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Deleveraging to be strong despite capex

Near-term margin outlook is positive

* Tata Steel (TATA) has been a key beneficiary of rising steel prices. As expected, it reported a strong 4QFY21, with consolidated EBITDA rising 205% YoY to INR142b (its highest ever) on the back of higher prices. Net debt fell INR123b QoQ to INR826b (lowest since Mar’18).

* We expect steel prices and margin to stay strong on tightening demandsupply in Asia and raise our FY22E/FY23E EBITDA estimate by 77%/36% and our TP by 35% to INR1,205/share. Net debt is expected to decline by a further INR188b in FY22E to INR638b, despite the resumption of capex for the 5mtpa expansion of the Kalinganagar plant.

* TATA is trading at a FY22E EV/capacity of USD899/t, which is at a 30% premium to its five-year average. This is already discounting the expected deleveraging from the current upcycle. We therefore remain Neutral.

Best ever quarterly EBITDA

TATA’s consolidated revenue/EBITDA/adjusted PAT rose 26%/50%/99% QoQ (est. +1%/-3%/0%) to INR499b/INR142b/INR76b.

* Standalone: EBITDA rose 37% QoQ to INR91.9b (est. INR86.8b) on the back of a 19% improvement in realization to INR64,153/t (up 5% v/s our estimate). Volumes were down 1% QoQ to 3.3mt (in line). EBITDA/t stood at INR27,800/t, up 39% QoQ (up 6% v/s our estimate). Adjusted PAT stood at INR56b, up 99% QoQ (up 6% v/s our estimate).

* Tata Steel Europe (TSE) posted an EBITDA of INR11.9b (est. INR31.3b) as against a loss of INR7.2b in 3QFY21. EBITDA/t stood at USD66/t (est. USD170/t). The miss on EBITDA was due to higher carbon credit provision of GBP69m (USD39/t) and a miss on realization as only one-fourth of the QoQ increase in EU steel prices was realized by TSE. This was due to contracts fixed earlier at lower prices.

* Tata Steel BSL had earlier reported an EBITDA of INR25.7b (est. INR20.5b), up 58% QoQ, on the back of higher realization (+20% QoQ) at INR61,367/t. EBITDA stood at INR21,510/t, up 52% QoQ.

* Consolidated net debt fell by INR123b QoQ to INR826b, led by strong FCF generation (INR88b) and receipt of final call on partly paid-up shares (INR32b). Net debt reduction was INR245b in FY21.

* Consolidated revenue/EBITDA/adjusted PAT rose 12%/75%/7x YoY to INR1,563b/INR305b/INR82.6b in FY21.

* OCF/FCF stood at INR379b/INR310b in FY21, up 88%/216% YoY due to higher EBITDA, working capital release of INR101b (adjusted for export advance), and a lower capex of INR70b (v/s INR104b in FY20).

KPO-II expansion back on track

* The company has restarted expansion work on the 5mtpa KPO-II, which would be commissioned in 2HFY24. This will involve a capex of INR230b, of which INR70-80b has already been spent. Pellet plant and CRM facility at KPO are expected to be commissioned earlier in 1HFY23.

* The management has guided at an increase in India EBITDA margin by INR4,000- 5,000/t (INR6,000-7,000/t increase in realization offset by an INR2,000/t rise in cost) and Europe spreads by EUR70/t in the Netherlands and GBP40/t in the UK in 1QFY22.

* The management has guided at incremental volumes of 1mt each in India/Europe (17.3mt/8.8mt in FY21).

* Capex guidance for FY22 stands at INR110b, of which INR75b is for its India operations.

Valuation and view

* With captive iron ore availability, TATA’s Indian operations are a play on steel prices. Given the prevailing higher prices, we expect margin to be strong. We estimate 1QFY22 EBITDA at INR175b (+23% QoQ), with standalone EBITDA/t of INR33,370/t (record high).

* While TSE’s EBITDA should be strong in FY22E, sustenance would be key to meeting cash outflow requirements (capex, debt, and interest).

* Deleveraging should remain strong, despite the resumption of growth capex. We expect net debt to decline by a further INR188b in FY22E to INR638b.

* We arrive at our TP of INR1,205/share, based on FY23E EV/EBITDA of 5x/4x for its India/Europe operations. Our TP implies EV/capacity of USD906/t, a 30% premium to its past five-year average of USD696/t, which prices in deleveraging from the upcycle. We therefore remain Neutral.

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