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Company update: Tata Steel (Outperformer) - Awaiting demand recovery

The last six months have seen BSE metals index slide 25% amid global trade war uncertainty and companies’ slipping profitability. Tata Steel (TATA) is no exception, given its leveraged balance sheet (down 36%). Though the balance sheet does not raise alarm on the possibility of a default, it does restrict equity value. We believe Q2 earnings will be the bottom for Tata on our base case of the economy bottoming out in the domestic market. We estimate 19% yoy rise in FY21E EBITDA, post 25% yoy fall in FY20E. We have cut EBITDA by 7%/3% for FY20E/FY21E (due to lower prices) and our target price to Rs488, valuing the Indian operation at 6.0x FY21E EV/EBITDA and European operation at 5.0x FY21E EV/EBITDA. We reiterate Outperformer rating on the stock.

FY20E could see incremental volumes of 1mt from India operations: We expect Tata Steel to achieve 1mt incremental volumes from the India operations in FY20E, on the back of newly acquired steel plant of Usha Martin (~0.5mt) and ramp up in Tata Steel BSL. We estimate sales volumes of 3.01mt (flat qoq, down 5% yoy) in Q2FY20E from standalone operations with higher exports on a qoq basis.

Tata Steel BSL merger and synergies on track: Tata Steel’s merger with Tata Steel BSL is on track and is likely to be completed by Q3FY20 end. TATA has excess iron ore mining capacity of ~4mt, which the company expects to supply to Tata Steel BSL over next two years, generating additional EBITDA of ~Rs8bn/year FY21E onwards.

Balance sheet to remain leveraged but peaked out: We believe Tata’s leverage is near to peak level but expect the company to remain leveraged with net debt of Rs996bn as at FY20-end (Rs1,054bn in Q1FY20). We do not expect significant reduction in TATA’s debt, given 1) Rs257bn capex over FY20-21E, which includes Usha Martin’s steel business acquisition and 2) subdued profitability in Europe.

Reiterate Outperformer with a revised price of Rs488/sh: We expect demand revival Q3FY20 onwards to drive earnings in H2FY20 and FY21. We have cut EBITDA by 7% for FY20E and by 3% for FY21E; however, a 7% tax rate reduction should boost PAT by 25%/23% in FY20E/FY21E, respectively. We value TATA’s India business at 6.0x FY21E EV/EBITDA (TATA’s 5-year average 1-year forward EV/EBITDA is 7.3x) and Europe steel business at 5.0x FY21E EV/EBITDA to arrive at our revised target price of Rs488/sh.