Tata Steel - ENAM

We are revising our long standing negative stance on Tata Steel and upgrading the stock to BUY. Our earlier negative call was largely based on concerns regarding the European ops, which have played out over the last 1 year. Since current stock price factors in zero EBITDA from Corus, we believe valuations are compelling.

- Domestic steel prices firm: Domestic steel prices have not declined along with global prices on INR depreciation and production disruption due to iron ore mining issues in India. Tata Steel's domestic ops are best placed to benefit from it as it has 100% captive iron ore. Though we do not rule out a slight correction in domestic steel prices, we expect the recovery in Chinese steel prices to support steel prices in India.

- Benga coking coal (Mozambique) to yield results soon: We are also bullish on the Benga coking coal project due to Rio Tinto's focused development program (Tata steel holds 35% with 40% off-take rights). As per Rio Tinto, production will start from end FY12, which will support profitability of Corus to some extent in FY13.

- Domestic volumes to grow in FY13, driven by the 2.9 mnt brownfield expansion scheduled to be completed by end-FY12.

- Operating environment for Corus to remain challenging due to weak steel demand in Europe. Q3FY12 will particularly report very weak profitability, as decline in RM cost will come through with a lag. Our EBITDA per ton estimates for FY12 and FY13 are at USD 16 and USD 31 respectively.

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Our EBITDA/ton estimates for domestic ops are at USD 420 in FY12 and USD 300 in FY13. We have factored in the impact of MMRD Bill (doubling of royalty and 26% tax on captive coal mining) for India ops in FY13. Without considering the impact of MMRD Bill, our FY13 EPS estimates would have been Rs 58 (vs. Rs 48 currently). We raise our FY13 EV/EBITDA target multiple to 5.5x from 5x earlier, in-line with recent rebound in valuations of comparable steel stocks. Upgrade the stock to BUY with a revised target price of Rs 481 (vs. Rs 420 earlier), 20% upside from CMP of Rs 403. The stock currently trades at 4.9x FY13 EV/EBITDA.

Key risk to our call – