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Tata Steel's Q2FY20 results (Outperformer) - Steel prices bottoming out; high debt restricts equity value

Q2FY20 result Highlights- Lower steel prices depresses earnings

Tata Steel reported lower than expected consol adj EBITDA of Rs40.2bn, down 29% qoq (IDFCe: Rs46.5bn). Though Europe and India business reported in-line operating results, the miss was on account of other trade related operations, which was primarily related to adverse forex movement.

• Tata Steel Standalone (TSI) reported in-line adj EBITDA of Rs33.3bn, down 22% qoq (IDFCe: Rs34.2bn) primarily due to lower realisation (down 7% qoq) and lower volumes (2.98mt, down 1% qoq). Realisations were lower on account of lower domestic prices and higher exports. Adj EBITDA/t stood at Rs11,178, down 21% qoq.
• Tata Steel Europe continues to underperform, though in-line, with reported EBITDA at Rs1.6bn (Rs0.6bn in Q1FY20) with EBITDA/t of US$10 (US$4 in Q1FY20). This continued underperformance in Europe is on account of lower steel prices, unplanned outages offset by lower raw material prices.
• Tata Steel BSL reported EBITDA of Rs5.2bn, down 33% qoq due to lower steel prices (down 14% qoq) which inturn was due to adverse product (lower auto sales) and geographical mix (higher exports). EBITDA/t stood at Rs5,198, down 45% qoq.
• Net debt increased by Rs39bn qoq to Rs1,092bn at Q2FY20-end.

Positives: lower operating cost in India

Negatives: Lower steel prices, increase in debt

Change in estimates: Reduce FY20E/FY21E EBITDA by 8%/3% to factor in lower steel prices

Valuation: Reiterate Outperformer with a revised TP of Rs447

Though domestic steel prices are set to rise, we expect Q3FY20 to be marginally better on a sequential basis and expect margins to improve from Q4FY20 onwards only. Tata Steel’s balance sheet is likely to remain leveraged. We expect debt to pare down from peak levels of Rs1,092bn at Q2FY20 to Rs1,019bn at FY20E end and Rs967bn at FY21E end. Divestment in South-East Asia, expected by Jan-20, and other assets in Europe would help reduce debt further (not factored in). We value TATA’s India business at 6.0x FY21E EV/EBITDA and Europe steel business at 5.0x FY21E EV/EBITDA to arrive at our revised target price of Rs447/sh (earlier Rs488/sh).