Outlook keeps deteriorating
Tata Steel (Tata) reported optically higher than expected consolidated EBITDA for Q1FY20 at Rs53.7bn against our estimate of Rs50.6bn. Brunt of the beat was due to sudden jump in ‘other trade related operations / other unaccountable’ EBITDA. Standalone EBITDA came in at Rs39.6bn (reported) against our expected Rs36.7bn. Unadjusted for forex loss (~Rs2bn) for Ind-AS116 benefits (~Rs500mn), standalone EBITDA stood at Rs13,158/te, slightly higher than our estimate which was based On the back of QoQ price hikes. Price increases witnessed in Q1FY20 were purely a timing issue, as the management predicted ~Rs3,000/te of price decline in Q2FY20E. Tata Steel Europe (TSE) EBITDA/te at US$4 was a potent reflection of the underlying business strength as carbon credit sales dried up and TSE had to provide for GBP16mn for purchase of carbon credits. We upgrade the stock to REDUCE from Sell, given the sharp price correction with a revised target price of Rs355/share (earlier: Rs411/share).
* Timing of flow-through of realisation increase helps standalone EBITDA. Realisation increased Rs916/te QoQ. However, the management was cautious enough not only to guide for higher exports given muted domestic demand, but also to point towards a QoQ realisation decline of Rs3,000/te. This does not factor-in the possible decline in contractual auto realisation when it comes up for renewal in H2FY19. Adjusted for exchange rate movement on investments in Tata Steel Holdings, the company highlighted a standalone EBITDA of Rs14,218/te in Q1FY20 against Rs13,619/te in Q4FYF19. This however does not adjust for the possible boost received on account of Ind-AS 116 adoption.
* TSE reveals its barebone EBITDA. As carbon credit sales (perhaps in preparation of Thyssen JV earlier) desist, EBITDA/te moderated to US$4/te. Even after adjusting for carbon credit purchase provisions of GBP16mn, EBITDA drop from US$90/te QoQ looks massive. Yet, we feel the drop is more reflective of the problematic nature of TSE operations aggravated by production shutdown impacting volumes in Q1FY20. The spread has further contracted by EUR11-12/te and meaningful cash conservation and cost reduction measures are being undertaken to prevent EBITDA loss and self-sustainability in European operations. Both the objectives seem uphill currently.
* Upgrade to REDUCE from Sell, with a revised target price of Rs355/share. We have reduced margins of India business as well as TSE. Reported net debt witnessed ~Rs100bn QoQ increase mainly driven by: i) Rs20bn lease liability created on account of Ind-AS 116 adoption, and ii) Rs40bn liability assumed on acquisition of Usha Martin. Tata management was perhaps strenuous in its commitment to maintain its deleveraging target of US$1bn in FY20E and is also contemplating reduction of group capex by 25% along with possible support of working capital release to achieve the same.
* Earnings/valuations adjusted to account for Ind-AS 16 as well as consolidation of Usha Martin. The failure to divest South-East Asia operations to HBIS further impacts the deleveraging outlook in the name.
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