Sharp release in working capital may help liquidity, while the pressures of debt maturities remain low.
With the second wave of COVID-19 emerging in China and India already into a lockdown, a steep cut in earnings of metals pack for FY21e seems likely. We have assumed a quarter of disruption in domestic and European operations for Tata Steel. This leads to FY21e Ebitda reduction of 49% while the company ‘may’ report a substantial loss if our scenario plays out. We expect FY21e standalone Ebitda to decline by 38% y-o-y and Europe to report an Ebitda loss driven by high fixed-cost base. Sharp release in working capital may help liquidity, while the pressures of debt maturities remain low.
While we acknowledge the large extent of possible earnings correction, we see deep value in the name purely on the basis of our asset-based valuation heuristic (P/B). Maintain Buy with a revised target price of Rs 594/share (earlier: Rs 635) based on 1x 1-year forward P/B.
Production, supply, distribution of steel and its raw materials have been brought under Essential Services Maintenance Act 1981: Yet, in the absence of demand, shutdowns of blast furnaces need to be pre-empted. Globally, we have seen steelmakers and miners alike taking a shutdown in locations of spreading pandemic. Further, situation in the UK remains critical and European steel demand is set to suffer meaningfully.
Pre-empting disruptions and adjusting earnings: While Tata Steel is yet to announce any plant closures (India/abroad), we exercise discretion to moderate our earnings estimates driven by demand/supply dynamics. We have reduced FY21e Indian business Ebitda by 38% as we lower volumes by ~25%. We have also reduced FY21e European volumes by 25%. Our consolidated Ebitda estimate witnesses a cut of 49% and we expect the same to fall by 35% y-o-y.
Balance sheet is manageable: With meagre debt maturity of Rs 15-20 bn over FY21e, the target of refinancing was anyway higher. Also, in such periods of shock, we have seen meaningful working capital release in the past, which helps liquidity. There will also be a moderation of capex for FY21e/FY22e – a part of which we have tried to build into our estimates (by lowering capex for the two years by 13% and 16% respectively). Reduced FY21e Ebitda implies a Net Debt to Ebitda ratio of 8.7x – alarming, yet serviceable.
Maintain Buy: Our P/B metric suggests deep value for Tata Steel as it breaches the CY08/CY15 lows. Pension provisions in the past were instrumental in the huge losses. The same has been taken care of as a precursor to merger with Thyssenkrupp (though the merger never happened). We maintain Buy on the stock. High loss estimate for FY21e reduces our FY22e book value per share. This also reflects in the reduced target price as we value the company at 1x 1-year forward P/B.