FREE

Event update: Tata Steel (Outperformer) - A step forward

Tata Steel has successfully negotiated with Thyssenkrupp AG (TK) and signed a definite agreement for a 50:50 joint venture (JV), which entails combining assets of European operations of both entities. There is a minor change in the deal compared to the memorandum of understanding (MoU) signed in Sep 2017. TK will now receive additional 10% stake of the expanded equity before the IPO of the JV (effectively TK’s stake will rise to 55%). The IPO may take place only after 2-3 years once the deal concludes, in our view. The deal is expected to be closed by FY19-end post regulatory approvals. We view the proposed JV to be positive for Tata Steel, as the deal will restrict future cash outflows from Indian operation. Reiterate Outperformer with a target price of Rs755.

Details

• The JV will become the 2^nd largest flat steel producer in Europe, with steel production of 21mtpa and potential EBITDA of EUR1.8-2.bn/year. We believe the proposed JV will be financially self- sustainable, as cash flows will be sufficient to cover the interest expenses (~EUR200m) and capex (EUR900-1,000m). However, we do not expect any major dividend payment by the JV in the initial two years.
• The proposed JV will have debt & liabilities of EUR6.5bn initially. Tata Steel Europe will transfer ~EUR2.5bn debt and TK will transfer its pension liabilities of ~EUR 4.0bn to a proposed JV, on similar lines as proposed earlier. The JV will have some working capital debt too, the amount of which will be known at the time of conclusion of the deal.
• Management expects cost synergies of EUR 400m-500m (expected EUR400-600m earlier) per year in next 2-3 years. We expect ~50% of the synergy benefits to accrue in the first year itself.

Our view: A much-needed agreement without any major change

We believe the signing of the definitive agreement for the proposed JV without much alteration will be positive for Tata.  The deal is expected to save any further equity infusion by Tata Steel India to the European operation. Tata’s balance sheet will remain leveraged (Net debt ex Europe JV will be ~Rs817bn) at FY20-end. We have not assumed the probable acquisition of Bhushan Power yet. While Tata’s cashflows will be sufficient to meet the debt, the equity value would reduce. We believe these negatives are already in the stock price and we thus advise buying on declines. Reiterate Outperformer with a TP of Rs 755, valuing Tata Steel ex-Europe at 6.5x FY20E EV/EBITDA (Rs659/share); we have taken 50% equity value of the proposed JV (Rs96/share).