Tata Steel Ltd - Impressive show, but may not sustain; Maintain Hold - Centrum

Tata Steel's results surprised us positively with improved operational performance across divisions but predict moderation in margins going ahead, particularly in European operations. Pressure on margins will return in coming quarters due to i) seasonal weakness and soft demand, ii) higher raw material costs and iii) inventory (built up in Q1) related pressure on costs and realizations. Estimates have been revised upwards marginally for FY14E/15E to account for better operational efficiency and product mix. We continue to maintain neutral stance on the stock with subdued outlook on its European operations, lower margin profile in domestic operations on reduced backward integration post expansion and high interest costs on account of the large debt pile. Maintain Hold with a target of Rs255.

Domestic operations show resilience: Domestic operations showed resilience in the tough demand environment with sales volume at ~2MT (up ~26% YoY) backed by 45% higher flat product sales. Realizations improved marginally on QoQ basis and EBITDA/t at Rs14100 surprised positively driven by lower RM costs and efficiency.

European operations surpass EBITDA estimates, lead to cons. margin beat: Cons. EBITDA stood at ~Rs36.9bn, ~15%/16% above our/consensus est. with a margin of 11.3% led by strong operational performance from European ops (EBITDA/t of US$44, up 24% YoY). However, we believe the higher inventory build up led by strong production was the reason for this outperformance which may not sustain going ahead as demand remains subdued. South-East Asian operations were also subdued with EBITDA/t of US$19 due to shutdowns and spread squeeze.

High margin may not sustain, earnings revised marginally up: We do not expect high margin performance to sustain going ahead particularly in Europe as low demand and inventory are expected to put pressure on volumes and realizations. Volume estimates are consequently cut to 13.5MT from 14 MT for European operations but higher EBITDA/t of US$30 (vs US$25 earlier) for FY14E has been pencilled in. Standalone EBITDA/t estimates have been reduced by 1.5%/2% for FY14E/15E to account for higher coking coal costs (negatively impacted by rupee depreciation). We revise our consolidated EBITDA estimates upwards by 3.4%/2.5% for FY14E/15E.

Valuation and risks - Maintain Hold: We continue to value the company on SOTP basis with domestic operations at 5.5x FY15E EV/EBITDA and overseas subsidiaries at 4.5x FY15E EV/EBITDA to arrive at a target price of Rs255. Maintain Hold. Key upside risks to our call would be continued better operational performance in Europe and higher volumes. Key downside risks would be lower volumes, sharp increase in RM prices and further depreciation in rupee increasing INR debt exposure.

Source : Equity Bulls

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