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Tata Steel's Q1FY20 results (Outperformer) - Near term weakness; hope hinges on demand revival in H2

Q1FY20 result Highlights- Higher steel prices supports earnings

Tata Steel reported in line adj EBITDA of Rs55.3bn, down 29% qoq.

• Tata Steel Standalone (TSI) reported better-than-expected adj EBITDA of Rs42.8bn (IDFCe: Rs40.1bn) due to higher realisation. Adj EBITDA was down 12% qoq due to lower volumes (3.01mt, down 16% qoq) offset by higher realisation (up ~2% qoq). Adj EBITDA/t stood at Rs14,209, up 4% qoq.
• Tata Steel Europe (TSE) could just break-even at EBITDA level with adj EBITDA of Rs625m, down 96% qoq. Reported EBITDA/t stood at USD4 v/s USD66 in Q4FY19. This underperformance is due to higher raw material cost, inventory valuation, lower volumes (down 12% qoq to 2.26mt) due to unplanned shut down at one of the facilities in UK during Jun and provision for purchase of carbon credits (~Rs1.4bn).
• Net debt increased by Rs82bn qoq to Rs1,031bn at Q1FY20-end. Approx. Rs39bn increase was on aacount of acquisition of Usha Martin’s steel business whereas reclassification of lease liabilities to debt on adoption of IND AS116 contributed to Rs28bn increase while the rest was on account of working capital movement.

Positives: Higher steel prices, FY20 capex guidance cut by 25% to ~Rs80bn;

Negatives: Lower volume, TSE nearly break-even EBITDA, weak pricing outlook

Change in estimates: Reduce EBITDA of FY20e/FY21e by 20%/9% to factor in lower prices and lower profitability in Europe

Valuation: Reiterate Outperformer with a revised TP of Rs512

Tata’s initiative to reduce working capital and cut in FY20 capex guidance by 25% is prudent amid weak macro environment.  Tata is still trying to offload its low margin South East operations (MoU signed with Synergy Metals) but should be at a lower price (earlier value with HBIS was USD327m), if it happens. With continuous weakening of domestic demand and higher exports, management’s guidance of Rs3,000/t fall in steel prices will depress profitability in Q2FY20 (expect EBITDA/t of Rs12,000, down Rs2,200/t). However, we believe that should form the bottom.  Management did not sound confident on Govt’s action to impose safeguard duties so as to restrict imports at a lower price from FTA countries, atleast in the short term.

We rollover our valuation to FY21 earnings. With cut in earnings, we revise downwards our TP to Rs512, valuing the Indian operation at 6.0x FY21E EV/EBITDA and European operation at 5.0x FY21E EV/EBITDA. We reiterate our Outperformer rating on the stock.