Stable spreads and ramp-up at Bhushan likely to drive performance; Europe to be a drag; FY19/20e Ebitda up 2/4%; ‘Buy’ retained.
Excluding non-recurring gains (in our view) aggregating Rs 12.1 bn, Tata Steel’s (TSL) adjusted Ebitda of Rs77 bn is 8% above consensus. Highlights: (i) Domestic Ebitda (excluding one-offs) rose 70% y-o-y to `57.4 bn (Ebitda/t: `18,057). (ii) Tata Steel Europe (TSE) Ebitda was marred by high cost of £124 mn. (iii) Forex gain at subsidiaries is estimated to be Rs5 bn. Going ahead, we expect the performance to be driven by domestic operations on the back of: (i) stable spreads; and (ii) ramp-up at Bhushan Steel and the possibility of a further improvement in its profitability. Factoring in TSL’s stronger-than-expected results, we are tweaking up FY19/FY20e Ebitda by 2/4%. Maintain Buy with a target price of Rs 720, implying an exit multiple of 6x FY20e Ebitda.
Strong domestic performance and one-offs result in stellar Ebitda
TSL’s Q2FY19 Ebitda of Rs 89.2 bn (up 88% y-o-y) includes the following non-recurring items: (i) an MTM gain on preference shares of Tata Steel Holding worth Rs 2.5 bn; (ii) benefits from carbon credit sales of £62 mn; and (iii) fair valuation of inventory on Bhushan Steel’s acquisition of Rs 3.5 bn. However, adjusted Ebitda came in 8% ahead of consensus due to the stellar performance of: (i) domestic operations; and
(ii) Bhushan Steel. We expect domestic operations and Bhushan Steel to sustain performance driven by stable spreads and ramp-up at the latter to 5mtpa in 24 months. TSE, however, is expected to remain a drag due to lower Q3FY19 volumes.
Key enablers: Clarity on Bhushan Power, progress on TK JV
Management mentioned that with the acquisition of Usha Martin’s steel division, the ‘criticality’ of Bhushan Power has dropped. On the European Commission’s phase-II investigations into the proposed merger of TSE and ThyssenKrupp’s (TK) Steel-Europe division, management said both the parties are collaborating and the investigations are expected to be completed within the envisaged timelines.
Outlook and valuations: Deep in value
We reiterate long-term value in TSL as TSE focuses on profitable domestic operations. The JV with TK is expected to assuage the burgeoning net debt. Taking cognisance of Q2FY19, we are tweaking up FY19/FY20e Ebitda by 2/4%. At CMP, the stock is trading at 5.4x FY20e Ebitda. Maintain ‘BUY/SO’ with a target price of `720.
Conference call takeaways
Industry fundamentals: Global steel production grew 4.7% y-o-y in 9MCY18 driven by higher production in China in recent months. Domestic steel demand remained robust despite monsoon-related seasonality, and imports increased to 2.1mnT; however, INR depreciation moderated supplies. While prices have declined from peaks off late, impending winter cuts in China should abate concerns. The domestic market is expected to remain protected from dumping owing to weakened rupee and higher international prices.
Consolidated performance: Q2FY19 consolidated Ebitda jumped 89% y-o-y to `89.2 bn due to improved realisation. Ebitda/t shot up 64.2% y-o-y to `12,021. Consolidated volumes grew 15% y-o-y (13.3% q-o-q) to 7.4mnT on account of Q2FY19 being the first complete quarter of consolidation of Bhushan Steel. The Usha Martin acquisition has been approved by shareholders of Usha Martin; Tata Sponge will be utilised as the vehicle for the acquisition that’s likely to be completed by end-FY19. Usha Martin adds longs to the domestic portfolio, and the company has purchased a land parcel of 115 acres adjacent to the complex for exploring further growth opportunities.