Tata Steel Limited - India operations to cushion weakness in Europe - Antique

In our view, captive resources along with low cost operations make Tata Steel's India operation as one of the strongest business models. We expect domestic business to report strong earnings growth led by capacity expansion and high visibility over volumes. We believe that though the European business is likely to report weak near-term earnings, this will improve from 2HFY14 led by improved operating performance and a likely recovery in steel prices. While the market is according little value to European operations currently, this could change over the next couple of years. We upgrade Tata Steel to BUY with a revised target price of INR480/share as we expect strength in Indian operations to help it tide over weak European earnings.

Recent uptick in steel pricing, capacity expansion to boost earnings

The recent steel price hike along with capacity expansion at India operations will boost India earnings. We believe that increased visibility over volume growth coupled with low cost of operations and captive resources will drive strong earnings growth for India operations with volumes growing at CAGR of 10% over FY12-15e and EBITDA growth of 10% over FY12-15e. Continued high quality of earnings will make up for the weakness in European operations.

European operations to improve towards 2HCY13

We expect European operations to report improved operating performance led by: 1) marginal recovery in steel demand, and hence, prices towards 2HCY13; 2) improved operating performance at European operations led by restructuring. We expect European EBITDA margins to normalise in the range of USD45/tonne over FY14-15e led by higher efficiencies, cost rationalisation and improved industry dynamics.

Market is currently according very little value to European business

Our reverse valuation exercise suggests that the market is currently according very little value to Tata Steel's European business. European business may be able to achieve normalised EBITDA of USD40-45/tonne compared to USD16/tonne which the current stock price is implying. We believe that this could improve significantly over the next 2-3 years led by improved efficiencies, capacity as well as cost rationalisation, pick up in European demand, and commencement of mining assets in Canada (iron ore) and Africa (coal).

Valuation and outlook

Raise earnings to factor in higher steel prices, marginally lower costs

We have revised our FY13/14/15e earnings estimates marginally to reflect the recent hike in steel prices, marginally lower coal costs as coal prices are being negotiated downwards. We upgrade Tata Steel to BUY from HOLD earlier with a revised target price of INR480/share. We believe that the recent rally in steel prices along with capacity expansion will drive earnings growth for Tata Steel. The stock is currently trading at 4.6x FY14e EBITDA, attractive in our view, compared to its historical range of 4-6x.

Source : Equity Bulls

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