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Management Speak: Tata Steel (Outperformer) - No more leveraging on the cards

We come back positive post our meeting with Tata Steel’s (Tata) top management, at its investor meet, on the following counts: (1) focus on India growth, (2) priority on deleveraging, which points to likely cessation of large-funded acquisitions, (3) smooth integration of recently-acquired Bhushan Steel, and (4) on track formation of JV of Tata Steel Europe (TSE) with ThyssenKrupp. We maintain our Outperformer rating on the stock with a target price of Rs778. We present key takeaways from the meeting:

Mission 2025 - can consider further expansion in India: Tata is increasing its steel capacity to ~25mtpa in India by FY22-end with a 5mtpa brownfield expansion in Kalinganagar (KPO), in line with management’s vision of 30mtpa steel capacity in India by CY25. Further increase could be either through brownfield expansion or the inorganic route. Priority nonetheless would be to enhance its long product portfolio. However, the company will consider further expansion after a review of the market conditions, cashflows etc.

Focus on balance sheet: Deleveraging is a priority for the company and management expects to reduce its debt by US$1bn within a year. We infer management is not too keen on acquiring Bhushan Power, especially after its acquisition of Usha Martin. Tata is also looking to sell its operations in South East Asia, as this is a low-margin business (4-5%) for the company.

Tata BSL integration to provide synergy benefits of Rs15bn/year: Management expects to achieve synergy benefits of ~Rs15bn/year with Tata BSL (Bhushan Steel renamed to Tata BSL), at the consolidated level, by using Tata’s surplus iron ore for Tata BSL, Tata BSL’s surplus power and through other operational benefits. Tata has an environmental clearance (EC) limit to mine ~38mtpa of iron ore from existing mines, which will suffice for its ~25mtpa steel production. The company has obtained the requisite approvals and has already begun supplying iron ore to its subsidiary, Tata BSL (excess iron ore is 3mt currently, and is ramping up further).

Reiterate Outperformer with a TP of Rs778: We expect domestic steel prices to remain under pressure, amid fall in global prices. However, for Tata the fall in blended price should be lower at Rs2,000/t in Dec 2018, in our estimate, given the company’s superior product mix. We perceive management’s priority to deleverage as a positive signal. In our view, Tata will not acquire Bhushan Power, which will remove the overhang on the stock. Tata’s net debt has peaked at ~Rs1,042bn as at Q2FY19-end. We reiterate our Outperformer rating on the stock with a target price of Rs778. We value the Indian operation at 6.0x FY20E EV/EBITDA (Rs683/sh) and the proposed European JV at 50% equity value (Rs96/sh).