In Q3FY17, India Ebitda was better than expected, but this was offset by lower TSE (Tata Steel Europe) Ebitda and loss in non core subsidiary. India margins should improve q-o-q in Q4, but this appears priced in. We believe India margins should decline post Q4. At TSE, margins could recover from Q3 lows, but lagged impact of higher raw material costs would weigh on TSE margins near term. Net debt should remain elevated. Maintain Underperform.
Adjusted Ebitda in line
Group Ebitda rose 19% q-o-q to R35.4 bn, vs. our R37.3 bn est. India Ebitda (69% q-o-q) was 25% ahead, but this was offset by lower TSE Ebitda (32% miss) and loss in trading subsidiary (loss $85m incl. MTM loss of ~ $45m). Ex MTM (mark-to-market) loss, Ebitda was in line. Q3 net debt rose to R766.8 bn (Q2 R755.6 bn).
India Ebitda ahead on lower costs, higher ferro alloy profit
Ebitda/t was R11,300/ton (Q2 R7610/ton) vs. our R9,050/ton estimate. ASP rose 10% q-o-q. Input costs were lower than expected. Sharp increase in ferro alloy Ebit (88%q-o-q) due to higher ferro alloy prices boosted standalone Ebitda/ton by R400/ton q-o-q. Spot ASP is up R3,500/ton vs. Q3 average, as per management. Tata expects coking coal costs to rise by $40-45/ton q-o-q.
TSE Ebitda falls 41% q-o-q
Volume was up 3% q-o-q. Ebitda/ton fell $29/ton q-o-q to $38/ton (JEFe $55/t). Surprisingly, TSE gross margin fell $52/ton q-o-q, even though Q3 costs reflected average coking coal cost of $89/ton. We think of multiple factors: (i) higher input costs (mainly iron ore); (ii) lower mix of output from its more profitable Ijmuiden unit due to maintenance shutdown; (iii) higher energy and maintenance costs, likely contributed to lower TSE margins.
Lift FY17-18e Group
Ebitda by 4%/1%
We lift our India Ebitda est., but cut our TSE and non core Ebitda est. India margins should fall post Q4 as: (i) domestic steel prices have likely peaked and may soften post Q4; (ii) vertical integration gains should erode as input prices fall; (iii) ferro alloy profits may not sustain as ferro alloy prices are down 19% from peak. We expect TSE margins to improve from Q3 lows as production mix normalises. Lagged EU spreads have improved from lows but still remain below 1HFY17 levels. Higher input costs would weigh on TSE margins near term.
Our revised PT of R388 (was R355) is based on SOTP valuation. We value India operations at 6.5x FY1e Ebitda and TSE at 6x FY1 Ebitda (March 18E). Upside risks: Higher prices, higher TSE margins. Downside risks: Lower steel prices, higher BS stress.