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Tata Steel
BSE Sensex S&P CNX
22,277 6,675 CMP: INR414 TP: INR531 Buy
Tata Steel India’s margins Tata Steel’s (TATA) margins of Indian business (TSI) are likely to benefit from
are likely to sustain improved domestic steel pricing outlook and lower costs driven by weakening
coking coal prices in the international market. These positives will likely offset any
pressure which may be inflicted by downward pressure on international steel prices,
driven by oversupply of iron ore. Thus, we are increasingly being convinced that
TSI’s margins are more likely to sustain.
Early signs of demand Indian long products witnessed a surge in prices in the seasonally weak month of
improvements in India April this year, bucking the old trend. Although JPC data continue to imply demand
slowdown, our channel checks indicate that the demand for TMT, used in
construction, has improved over the last three to four months. Indian steel mills
lowered flat product prices in April on import pressure. The pressure from imports
has eased now. The downside risk to average steel price realization is abating.
Softening coking coal prices Slowing growth in Chinese steel demand continues to pose a risk to international
are reducing costs steel prices driven by falling coking coal and iron ore prices. However, there may not
be a similar risk to margins of primary steel producers in India as weaker prices of
coking coal help reduce costs.
Iron ore oversupply may be Weaker prices of iron ore in international market can affect steel prices and margins
limited due to high level of of Indian steel producers, for example the Indian business of Tata Steel (due to
consolidation. Expected rise captive mine). Downward pressure is likely on global iron ore prices as supply grows
of region premiums will
but in a limited way. Global iron ore supply still remains highly concentrated in the
cushion downside risk to
hands of four suppliers who control 75% of seaborne trade. According to BREE
margins
estimates, seaborne world trade in iron ore will increase by 90mt only (v/s our
previous estimate of 130-200mt) to 1,315mt in CY14 as many projects are either
shelved or running behind schedule. Further, big four iron ore suppliers are
reorienting their strategy towards low cost projects and deleveraging of balance
sheet to prepare for uncertainties, as the largest consumer in the world is slowing
down. We believe that iron ore prices can sustain at a little higher level of
USD90/dmt FOB Australia v/s our earlier expectation of USD83/dmt (please refer
our sector update dated August 29, 2012). Thus, the downside risk of iron ore prices
is ~USD17/dmt. Hence, the cost of production for non-integrated marginal steel
producer can see a maximum correction of USD25-26/t (1.7x of iron ore prices) on
account of weaker iron ore prices alone. This can be well covered by the increase in
Indian premiums, in our view. Indian steel demand growth, which appears to have
hit a cyclical bottom, is likely to accelerate and drive up regional premiums.
We upgrade realization, We upgrade the average Indian business steel realization by INR470/t and INR600/t
margins estimates and to INR45,000/t each for FY15E and FY16E respectively. Hence, the EBITDA/t is raised
target multiple by USD23 and USD27 to USD241/t and USD240/t respectively. Steel sales volumes
are expected to increase by 3.5% YoY to 8.9mt in FY15 on further ramp-up and by
6.2% YoY to 9.8mt in FY16 on commissioning of the 3mtpa KPO (Kalinganagar
Project in Odisha). The KPO will open a new center of volume growth in a high
21 April 2014 2
Tata Steel
margin business for next five to 10 years as the layout is designed keeping in mind
future growth requirements. Improved visibility on volume growth and abating risk
to margins is likely to re-rate the Indian business. We raise the target multiple to
6.5x (earlier 5.5x) for Indian business.
Indian mills cut HRC prices Indian HRC import parity price in Mumbai (INR/t, exl. ED & VAT)
in April under import 43,000
pressure, but the pressure
40,000
has now eased
37,000
34,000
31,000
28,000
Aug-09
Aug-10
Aug-11
Aug-12
Aug-13
Apr-10
Apr-11
Apr-12
Apr-13
Apr-14
Dec-09
Dec-10
Dec-11
Dec-12
Dec-13
Source: MOSL
Indian rebar prices are Indian rebar prices in Mumbai (INR/T, exl. ED & VAT)
moving up in a seasonally 41,000
weak quarter against
historical trend 39,000
37,000
35,000
33,000
31,000
Jan-11
Jan-12
Jan-13
Jan-14
Jul-11
Jul-12
Jul-13
Oct-11
Oct-12
Oct-13
Apr-11
Apr-12
Apr-13
Apr-14
Source: MOSL, SteelMint
Indian steel demand growth has come to a grinding halt in FY14. The growth rate at
0.6% is among the slowest one in demand seen in the last 20 years.
