Tata Steel - Pressure points beginning to return; downgrade to Sell - Centrum

We downgrade Tata Steel (TISCO) to Sell from Hold earlier with a revised target price of Rs310 (from Rs340 earlier). The stock has outperformed broader indices of late with a smart up move of 32%/41% in 3M/6M respectively and has run ahead of fundamentals in our view with pressure points (demand, pricing and margins) beginning to return. Our recent meeting with the company reaffirmed our stance of limited room for margin upside going forward. Pressure on volumes and pricing in both Indian and European operations has returned in Q3 and is expected to keep margins flat QoQ. We cut volume estimates and marginally tweak realizations leading to a drop in our cons. PAT estimates by 6.8%/7.4% for FY14E/15E.

- Demand pressure in domestic operations, volumes to disappoint: Domestic operations are facing severe demand pressure (consumption growth of 0.4% during Apr-Nov) and price hikes (taken in Sep-Oct) have not been sustained through Q3. Management interaction reveals flat QoQ volumes, marginal uptick in pricing at best and subdued margins in Q3. India operations are also likely to miss the 8.5MT volume guidance (given earlier) for FY14E. We have revised our volume estimates for domestic operations lower to 8.2MT/8.7MT from 8.4MT/8.9MT for FY14E/15E.

- Further positive surprises from European operations unlikely: After surprising the street positively at EBITDA level in the last two quarters, we see low probability of further positive surprises from European operations. The demand in Europe has not looked up (despite better PMIs), spreads have narrowed with prices dropping in Oct-Nov period and savings from operational efficiencies are already factored in to a large extent. We retain our EBITDA/tonne estimates of US$30/40 for FY14E/15E and but see downside risks. South-East Asian operations are also under pressure currently due to shutdown in Thailand (due to political tensions) affecting volumes and narrowing spreads at Natsteel.

- Earnings revised downwards on lower traction in margins: We believe that margin traction (at cons. level) would remain limited going ahead (despite positive impact of higher share of domestic volumes) as most cost benefits have flown through and price/cost differential is not expected to widen further. High capex requirements for sustenance (US$500mn for Europe and US$200mn for domestic) along with capex for Orissa project is expected to delay the much needed balance sheet deleveraging. We adjust our volume estimates marginally lower due to continued demand pressure and revise consolidated PAT estimates downwards by 6.8%/7.4% for FY14E/15E.

- Valuation and risks – downgrade to Sell: We continue to value the company on SOTP basis and retain our Sep15E EV/EBITDA valuation multiples of 5.5x for domestic operations and 4.5x for subsidiaries despite an up move in global average multiples as we believe that the industry scenario has not improved dramatically as such. We arrive at a reduced target price of Rs310 on account of reduction in estimates and downgrade the stock to Sell. Key upside risks are higher volumes, higher steel prices and further cost savings in Europe.

Source : Equity Bulls

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