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India growth continues; Europe recovers

Tata Steel (TATA) posted adjusted EBITDA of Rs178.1bn for Q2FY22, which though up 12% QoQ, missed our estimate by ~13% due to lower-than-expected profits in both India (TSI) and Europe (TSE). Domestically, higher steel prices and volumes were more than offset by higher coking coal prices and other opex. This resulted in TSI EBITDA/t declining by ~Rs1,971 QoQ to Rs30,710. Higher spreads led TSE to record EBITDA/t of USD209 (up USD120/t QoQ). Working capital increased further, restricting net debt reduction at Rs51bn to ~Rs752bn. While we keep our TSI EBITDA unchanged, we reduce TSE EBITDA by 35% to factor in lower spread, leading to a 10% reduction in FY22E consolidated EBITDA. We largely maintain our FY23 estimates. As a result of lower earnings and lower reduction in debt, and partly rollover to FY24, we reduce our target price to Rs1,698 (earlier Rs1,833), valuing India business at 6.5x average of FY23E & FY24E EV/EBITDA and Europe & Others at 4x average of FY23E & FY24E EV/EBITDA. Reiterate BUY.

India: Higher steel prices and volumes offset by higher RM and opex

TATA has merged Tata Steel BSL (TBSL), and Q2FY22 standalone numbers include TBSL; Q1FY22 and Q2FY21 numbers have been restated too. TSI reported adjusted EBITDA of Rs135.7bn, up 4% QoQ and EBITDA/t of Rs30,710, down by Rs1,971/t QoQ. This was despite higher steel prices (up Rs3,400/t QoQ) and volumes (up 10.8% QoQ to 4.42mt). Besides higher coking coal prices, purchase of pellets and higher opex also hit cost. The change in MMDR Act led to ~Rs5.1bn i.e. Rs1,154/t (for H1FY22) additional premium, which TATA has to pay to the Government as it used to sell to TBSL. With the merger of TBSL, there will be no further cash outflow on account of this. Overall CoP/t increased by Rs7,495 QoQ to Rs43,331. Management does not expect any fall in domestic steel prices in Q3FY22 and guides Rs2,500/t QoQ increase in realization in Q3FY22 with coking coal cost increase of ~USD100/t.

Europe: Higher spread offset volume fall

The increase in gross profit/t (up USD184 QoQ to USD830/t) amid higher steel spread offset weakness in volumes (down 7% QoQ to 2.16mt). This helped TSE to record EBITDA/t of USD209, up from USD89 in Q1FY22. Further improvement in spread and higher volume is expected to offset higher coking coal and energy cost in Q3FY22 and should result in further increase in EBITDA/t QoQ (by USD20-25/t).

 High profitability, deleveraging on; reiterate BUY

Domestic demand is improving, which can withstand higher steel prices in Q3FY22. TSI’s profitability has peaked out (Q3 EBITDA/t may fall by ~Rs2,500/t QoQ to ~Rs28,000+) but should remain at elevated levels in H2FY22. TSE’s profitability is expected to remain firm in H2FY22. Though the pace of deleveraging has been slow in H1FY22 (net debt reduced by ~Rs73bn) due to higher working capital requirement, we expect it to accelerate in H2FY22 with stable operating profits and release of working capital. We expect net debt to decline to Rs545bn in FY22 and further to Rs305bn in FY23. We do not foresee any major acquisition by TATA till FY23. We retain BUY, with a revised target price of Rs1,698.

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