Overweight rating on Tata Steel; Sale of long products business a very positive development

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Published: April 18, 2016 6:10:01 AM

It should see TATA’s reported Ebitda improve by ~$150-250 mn

TATA surprised the markets by announcing the sale agreement for the Europe Long products business to private equity firm, Greybull Capital, as investors did not expect any buyers to turn up for the loss-making assets. While the deal details are not yet public, in our view there is likely no debt reduction for this asset and there is only a ‘nominal consideration’.

TATA’s reported Ebitda should improve by ~$150-250m as these assets were loss-making, and now sustainable reported earnings should be higher for TATA to that extent (~Rs 10/share at least). Second, with the large loss-making asset sale done, there could be some debt reduction for those assets when they are sold off. The remaining uncertainty is the pension deficit and when the deferred pensions are recalculated, how much of the deficit would need to be funded by TATA needs to be seen. Overall, this is a strong positive development for TATA to reduce its loss-making exposure, in our view.

Long product business sold for a ‘nominal consideration’: The sale agreement for the long product business in Europe  includes the Scunthorpe steel plant and downstream units. As per our calculations, the assets have steel making capacity of ~4.5MT and as per the release have an employee count of 4,800. Total TATA UK headcount as of FY15 stood at ~16,000-17,000 employees. The release mentions that there is a nominal consideration for the assets, and there is no mention of any debt being taken over by the buyer, which implies TATA essentially has cut its losses in Long product Europe and moved out without any reduction in debt or cash inflow.
* The positives—Reducing Ebitda losses once and for all: The key positive, in our view, is the permanent reduction of TATA’s Ebitda losses in Europe, as the long product business has been consistently Ebitda loss making. Ebitda losses over FY12-15 in the UK operations have been in the range of £63-224m and this includes Port Talbot operations, which are break-even to slightly Ebitda positive. Hence, TATA by divesting the loss-making Long products business should see reported Ebitda improve by ~$150-250m at least. More importantly, the steady cash outflow for TATA on an annual basis to fund the losses should stop and should go into re-rating TATA as it reverts back to its lowest cost steel producer status. We believe reported EPS should improve materially as the loss making operations are divested.
* Pension deficit position not clear —could be a liability for TATA: What is unclear is what happens to the pension deficit as Greybull is not taking over pension liabilities. The pension deficit for the BSPs scheme stood at £485m as of March 2015 and this covered the entire UK employee base. Now the ~4,800 employees would become deferred pensioners and the deficit related to them would be re-worked lower. It needs to be seen as to who would fund this deficit—whether TATA (one time impact for TATA) or the UK government.
* Next—Progress on Port Talbot: The only other plant remaining is Port Talbot, and this is a profitable steel plant vs the Long product segment, at least at the Ebitda level. We do expect some value to be realised for the Port Talbot plant.
* Stock price impact—Initially muted but should see re-rating eventually: Investor expectations of any success for TATA in divesting the loss-making assets were very low, in our view, and broadly most expected TATA to take a large financial hit for divesting the long product assets in terms of either: (i) guaranteeing debt of the buyer or (ii) giving debt to the buyer. No such event has taken place and TATA has been able to sell the assets. Now interest would shift to potential values for the Port Talbot divestment. As we highlighted in our recent research, dated 4th April, 2016, the stock price does not factor in any exit of TATA from the loss-making assets, and it has just completed the divestment of the largest loss-making asset, Long Products Europe. Port Talbot should be relatively easier, in our view. We expect large consensus earnings upgrades for TATA.

Gr4

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