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Weak performance; Europe continues to struggle

* TATA reported a weak financial performance in 3QFY23, missing our estimates. It was affected by lower realizations, higher input costs, higher interest expenses and depreciation, and higher freight and handling charges.

* TATA’s standalone revenue was down 5% YoY/6% QoQ at INR305b, in line with our estimate of INR292b.

* Standalone EBITDA was down 57% YoY and up 7% QoQ at INR52b (15% miss). ASP declined by INR8,837/t YoY. EBITDA/t was down 61% YoY at INR11,241/t, missing our estimate by INR2,643/t.

* APAT was down 66% YoY and up 1% QoQ at INR27b (26% miss), due to lower EBITDA and higher interest expenses and depreciation.

* Tata Steel Europe (TSE) missed our estimates significantly. TSE posted an operating loss of INR15.6b, as ASP declined by USD219/t QoQ and USD141/t YoY, along with a corresponding hike of USD/136t YoY in the overall costs.

* TATA’s consolidated revenue was down 6% YoY/5% QoQ at INR571b, an 11% miss on our estimate of INR643b. EBITDA declined 75% YoY and 33% QoQ to INR40b, missing our estimate by 59%.

* Consolidated EBITDA/t was down 75% YoY and 32% QoQ at INR5,661. TATA posted a loss of INR24b against our estimate of a INR43b profit, due to higher deferred tax (INR21.5b mainly relating to BSPS with Tata Steel UK) and margin compression at TSE.

* Gross debt was stable QoQ at INR876b (INR875b in 2QFY23) and net debt stood at INR717b. Net debt/EBITDA stood at 1.76x

Europe to face headwinds; India demand resilient

* European operations, especially Britain, are expected to face headwinds owing to recessionary pressures in Europe, an overhang from BSPS, increasing coking coal consumption costs and assets nearing their end of usage life.

* A majority of steel contracts will be repriced in Europe, which may reduce revenue for TSE as the price reset will be lower compared to last year. If input costs do not correct to a similar extent, there could be a significant compression in margins going forward.

* Coking coal prices have shot up again in the last few weeks to USD365/t from the recent low of UDS250/t. The price increase will be reflected in 1QFY24 results, adding pressure on margins.

* Domestic ASP, however, is more reflective of the spot international market (compared to TSE, which has a lag in ASP vs spot prices). 4Q is a strong quarter in India and we expect steel prices to pick up, driving margin improvement.

* Demand from the automobile and oil & gas sectors is also expected to improve, which will further boost TATA’s margins.

Valuation and view

* During the quarter, the company witnessed the full impact of the correction in steel prices, which touched a low in Nov/Dec’22.

* The entire reduction in steel ASP was reflected in the reduction in EBITDA/t as the benefit of lower coking coal consumption costs was offset by high other costs and high freight and handling expenses.

* 4Q is a seasonally strong quarter owing to higher construction activities, no impediments from monsoon and supportive weather. The recent Union Budget also gave an impetus to the steel sector by increasing the budgetary allocation to the infrastructure and construction sectors, which will also drive steel demand in India.

* Domestic steel prices have started to recover from their recent lows and realizations are expected to be INR1,500/t more than the 3QFY23 average. However, realizations in Europe are expected to witness headwinds over the next few quarters.

* We believe rising coking coal costs, higher interest rates, an overhang from BSPS, assets nearing their end of usage life, and inflationary pressures across Europe are key concerns that will keep the performance subdued in Europe.

* Further, TATA may not achieve its deleveraging target for FY23, which could also prevent outperformance of the stock in the near term.

* The stock is trading at 1.1x FY24E P/B, with 16% RoE expectations, which we believe is pricing in the downside as well. The stock is available at 6.1x/4.6x FY23E/FY24E EV/EBITDA, which looks optimally priced at mid-cycle valuations. We trim our FY24 EBITDA estimate by 5%, factoring in cost pressures and the macro-economic scenario in Europe.

* We reiterate our Neutral rating on the stock and lower our SoTP-based TP to INR 115 (v/s INR123 previously).

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