Buy Tata Steel Ltd For Target Rs.767
Deleveraging surprises positively; maintain Buy
* Consolidated revenue/EBITDA/PAT of Rs396bn/94bn/40bn were in line with our estimates of Rs383bn/94bn/39bn. Revenue/PAT/EBITDA grew 7%/55%/141% qoq, driven by strong operating environment and a benign cost trajectory.
* India operations saw the highest-ever EBITDA, driven by significant price hikes effected in Q3 - especially in Dec, which should get reflected in Q4 results as well. The company repaid Rs77bn debt in Q3. Net debt was down by Rs103bn in Q3 and Rs186bn in 9MFY21.
* Tata Steel has restarted the pellet plant and CRM expansion at Kalinganagar as part of its KPO-2 expansion program. The pellet plant will be commissioned in 12 months and CRM in about 18 months. Simultaneously, the work on KPO-2 is likely to start in Q1FY22.
* Though we remain wary of falling steel prices and rising coal prices, which in turn compress margins, we note the tailwinds of a high NSR regime are strong enough to effect another round of heavy deleveraging. While we raise FY21E EBITDA by 23%, we are reducing FY22E EBITDA by 7%. In our view, deleveraging-supported valuation is attractive. Maintain Buy with a TP of Rs767 (Rs638 earlier).
Flush with liquidity: Tata Steel reported net debt reduction of Rs186bn in 9MFY21. It received Rs60bn toward advance sale of steel in the exports market. Further, Rs72bn liquidity was achieved through the release of working capital. It has also exercised a call option for PP shares issued in Feb’18, which should bring in additional liquidity of Rs36bn in Q4. Q4 ASP is likely to be higher by Rs6,000-7,000/t qoq. All this should lead to net debt reduction in Q4 closer to Rs800bn vs Rs861bn achieved in Q3.
To restart India expansion: Tata Steel has announced the restarting of the pellet plant and CRM at Kalinganagar. We believe it is a matter of time before the 5mt brownfield expansion (KPO-2) is also announced, although the commissioning will be at least 36 months from the date of announcement.
Outlook & valuation: The company’s quantum of debt repayment has taken us by surprise. The commissioning of the pellet plant and CRM mill will add value in FY22/23E. The reduction in net debt is likely to re-rate the stock, provided: 1) steel prices do not correct sharply from current levels; 2) the company does not get into the acquisitive mode again; and 3) Europe delivers positive EBITDA. We value the Indian business at 7x FY22E EV/EBITDA and the European business at 4x due to its non-integrated nature, coupled with inefficient processes at Tata Steel UK. We raise of TP to Rs767 from Rs638, factoring in the strong tailwinds of price hike and net debt reduction set to happen in H2FY21. Key risk: Higher-than-expected moderation in steel prices after trade activity resumes in China post the New Year holidays.
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