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Weak operating performance as expected; losses in Europe business likely to reduce ahead

Domestic ASP expected to increase by INR2,200/t and coal costs likely to reduce by USD10/t in 3QFY24

* Tata Steel (TATA) reported an in-line operating performance in 2QFY24, aided by improved volumes in India business, lower input costs and better operating efficiency.

* Consolidated performance: Revenue/EBITDA at INR557b/INR43b were in line with our estimates, aided by lower input costs and better efficiency.

* Consolidated ASP stood at INR78,758/t, which was INR808/t lower than our estimate of INR79,566/t. EBITDA stood at INR6,037/t, which was INR59/t above our estimate of INR5,978/t. APAT stood at INR7b, which was 17% above our estimate of INR6b.

* The European operation remained weak and posted an operating loss of INR25b (in line). Operating loss per tonne stood at USD155/t (up USD57/t QoQ). The miss was led by lower production due to planned relining in the Netherlands, subdued demand in Europe, high emission-related costs, an increase in coal costs in the Netherlands and lower sales volumes.

* Gross debt remained stable QoQ at INR897b (vs. INR904b in 1Q), while net debt increased by INR56b to INR770b (vs. INR714b in 1Q). The net debt-toEBITDA ratio exceeded FY21 levels and came in at 3.5x (up 146bp in 1HFY24) and the net debt-to-equity ratio stood at 0.79x (up 18bp in 1HFY24).

* Standalone performance: Revenue was down 4% YoY at INR332b, 8% above our estimate of INR309b. EBITDA increased by 45% YoY to INR68b, in line with our estimate of INR65b.

* Standalone ASP declined INR1,628/t YoY to INR68,928/t (INR2,392/t above our estimate of INR66,526/t). ? EBITDA/t improved by INR4,503/t YoY to INR14,006/t, in line with our estimate of INR14,063/t. APAT was up 100% YoY at INR45b, 17% above our estimate of INR38b.

* Sales were down 2% YoY at 4.8mt, in line with our estimate of 4.7mt.

Highlights from the management commentary

* On a standalone basis, coking coal costs declined USD59/t QoQ and is expected to increase by USD10/t in 3QFY24.

* Standalone realizations could improve by INR2,000-2,200/t in 3QFY24.

* For TSE, coal costs would decline by ~USD60/t in the Netherlands and ~USD20/t in the UK. Dispatches from TSE are expected to be ~8mt in FY24.

* Negotiations are going on with trade unions in UK and will end in 45 days.

* BF, which was under relining in the Netherlands, is expected to come on stream in 3QFY24, which will claw back 40% of volumes lost in 1HFY24.

* BF at Kalinganagar is expected to come on stream in the next six months and a 0.75mt EAF facility in Punjab is expected to come on stream by FY26.

* Net debt is expected to be around the current levels.

Impairment at TSE drives exceptional loss

* TATA reported INR130b on standalone basis and INR69b as exceptional item in 2QFY24.

* As the UK facility is nearing its end of life, TATA proposes to change the steel manufacturing route by shutting down BF and shifting to the EAF facility.

* Hence, TATA has carried out impairment of the UK facility for its heavy end assets.

* Consolidated exceptional items also included INR12b related to past service costs due to benefits granted under BSPS.

* The management has indicated that there will not be any further impairment related to the UK operations.

Valuation and view

* Though TATA reported a substantial exceptional loss, the management has guided for no further one-off losses from TSE operations.

* BF at the Netherlands is expected to come on stream in 3QFY24. With strong demand from domestic automobile, construction, consumer durables and rural customers, we believe TATA is expected to achieve its yearly sales guidance.

* TATA has guided for a lower coking coal cost across all geographies, which should boost margins. Similarly, natural gas prices in Europe have eased, so the cost is expected to be lower in 2HFY24 vs. 1HFY24.

* We marginally increase our FY25 revenue/EBITDA estimates by 5%/4%. The stock is trading at 6x FY25E EV/EBITDA and 1.4x FY25E P/B. We reiterate our Neutral rating on the stock with our SOTP-based TP of INR115.

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