Tata Steel - Mounting challenges; Hold - Anand Rathi

Cost increases to have hit India operations. Utilization at Tata Steel's India operation is likely to have improved, with 3QFY14's 10% yoy volume growth to 2.1m tons. Domestic demand weakness would have been offset by more exports. Currency-driven higher realizations are likely to have seen 3% qoq growth but slight erosion is likely due to a weaker product mix. On the ramp-up of its captive coke-oven battery, progressive benefits would have arisen but rupee depreciation would have hit input costs. Qoq forex losses would have been curtailed by the lower depreciation in the Indian currency.

European business' seasonal weakness. European operations in 1HFY14 have surprised positively, with EBITDA of US$35 a ton due to a steep drop in raw-material prices. But the lagged impact of reduced steel prices is likely to be visible in 3QFY14 due to the pronounced seasonal weakness. Slower European demand would have capped volumes at 3.2m tons and, hence, margins. Asian operations would have been hit by the sharp fall in pig ironrebar spreads.

Less earnings volatility. By FY15, India sales volumes, as share of total sales, would rise 527bps to 37%, reducing the earnings-volatility impact of European operations. Capital deployed on high-yielding assets would improve returns despite ~US$1bn cash infusion in the global operations over three years to fund the losses.

Our take. At the CMP, the stock trades at 5.9x FY15e EV/EBITDA. We have valued it on a sum-of-parts basis with a premium multiple for India, and the low-margin European operations at a discount. Though the company is the best placed of its peers due to its strong marketing network and brand equity, demand conditions in India convey weak volumes and realizations. Hence, we maintain our Hold call and target of Rs. 380 due to the unfavourable risk-return ratio. Risks. Better coal production in India, more resource taxation.

Source : Equity Bulls

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