Road ahead is challenging; downgrade to Hold
* Indian business delivered a strong operating performance, with EBITDA of Rs12,187/t. However, we note that the bigger surprise was Europe delivering positive EBITDA of $4/t. We expect the TSE business to report a loss in H1, due to compressing steel spreads.
* Leverage remains high and absolute net debt is also above the Rs1tn mark. We expect no deleveraging in FY21 and FY22 as the support to Europe and capex in India will ensure high leverage. Only an uptick in the steel cycle will not support deleveraging.
* Lower capex in FY21 implies that the Kalinganagar–II project is delayed further. We note that the pellet plant at Kalinganagar will also come up after 12-15 months. The second wave of Covid-19 in Europe, China and other parts of the world will impact steel further.
* We cut our FY21/22E steel deliveries by 12%/9% and EBITDA by 49%/12%. We expect Tata Steel to report a loss in FY21. We roll over valuation to Mar-22 on a SoTP basis and cut the TP to Rs340 (from Rs485). Downgrade to Hold (from Buy), with UW in Sector EAP.
Management guided that FY21 steel volumes will match FY20 with the help of exports. In India, exports constituted 50% of total volumes in Q1FY21 and is likely to come down to 30% in Q2FY21. Thereafter, depending upon the domestic demand, the company will slowly withdraw from the export market. Exports traditionally are a low-margin business as the company sold more of semis, which fetch lower ASP as well as margins. Capex is throttled to allow for regulatory, environment, sustenance and maintenance capex. Growth capex has been practically ruled out.
No resolution of European operations in sight:
Management is in talks with UK and Dutch governments for a long-term solution of these plants, especially UK. Tata Steel has closed/hived off 70% of the capacity acquired in UK in 2007 after a massive write-off over a period of time, but the facility still is completely dependent on steel spreads to generate EBITDA. With ThyssenKrupp merger ruled out, we are not sure about the long-term resolution of the UK business.
Outlook and Valuation:
The stock is trading at 0.5x our FY22 P/B estimates, which is close to its trough valuation. However, it lacks triggers for upsides other than steel prices. With no volume growth and divestments plan, we expect the European business to continue to be a drag on parent operations and constrain any plans for deleveraging in the near term. The outlook for the global economy, especially with second wave of Covid-19 in China and many other countries, can impact any green shoots of revival. Further, mining disruption in Brazil due to Covid-19 can lift iron ore prices and compress TSE spreads further. We downgrade to Hold. Key risk is a surge in steel prices. Downside risk is the second wave of Covid-19.
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