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Tata Steel's Q1FY19 results (Outperformer) - High steel prices supports earnings

Q1FY19 result Highlights- TSI in line while TSE shines

• Tata Steel’s India operation performance was in-line with expectations but Tata Steel Europe’s performance was above estimates. Consol EBITDA of Rs64.7bn (IDFCe: Rs65.9bn), down 0.5% qoq, was adversely affected by ~Rs5.0bn unrealised forex losses which will remain amid appreciating US$. The operational entity’s EBITDA stood at Rs72.3bn, up 12% qoq
• Tata Steel India (TSI) reported EBITDA of Rs 50.7bn, up 5.5% qoq, and EBITDA/t of Rs17,077, up 7.6% qoq, driven by higher realisation (up 3.4% qoq) partially offset by lower volume ( down 2% qoq to 2.97mt) and higher RM cost. The management informed Rs1.7bn one-off cost related to rates & taxes which will not be repeated. However, we treat these costs as a part of business operations. TSI made provision of ~Rs3.3bn to be paid to govt for additional interest on differential royalty on coal (shown as exceptional item), though it is contested.
• Tata Steel Europe (TSE) results improved with reported EBITDA of Rs 16.7bn, up 44% qoq driven by high steel prices (up 1.4% qoq) coupled with improved operational efficiencies at its UK plant as Q4FY18 was affected adversely due to operational issues at its hot strip mill in UK plant which led to adverse product mix. EBITDA/t stood at US$102 v/s US$70 in Q4FY18. At its South-East Asia operations, EBITDA increased by 16% qoq to Rs1.1bn due to higher spreads.
• Other trade related operations recorded MTM loss of Rs3.66bn v/s profit of Rs4.2bn in Q4FY18 due to adverse forex movement at the South East Asia financing entities. In standalone entity too, it recognised MTM loss of Rs1.26bn v/s MTM gain of Rs3.3bn in Q4FY18.

Positives: Higher steel prices, TSE EBITDA/t improves to US$102

Negatives: Lower volume at TSI, higher CoP, MTM forex loss of ~Rs5bn

Valuation: Reiterate Outperformer with a TP of Rs755

The key concern is Tata’s leveraged balance sheet with net debt of ~Rs1,067bn as at Q1FY19-end. While the company’s cash flows will be sufficient to service the debt, it would reduce the equity value. It would be positive for the stock if Tata does not acquire Bhushan Power. We value the Indian operation at 6.5x FY20E EV/EBITDA (Rs659/sh) and take a 50% equity value of the proposed JV (Rs96/sh) to arrive at a target price of Rs755. We reiterate Outperformer.