q2FY11.
With austerity measures in place and governments reviewing spending, demand could be sluggish in Q3, too. However, given the strength in raw material prices, at least 25% of commodity grade HRC (hot-rolled coil) manufacturers and 20% of long product manufacturers are not making any money. Also note that inventory is running low in the system.
Moreover, in the past fortnight or so, the following events have taken place, like the Turkish wire rod export prices have gone up by $20, scrap prices have inched up by almost $10/ton, Chinese export prices have gone up to around $610-615/ton, and after weeks of consolidation, iron ore prices have gone up in China. CFR (cost and freight) China port prices have gone up by $2-3 in the previous week. US steel makers have also raised prices. These events coupled with the fact that marginal manufacturers are losing money indicate that steel prices have probably bottomed out.
Indian steel prices have little scope to slip further. The main reason for the drop in Indian steel prices was the threat of imports from China. However, Chinese steel prices have started to harden. This, added to currency volatility, makes imports risky. Hence, we believe that once the festival season is over, demand could bounce back, in turn firming up Indian steel prices.
To account for the better performance at Tata Steel Europe, we raise our earnings estimate for FY11 by Rs 1.1 to Rs 62. We maintain the Outperform rating and price target of Rs 760.
?Standard Chartered