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Beneficiary of a deficit supply dynamics

We raise our TP to Rs1480 and re-iterate BUY rating on Tata Metaliks (TML). We raise our FY23E earnings by 22% on steep surge in DI pipe realisations due to supply deficit market scenario and robust government spending on water projects. We raise our target multiple to 7x on certainty of DI pipe capacity expansion. This implies that TML will have 80% EBITDA from high margin value added product which will be de-risked from commodity cycles. Although the performance in 1QFY22 was backed by high pig iron spreads, we believe the deficit market dynamics for DI pipe business will be a game changer for TML.

Record PI sales and realisations drives performance:

TML reported record high Pig iron dispatches at 89kt (+177% yoy; +11% qoq) on diversion of production to export markets as domestic foundries operated at 30-40% utilisation in 1QFY22 leading to tepid demand for foundry grade pig iron. However, domestic demand for pig iron has recovered with improved utilisation rates at foundries in July’21. Pig iron realisation touched record highs at Rs42,400/tonne, +52% yoy due to multiple price hikes. Performance of DI pipe division was muted due to 33% qoq fall in volumes to 51kt on the back of pandemic led labour restrictions. Effectively, revenues surged by 187% yoy to Rs6bn.

Cost saving initiatives further aid to margin expansion:

Despite multiple hikes in iron ore cost, TML’s cost saving initiatives led to expansion in gross margins at 50% vs 46% yoy. Reduction in coke rates due to high injection of pulverised coal (115kgs), full utilisation of new coke oven and lower cost of domestic coke together helped control the RM cost. Other expense also declined due to savings on power cost from new captive plant and low freight cost. As a result, EBITDA/tonne for pig iron expanded to Rs10,500 vs Rs1722 yoy; Rs8000 qoq. Effectively, TML reported highest ever EBITDA at Rs1.53bn; (+1400% yoy; +7% qoq).EBITDA margins expanded by 2060bps to 25.5% yoy.

DI pipe deficit market a huge opportunity for TML:

Although the record high pig iron spreads will not sustain as pig iron prices have started wearing out and coking coal price has surged by US$100/tonne, we remain bullish on TML’s business due to the supply deficit market DI pipe market and its capacity expansion plan (to be commissioned in 4QFY22). The management has indicated that due to massive spending by government for water projects, the industry is facing demand which is 3x the current DI pipe capacity which in turn has led to 25-30% hike in DI pipe pricing. We upward revise our FY23 estimates by 22% to account for higher DI pipe realisation partially offset by high coking coal cost. We believe that record high margins for DI pipe business due to deficit market scenario and new capacity to cater to this opportunity will be a game changer for TML.

Valuation and risks:

We value TML at 7x FY23E EV/EBITDA to arrive at a TP of Rs1480 and maintain a BUY rating. We raise our target multiple to 7x due to certainty on DI pipe capacity expansion project. This implies that after doubling of DI pipe capacity, TML will have 80% EBITDA from high margin value added product (DI pipe) which will be entirely de-risked from commodity cycles unlike the pig iron business. Key risks: Commodity price risk and delay in capacity expansion.

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