Accumulate Tata Steel for target of Rs 555 - Elara Capital

• Rating : Accumulate
• Target Price : INR555
• Upside : 10%
• CMP : INR506 (as on 14 July 2010)

Tata Sons ups stake

Tata Sons to pour in ~INR16bn, warranting ~3% dilution

Tata Steel (Tata) has announced issuance of additional shares and warrants on a preferential basis to its promoters, Tata Sons Ltd. Accordingly, the company will issue 15mn equity shares and 12mn warrants to Tata Sons. The shares will be issued at a price of INR594/share – at ~17.5% premium to the current market price. The warrants will be convertible into one equity share each at a conversion price of INR594/share. Combining the warrants and equity issuance, the dilution will be to the extent of ~2.8%.

Issue to bring in cash, help increase debt repayments

The total issue is expected to bring in a total sum of INR16.0bn (post the conversion of warrants). Though the same looks inconsequential, considering its consolidated debt of INR531bn, the infusion would help the company tone down the consolidated total debt: equity ratio - from 2.3x to 2.15x. However, Tata is comfortable on the debt repayment schedule as it has repaid ~70% of the debt obligations for FY11 in May 2010. Hence, we believe, the company might increase the debt repayments and prepay its debt.

Further dilution seems probable

Considering the scenario in the steel world, we do not expect margins for Tata (Consolidated) to improve as the major share of its earnings comes from Corus, which is operating in the struggling European region. Despite a strong performance in the March quarter, we believe margins for Corus will be under pressure going ahead due to rising input costs and sluggish realizations. While, Tata Steel India's operations are set to contribute ~33% of the volume sales in FY11E as well as FY12E, the same is expected to contribute ~60% of the consolidated EBITDA. Hence, the profitability of Corus will be critical to the fortunes of the company going forward. Considering the uncertainty in the European steel market and rising cost pressures, Tata might go for additional equity dilution to comfort the financial leverage and bring down the interest burden.

Valuation and recommendation

We expect Tata Steel (Consolidated) to post consolidated EBITDA CAGR of 44% from FY10 to FY12E, largely on the back of a volume growth in Indian operations. We have factored in an EBITDA/tonne of ~USD55/tonne for Corus operations which is lower than its March 2010 quarter figure. At the current valuation, the company is trading at 5.2x FY12E EV/EBITDA which is a discount to its Chinese peers. Hence, considering the current valuation, the fact that Indian operations continue post a robust growth, healthy EBITDA/tonne for Corus and the easing of debt burden, we continue to maintain our Accumulate rating on the stock with a changed target price of INR 555/share (based on 5.5x FY12E EV/EBITDA).

Source : Equity Bulls

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