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Profitability in Europe to improve

India margin to stay strong

* TATA has been a key beneficiary of rising steel prices. While margin in India has been strong in the last few quarters, Europe should see a sharp jump, with EBITDA/t expected to cross USD250/t by 3QFY22. The deleveraging cycle should continue, with consolidated net debt expected to fall by 32% YoY to INR565b (0.8x EBITDA) in FY22.

* Consolidated EBITDA rose 14% QoQ to INR161.1b (highest ever) in 1QFY22. PAT at INR90.9b was higher than FY21 levels (INR82.7b).

* We raise our FY22E/FY23E EBITDA estimate by 16% each to factor in an improved outlook for Europe. We, however, rate it Neutral as it is trading at an EV/capacity of USD1,064/t, a premium of ~50% to its past five year average.

Pricing boosts EBITDA to a record high despite lower volumes

Consolidated revenue/EBITDA/adjusted PAT increased by 7%/14%/19% QoQ to INR533.7b/INR161.1b/INR90.9b and was 2%/6%/7% below our estimate in 1QFY22.

* Standalone: EBITDA rose 11% QoQ to INR102.5b (4% above our estimate), despite a 13% decline in volume (2.87mt) in 1QFY22. This was on the back of a 13% QoQ improvement in realization to INR72,468/t, which boosted EBITDA by INR7,750/t to INR35,558/t (est. INR34,200/t).

* Tata Steel Europe (TSE) disappointed with EBITDA 42% below our estimate at INR15.3b (though up 28% QoQ). EBITDA/t improved by just USD22/t QoQ to USD88/t (est. USD153/t), despite a USD155/t increase in realization and lower carbon credit costs. This was due to higher raw material and employee cost, and a one-time repair and maintenance cost of INR2.5b.

* Tata Steel BSL had earlier reported an EBITDA of INR30.9b, up 21% QoQ, on the back of higher realization (+14% QoQ) at INR70,226/t. EBITDA stood at INR27,648/t, up 28% QoQ.

* Reversal in working capital, due to higher finished goods inventory and payment of carbon credits, led to low FCF generation (post interest and capex) of INR35.5b, despite record EBITDA of INR161.8b. Working capital increased by INR82.7b QoQ. As a result, reported net debt declined by INR14.2b QoQ to INR739.7b.

TSE outlook improved significantly

* The management guided at a QoQ improvement of EUR200-240/t in realization in 2FQY22 (USD240-290/t) on account of contract renegotiations. Iron ore/coking coal costs are guided to rise by USD20/USD10 per tonne QoQ. As a result, margin is expected to improve significantly in Europe.

* The management guided at an INR3,000/t QoQ increase in steel realization in its India operations.

* The company is aiming to significantly reduce its overseas debt in Europe and Singapore. It pre-paid a EUR0.5b loan in TSE.

Valuation and view

* With captive iron ore availability, TATA’s Indian operations are a play on steel prices. Given the prevailing high prices, we expect margin to remain strong. We estimate 2QFY22 EBITDA at INR200b (+23% QoQ), with standalone EBITDA/t of INR36,574/t (record high).

* While TSE’s EBITDA should be strong in FY22, sustenance would be key to meeting its cash outflow requirements (capex, debt, and interest).

* Deleveraging should remain strong, despite the resumption of growth capex. We expect net debt to decline by ~INR260b in FY22E to INR565b.

* We arrive at our TP of INR1,565/share, based on FY23E EV/EBITDA of 5x/4x for its India/Europe operations. Our TP implies an EV/capacity of USD1,064/t, a premium of ~50% to its past five year average of ~USD700/t, which prices in deleveraging from the up cycle. We, therefore, rate it Neutral.

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