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Tata Steel's Q2FY19 results (Outperformer) - Improved earnings; no further leverage

Q2FY19 result Highlights- Indian operation shines while Europe falters

• Tata Steel reported higher-than-expected consol EBITDA of Rs89.2bn, up 37.9% qoq. However, approx Rs11.8bn was non-operational (~Rs5.8bn forex gain including Rs2.54bn in standalone and ~Rs6bn asset monetisation benefits in Europe). Adjusted for the same, consol EBITDA stood at Rs77.4bn (IDFCe: Rs70.1bn)
• Tata Steel India exceeded our expectations and reported EBITDA of Rs59.9bn (IDFCe: Rs51.6bn), up 18% qoq due to higher volume (up 7% qoq to 3.18mt) and prices. The beat was due to higher than expected blended steel realisation (up 1.6% qoq v/s expectation of 0.3% qoq lower) and lower other expenses which included ~Rs2.54bn forex gain on account of change in fair value of its investment in Tata Steel holdings. Even after adjusting for forex gain, standalone EBITDA stood at Rs57.4bn and adjusted EBITDA/t stood at Rs18,057
• Tata Steel Europe (TSE) operating performance deteriorated and it reported EBITDA of Rs11.1bn which included ~Rs6bn asset monetisation benefits. Adjusted for the same, EBITDA stood at Rs5.1bn (IDFCe: Rs10.8bn), down 69% qoq. This was due to lower volumes (2.27mt, down 7% qoq), higher raw material and energy costs and higher maintenance costs due to production outages.  Adj EBITDA/t stood at US$32 v/s US$102 in Q2FY18.
• Bhushan Steel reported EBITDA of Rs11.7bn during its first full quarter of operations under Tata with EBITDA/t of Rs10,320. It sold 1.14mt during Q2FY19, up 33% qoq.
• South-East Asia operations reported EBITDA of Rs1.12bn, up 2% qoq due to higher volumes (0.67mt, up 11% qoq) offset by lower realisation (US$628/t, down 3% qoq).
• Other trade related operations recorded MTM gain of Rs3.23bn v/s loss of Rs3.66bn in Q1FY19 at the South East Asia financing entities.

Positives: Higher steel prices, lower opex, guidance of debt reduction of ~US$1bn within a year

Impact on financials: Increase EBITDA by 11% in FY19 and by 9% in FY20 to factor in higher steel prices in India

Valuation: Reiterate Outperformer with a revised TP of Rs778

Management indicated deleveraging as one of its priorities now, which is a positive signal. We also believe that TATA will not acquire Bhushan Power which will remove overhang on the stock.  Tata has a net debt of ~Rs1,042bn as at Q2FY19-end and the company’s cash flows will be sufficient to service the debt. Despite factoring in ~3% decline in domestic steel prices in H2FY19 from Q2FY19 avg, we believe that TSI can generate FY19e avg EBITDA/t of Rs17,015 and Rs16,041 in FY20e. With increase in earnings, we raise our TP to Rs778 (earlier Rs755). We value the Indian operation at 6.0x (earlier 6.5x) FY20E EV/EBITDA (Rs683/sh) and take a 50% equity value of the proposed JV (Rs96/sh). We reiterate Outperformer.