Weaker than expected: Tata Steel’s consolidated Ebitda (earnings before interest taxes depreciation and amortisation) of R15.4 bn (-69% year-on-year, -44% quarter-on-quarter) was materially lower than our estimate and weak even after considering one-offs of R8 bn at subsidiaries. Depressed steel prices, large exports by China and the CIS continue to impact earnings at all three locations. Indian operations were further constrained by higher regulatory costs. The expansion projects in a weak steel cycle will keep net debt high. We retain our Reduce rating and the target price of R300.
Q4FY15 results: Tata Steel’s Ebitda was weak even after considering one-offs at its subsidiaries (total such impact of
R8 bn) pertaining to (i) R6 bn in forex losses on loan translation at Tata Steel Global Holdings, and (ii) R1.9 bn for provisioning of receivables in South East Asia (China).
Standalone Ebitda declined 15% q-o-q to R16.8 bn (-59% y-o-y, Ebitda/tonne of R6,970) and was 14% lower than our estimate. Ebitda was weak due to (i) 5% q-o-q (R2,500/tonne) drop in blended steel realisations upon the sharp decline in domestic steel prices, (ii) R1.9 bn provisioning for payment to District Mineral Foundation as per the amended MMDR Act, (iii) low revenues from ferro-chrome business (R2.2 bn.-74% y-o-y), and (iv) R4 bn of additional costs from purchased iron ore (0.57 mtpa in the quarter).
Europe Ebitda increased 29% y-o-y to R10.5 bn (+5 q-o-q, $44/ton of Ebitda) while shipments declined 6% y-o-y to 3.81 million tonne. The company reported consolidated net loss of R56.7 bn (R1.5 bn net income in Q3FY15) after providing for R48.1 bn of impairment charge; impairment mostly relates to long products in the UK, Benga (Mozambique) and write-down for New Millennium (Canada).
Sharp decline in steel prices; regulatory, external costs to pressure FY16: Domestic steel prices have declined by 19% over the past six months due to the surge in imports. As per the management, the prices are again lower by R1,500/tonne since March. Given the poor demand in China and lower raw material prices, we expect steel prices to be lower by 8% y-o-y (on average) in FY16.
We note that higher royalty rates from September 2014 and additional contributions to the District Mineral Foundation (up to 100% of royalty) can increase Tata Steel’s costs by R12 bn, and 1 mtpa of external iron ore usage from carry over inventory in FY16 will increase costs by R7-8 bn. We expect standalone Ebitda to decline 16% y-o-y to R9,600/tonne in FY2016. We expect net debt to increase due to low Ebitda, high capex and working capital. Tata Steel’s net debt was flat y-o-y at R728 bn in FY15 despite capex of R135 bn aided by disposal of assets (land sale, Dhamra port).
We expect the company’s net debt to increase to R770 bn/ R778 bn in FY16/17e due to a combination of lower Ebitda, high capex interest and working capital from the ramp-up of new projects. We cut our Ebitda estimate by 1-3% for FY16/17e.
Changes in estimates: The consolidated Ebitda estimate for FY16-17e is cut mainly due to a 2-7% cut in our standalone Ebitda for those years. We cut our standalone Ebitda by 7% for FY16e to account for (I) 1 mtpa of external iron ore usage, and (ii) lower revenues from ferro-chrome business. We maintain our TSE Ebitda estimate at $55-60/ton for FY16-17e. Our consolidated EPS (earnings per share) is cut by 2-17% for FY2016-17e. We estimate FY18e consolidated Ebitda of R181 bn and EPS of R28.5.
Capex to decline 20% in FY16: Tata Steel expects FY16e capex spend to decline 20% from R135 bn spent in FY15. The company expects to spend about R40-45 bn in Kalinganagar (KPO), R40 bn in Europe and balance in the sustaining capex in Jamshedpur. The capex at global mining projects will not be material given the weak prices and bleak outlook. We note that Tata Steel had spent R209 bn at the KPO project by FY15 end. The capex spend at KPO in Q4FY15 was R11 bn and in FY15 was R44 bn. According to the management, about 20% of the payment in such projects is usually at the commissioning stage (performance payouts, retention, etc).
Kalinganagar project to be up by Oct: The heating of the coke oven at KPO has commenced and phased commissioning of the projects will begin soon. Tata Steel expects to commission KPO by October 2015 and start commercial production from Q4FY15. The company has maintained its volume guidance for KPO at 0.5 million tonne in FY2016 (mostly from Q4FY16).
The management also reiterated that KPO is designed as a 6 mtpa plant with Phase I and II of the projects. A lot of work relating to Phase II has already been done in Phase I and as such the whole investment will be utilised at optimum levels based on the entire 6 mtpa capacity. We believe the company may pursue the investment in KPO from FY17 onwards.
Margin pressure to continue at Indian operations: We expect Tata Steel’s standalone Ebitda to decline 10% y-o-y to R90 bn in FY16e led by margin pressure from lower steel prices and increasing regulatory costs. We expect Tata Steel’s India volumes to increase 7% y-o-y to 9.4 million tonne while Ebitda/tonne to decline 16% q-o-q to R9,600/tonne in FY2016 from R11,440/tonne in FY2015. This is despite R26 bn in adverse one-off costs that impacted FY15. Note that Tata Steel’s standalone Ebitda in FY2015 was lower due to the one-offs impact (R26 bn).
Of this, we expect FY16 will be affected by (i) R7-8 bn due to use of 1 million tonne of external iron ore, and (ii) R12 bn due to payment towards DMF and higher royalty rates. Note that the R1.9 bn provision towards DMF in FY15 was only for the Q4FY15 (after MMDR Ordinance was approved) while royalty rates on iron ore increased to 15% from 10% earlier from September 2014 onwards, and (iii) lower steel prices.
We note that domestic HRC ( hot rolled coil) prices in retail markets (Mumbai, ex-excise, tax) were trading at R37,800/tonne and R38,200/tonne in Q1FY15 and Q2FY15, when Tata Steel reported Ebitda/tonne of R15,500/tonne and R14,700/tonne. The domestic HRC prices have since declined to R31,000/tonne levels (Mumbai, ex-excise, tax). Tata Steel’s integrated operations do not offer it cushion of decline in raw material as in the case of converters.
As per our calculations, the current domestic prices are at 7-8% higher than import offers from the CIS and China. Any benefit of import duty hike will likely be diluted given imports from Japan; Korea will be outside the purview of duty hike under free trade agreements.