13.9
13.3
12.9
11.9
11.4
9.8
8.0
7.6
7.0
6.9
6.6
6.0
4.9
4.1
4.0
3.8
3.3
3.2
2.2
1.9
0.6
0.4
FY94
FY95
FY96
FY97
FY98
FY99
FY00
FY01
FY02
FY03
FY04
FY05
FY06
FY07
FY08
FY09
FY10
FY11
FY12
FY13
FY14
FY15
FY16
FY17
21 April 2014 3
Tata Steel
Looking closer during FY14 on YTD demand growth, it is evident that Indian steel
sector hit the lowest point in May 2013. Demand remained subdued until October
2013, which coincided with weak pricing trend. However, steel pricing and demand
has improved thereafter marginally leading to an improvement in pricing scenario.
Our survey of steel producers suggests that they are witnessing some improvement
in offtake.
Closer look at data suggests Steel demand growth (%) YTD since April 2013
marginal improvement in 3.54
demand. This is also
buttressed with channel
checks
0.80 0.69 0.58 0.60
0.22 0.23 0.35 0.42 0.48
-0.77
Jul-13
Aug-13
Oct-13
Apr-13
May-13
Nov-13
Sep-13
Feb-14
Jan-14
Jun-13
Dec-13
Source: MOSL, JPC
Indian steel mills are likely to benefit from sharp growth in coking coal supplies,
softening prices and easing of demand pressure from China.
222 220
208
196 192
186 181 186
173
CY01
CY02
CY03
CY04
CY05
CY06
CY07
CY08
CY09
CY10
CY11
CY12
CY13
CY14E
CY15E
…has exerted pressure on Coking coal prices in spot market (USD/t, FOB Australia)
coking coal prices and
Spot coking coal (fob Australia)
reduced costs for 300
Indian mills
250
200
150
100
Aug-11
Aug-12
Aug-13
Oct-10
Oct-11
Oct-12
Oct-13
Apr-11
Apr-12
Apr-13
Apr-14
Feb-11
Feb-12
Feb-13
Feb-14
Dec-10
Jun-11
Dec-11
Jun-12
Dec-12
Jun-13
Dec-13
Source: MOSL
21 April 2014 4
Tata Steel
Over 2006-13, world trade in coking coal has increased by 63% or 122mt to 314mt.
China alone has absorbed 70% of the growth in supply over last seven years, while
rest of the world absorbed the remaining 38mt largely to compensate for the
reducing coke exports from China.
9 10 12
CY06 CY07 CY08 CY09 CY10 CY11 CY12 CY13 CY14E CY15E
Source: BREE
Coking coal supply will still grow by at least 7mt each in 2014 and 2015 as Australian
miners remain committed to deliver new projects at low costs to feed eventual
growth in Indian consumption of coking coal. Slowing growth in China’s pig iron
production will ease the demand pressure thus benefiting Indian steel mills.
World steel demand growth World steel demand growth rate (%) outside China
is expected to accelerate
22.5
outside China
8.7
3.9 6.0 3.7
1.7 1.5 3.1
-3.7
-24.4
2006 2007 2008 2009 2010 2011 2012 2013 2014 2015
Source: WSA
21 April 2014 5
Tata Steel
-1.4
-2.0
-3.0 -2.8 -2.7
-4.1
FY00
FY01
FY02
FY03
FY04
FY05
FY06
FY07
FY08
FY09
FY10
FY11
FY12
FY13
FY14
FY15E
FY16E
Source: MOSL, JPC
India has already tasted a India: monthly net steel exports (kt)
net exports situation during 300
September 2013-January
2014, which helped to 75
improve pricing power
-150
-375
-600
Jul-12
Aug-12
Jul-13
Aug-13
Oct-12
Oct-13
Apr-12
May-12
Apr-13
May-13
Nov-12
Nov-13
Sep-12
Feb-13
Sep-13
Feb-14
Jan-13
Jan-14
Mar-13
Jun-12
Dec-12
Jun-13
Dec-13
Source: JPC
Iron ore prices have Iron ore prices: 62% grade, cfr China, USD/t
bounced back from 200
bottom…
170
140
110
80
Jul-10
Jul-11
Jul-12
Jul-13
Oct-10
Oct-11
Oct-12
Oct-13
Apr-10
Apr-11
Apr-12
Apr-13
Apr-14
Jan-10
Jan-11
Jan-12
Jan-13
Jan-14
Source: Bloomberg
…High iron ore inventories Iron ore inventories (mt) in Chinese ports
at ports remains a risk to 108
iron ore prices
96
84
72
60
Sep-12
Feb-13
Sep-13
Feb-14
Dec-12
Dec-13
Jul-12
Jul-13
Oct-12
Oct-13
May-12
Apr-13
May-13
Apr-14
Source: Bloomberg
21 April 2014 6
Tata Steel
High level of consolidation Share of key suppliers in seaborne iron ore trade
in seaborne iron ore trade
and high cost Chinese mines Vale
will limit the downside risk Others
24%
