Maintain ‘Underperform’ as steel prices and spreads likely to correct; positives of deal with TKA priced in; risk-reward unfavourable.
We visited Tata’s Jamshedpur (JSR) and Kalinganagar (KPO) units and also met with management. New KPO unit is impressive and at JSR there has been further operational gains. Tata is evaluating 3-5 mt expansion, which could lift India volume. Medium term, though it would delay deleveraging too. We maintain Underperform as we believe steel prices and spreads should correct; Tata-TKA deal positives appear priced in and at 7.8x FY19e Ebitda, risk reward appears unfavourable.
Kalinganagar: modern facility; efficient layout
New 3-mn-ton KPO unit is impressive given (i) modern assets; (ii) efficient plant layout, aimed at optimising logistics and designed factoring in possible future expansions; and (iii) lower manpower intensity (3000) vs. JSR. Facilities have largely ramped up (~95% utilisation). Coke rate at 390-400 kg/ton hot metal is higher vs. JSR, but could trend lower. While JSR product mix is richer, KPO is producing wide range of HRC grades, allowing Tata to enter new segments like oil and gas.
Jamshedpur: Operational upgrade
Operational parameters have improved. Average coke rate has dropped to 330 kg per ton hot metal in FY17 (443 kg /thm FY15). Debottlenecking initiatives have started and could lift capacity gradually to 11 mn tons in 3 years.
Focus on value added products, branding and retail
The Tata Steel Management highlighted its focus on value added products, branding and retail segment. Sales to auto segment was around 1.58 million tonne in FY17 (total 10.97 mn tons FY17). Management stated that (i) branding has helped Tata Steel realise higher premium in retail and (ii) it has started providing construction solutions to retail (Business to Customer — B2C) and (iii) pricing is relatively more stable in this segment.
KPO Phase II: 3 million tonne or 5 million tonne?
The size of expansion is yet to be decided. Phase I expansion (capex $1300/ton) included part of enabling infra for 3 mn ton expansion. Thus, capex/ton should be lower vs. phase I. Phase II may also include additional capex for downstream expansion. In case of 5 mn ton expansion, supporting infra for 2 mn tons may be required. We note reported net gearing would stay elevated till Tata TKA deal is completed (likely Dec 2018). Management stated expansion capex would likely be back-ended and near term impact on reported net gearing may not be meaningful.
Tata is trading at 7.8x FY19E Ebitda (avg 6x FY1 ex post). Our `424 PT values India ops. at 6.5x FY1e Ebitda and TSE at 6x FY1 Ebitda (Sept 18E). Upside risks: Higher prices, lower coking coal cost, higher TSE margins.
Highlights from operations visit
We visited Tata’s India operations at Jamshedpur and Kalinganagar and also met up with Senior Management at Tata including India and South East Asia Managing Director T.V. Narendran and Group CFO Kaushik Chatterjee.
Operational parameters have improved at Jamshedpur: There are 6 operational blast furnaces at Jamshedpur at present (total plant area 1700 acres). Plant layout is relatively complex as available area has been utilised for expanding capacities over the years. While operations at Jamshedpur are stable, operational parameters continue to improve led by various cross functional initiatives. Tata indicated that coke rate at Jamshedpur has declined to around 330 kg per ton hot metal (thm) in FY17 from around 440 kg/thm in FY15 leading to cost savings over last few years. Tata has started its various debottlenecking initiatives, which should gradually increase steel capacity at Jamshedpur to 11 mn tons from 9.7 mn tons in around three years. The increase would be gradual and the corresponding capex is included in overall India capex guided by Tata.
Kalinganagar: modern facility, efficient plant layout — We were impressed by Tata’s new 3 mn tons steel facility at Kalinganagar, Odisha. While plant layout at Jamshedpur is complex due to expansions over the years, KPO has a clean linear layout aimed at optimising logistics. Area for raw material handling, logistics and auxiliary infrastructure is clearly demarcated with provisions for future expansions. Logistics flow for raw material and finished good movement is broadly linear. The plant is located close to Tata’s captive iron ore mines and also near port (100 km). Management believes steel produced from KPO could help Tata access South and Western India steel markets.
KPO: lower manpower intensity vs JSR — KPO has around 3000-3500 employees. To put this in perspective, Tata has around 35,000 employee in India of which around 10,000 employees are in mines. Thus, employee at Jamshedpur and other offices would be almost 22,000.
Richer product mix at Jamshedpur; wider HRC grade variants at KPO — Product mix at Jamshedpur is better given downstream CRM units , galvanising lines. KPO on the contrary produces wide range of HRC grade variants, which has helped Tata target new segments like oil and gas.