MOSL: TATA STEEL (Neutral)-Tata Thyssenkrupp JV will de-risk Tata’s balance sheet-Focus on growth over deleveraging

​TATA STEEL: Tata Thyssenkrupp JV will de-risk Tata’s balance sheet; Focus on growth over deleveraging; Maintain Neutral

(TATA IN, Mkt Cap USD10.4b, CMP INR688, TP INR669, 3% Downside, Neutral)

• ​Tata Steel (TATA) has signed an MoU with ThyssenKrupp (TK) to combine Tata Steel Europe (TSE) with TK's European steel business (TK-SE) in a 50:50 joint venture (JV). Debt of EUR2.5b will be transferred by TATA and EUR4b (including Euro3.6b of unfunded pension liabilities) by TK to the JV. Assuming EUR500m of working capital loan, total net debt in the JV will be ~EUR7b, while combined EBITDA will be EUR1.5-1.6b. Thus, the JV will have net debt/EBITDA ratio of ~4.5x. TATA's net debt will decline to ~INR570b under Ind-AS accounting post formation of the JV.
  
• The entire process of due diligence, regulatory and anti-trust approval is expected to be concluded by end-FY19. Therefore, the JV is likely to become effective in FY20 and realize synergies of EUR400-600m over 3-5 years from now by eliminating duplication of sales, human resource, R&D and administration functions.
  
• The JV will have total sales of 21mt, which will require ~EUR750m of sustenance capex, ~EUR300m of finance cost and EUR100-150m of tax payout. It is likely to generate free cash flow (FCF) of EUR300-400m (EBITDA - sustenance capex - finance cost - tax), which will remain volatile depending upon market conditions. Some of expected synergies will be absorbed by the market, as has been the case in the past. Therefore, we believe the capital structure of the JV has built in enough headroom to absorb market volatility so that there will be no need of funding from the parent. This will unshackle growth of the Indian business and has been a reason for the re-rating of stock. We are increasing EV/EBITDA multiple in SOTP from 5x to 6.5x for TSE, and raising TATA's target price to INR669/sh.