25%
on prices
FMG
10%
Rio
23%
BHP
18%
1 2 .0
384
363 10.9 1 1 .5
1 1 .0
347
9.4
1 0 .5
329
300
1 0 .0
8.9 9 .5
8.5
295
9 .0
250
7.5
8 .5
6.6
8 .0
241
240
240
240
6.4 7 .5
227
200
6.2
263
7 .0
6 .5
150
4.8 5.2 6 .0
5 .5
5 .0
100 4 .5
FY08 FY09 FY10 FY11 FY12 FY13 FY14 FY15E FY16E FY17E FY18E
Source: MOSL
21 April 2014 7
Tata Steel
856 1,012
543 443 414 411
313 215 212
56
-274 -152
-456 -389
-906
-1,358
Source: MOSL
525
480
435
390
Feb-13
Feb-14
Jun-12
Dec-12
Jun-13
Dec-13
Aug-12
Aug-13
Oct-12
Oct-13
Apr-12
Apr-13
Apr-14
Source: Bloomberg
21 April 2014 8
Tata Steel
…spreads are healthy due Spreads in USD/t: (HRC – 1.6x iron ore cfr China – 0.7x coking coal price FOB Australia)
to sharper decline in input
South Europe China
costs 400
345
290
235
180
Aug-10
Aug-11
Aug-12
Aug-13
Apr-10
Apr-11
Apr-12
Apr-13
Apr-14
Dec-10
Dec-11
Dec-12
Dec-13
Source: Bloomberg, MOSL
-35.7
2006 2007 2008 2009 2010 2011 2012 2013 2014 2015
Source: WSA
58
51 52
38 37
10 11
-11
FY07 FY08 FY09 FY10 FY11 FY12 FY13 FY14E FY15E FY16E
21 April 2014 9
Tata Steel
Upgrade to Buy
Net debt to EBITDA ratio to decline
We believe the consolidated EBITDA for TATA will post a CAGR of 13% over FY14-
16E to INR209b driven by volume growth in Indian business and gradual recovery in
TSE&OS’ margins. We have revised EBITDA estimates by 7.4% and 8.8% for FY15E
and FY16E respectively on improved margins for Indian business as discussed earlier.
-9
Source: MOSL
TATA has been working continuously to unlock value by selling assets that have not
been generating cash flows. Recently, Borivali land (Mumbai) was sold for INR11.5b
and Tata Steel International (Australasia), New Zealand was sold for INR1.4b. INR13b
of cash has been generated in FY15 without loss of material EBITDA. There are many
such assets -- investments in Dhamra Port, Tata Motors, Titan etc which can fetch
~INR100b or more if management so decides. We are valuing these assets at
INR75/share after factoring 20% discount to value of listed stock only. Improved
operating cash flows, no further step-up in capex and recent sale of assets will
deleverage the balance sheet. We expect net debt/EBITDA ratio to gradually decline
to 3.4x by end-FY16. As the benefits of KPO start kicking in during FY17, the gearing
will decline faster.
0.5 0.4
140
494
180
538
181
463
494
160
525
124
601
123
763
163
713
192
707
209
28
62
26
63
74
80
FY05 FY06 FY07 FY08 FY09 FY10 FY11 FY12 FY13 FY14 FY15 FY16
Source: MOSL
21 April 2014 10
Tata Steel
We are upgrading the target price to INR531 (earlier INR268) on improved margin
and higher target multiple of 6.5x (v/s 5.5x) for TSI. The sensitivity to equity value is
high on account of high level of leverage. Further, we upgrade the rating to Buy as
we believe there is no further stretch on balance sheet, while cash flows will keep
improving on acceleration in volume growth in high margin Indian business. The
revised target price of INR531 has an upside of 30% at CMP.
Net debt cut by INR29-30b INR/share 509 541 619 738 734 728
D/E x (adj for goodwill) 2.4 2.1 2.8 3.1 2.5 2.1
CWIP (e) 246,544 298,543
INR/share 254 307
(d1) Discount (%) 33 33
Investments (f) 90,889 90,889
Investment value revised by INR/share 94 94
INR25b (d2) Discount (%) 20 20
TP (c-d+e*(1-d1)+f*(1-d2)) 516,278 598,269
Target Price (INR /share) 531 616
Risk factors
Sharper decline in international iron ore prices -- below USD100/t cfr China
basis.
European steel demand growth falters.
Allocation of capital in investments with higher than 5-6x EV/EBITDA.
Investment in capital intensive low grade iron ore project in Canada.
21 April 2014 11
Tata Steel
21 April 2014 12
Tata Steel
21 April 2014 13
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