Overweight rating on Tata Steel; European operations prove a dampener

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Updated: November 16, 2015 12:42:58 AM

But Tata Steel has scored key positives in its pension schemes in Europe, and its India operations remain relatively robust

Q2FY16 was exceptionally noisy, even by Tata’s historical standards. The two key highlights were Ebitda (earnings before interest taxes depreciation and amortisation) losses in Europe and the company’s use of one-time pension gains totaling ~Rs 97 bn to make impairments and provisions totaling ~Rs 103 bn, mostly in Europe. Tata has scored key positives in its pension schemes in Europe that make its long-term financials more robust, and India operations remain relatively robust, but the European loss is worrying, as it comes after many quarters, and management commentary was broadly negative regarding Europe. Steel prices in India are expected to decline q-o-q, though there could be a large jump in Ebitda from ferro chrome and seasonally higher steel volumes. Tata also monetised group investments totaling ~Rs 32 bn in Q2 over and above Rs 10 bn in Q1, which has essentially helped keep net debt flat q-o-q even as spending stood at Rs 26 bn. Our estimates are under review. Tata’s book value increased to Rs 360/share as of September-end vs. Rs 323/share at March-end. Tata is trading at a ~0.6x P/B (price-to-book ratio), near multi-year lows.
* The results: PAT (profit after tax) stood at Rs 15.5 bn vs. the company’s compiled consensus estimate of Rs 8.9 bn. However, this is after a series of one-offs and gains from sales of investments. Ebitda stood at Rs 18.3bn, down 34% q-o-q and sharply lower than the company’s compiled consensus estimate of Rs 24.6bn and JPMe of Rs 25.3 bn. Investment gains stood at Rs 28 bn. There were exceptional write-offs/impairments totaling Rs 103 bn, with a write-off of Rs 73 bn in UK Strip products the largest; offsetting this was a one-time credit totaling Rs 97 bn from pension scheme restructuring. Tata has undertaken large-scale impairments over the last three years, with FY15 impairments at Rs 60 bn and FY13 impairments totaling Rs 83 bn. In total, Tata has impaired Rs 246 bn of assets in the last two and a half years, mostly from Europe. Tata highlighted that a significant portion of the UK assets are now written off.

* India: Operations solid, even adjusted for the DMF write-back: Ebitda stood at Rs 18.6 bn, with Ebitda/t at Rs 7990/t, up 1% q-o-q. Reversing the DMF provision write-back of Rs 3.77 bn, Ebitda/t stood at ~Rs 6372/t, down 19% q-o-q vs. Q1 Ebitda/t of Rs 7880/t. However, Q2 also included higher purchases of imported iron ore and pellets that offset the benefit from DMF write-back. Tata consumed 0.8MT of purchased iron ore totaling Rs 4.4 bn and also had onetime water charge provisions of Rs 0.9 bn that broadly offset the DMF write-back. Steel sales volumes increased 11% y-o-y in a tough domestic environment, while implied ASP/t fell ~6% q-o-q , driven partially by an inferior product mix in Q2. Ferro alloy segment Ebit stood at Rs 0.27 bn, the highest in four quarters. SE Asia operations reported positive Ebitda, at Rs 0.7 bn, up 106% q-o-q .


Tata guided that: (i) the ferro alloys and minerals division will start contributing significantly from H2FY16; and (ii) India volumes will be ramped up, among others, in second half vs. first half. The company highlighted that the safeguard duty has been of some benefit, as the fall in Chinese steel prices has partially offset the impact, and that there was an upward movement of steel prices of ~Rs 1,000/t following the safeguard duty, but there have been discounts since, and Tata did guide to lower steel prices in Q3 vs. Q2.
* Europe: First Ebitda loss after Q3FY13: The key negative was the Ebitda loss at the European operations. Ebitda/t stood at $11/t vs. JPMe of +$29/t. Steps taken in the European operations impacted deliveries and production, with sales volume down 3% y-o-y. Overall commentary on Europe was negative, with no firm comments on Ebitda profitability in European operations.
* Debt, pensions and asset sales: Underlying net debt was broadly flat q-o-q , at Rs 735 bn, as Tata made asset sales totaling Rs 32 bn in Q2 . Capex stood at R26 bn. Essentially, sales of investments allowed Tata to maintain net debt at current levels. In pensions, the UK pensions were restructured, which resulted in a one-time P&L credit of Rs 86 bn. The triennial valuation was completed, and the net deficit declined to £90m vs. £553m in 2011. The main pension scheme in the Netherlands is now considered a defined contribution scheme, which resulted in a one-time credit of Rs 11.1bn.
* Are the write-downs done with? It looks like it: Tata did its most aggressive write-off/provisions in recent history, with large write-offs not only across the UK., but also in India, South Africa and Southeast Asia.
* 2H vs. 1H: What should change? While our estimates are under review, we highlight the following changes: (i) a sharp ramp-up in the ferro chrome segment as mining ramps up? and (ii) India steel sales volume increase from new plants, with up to 0.5M  of additional sales volume from KPO with the hot strip mill ready.

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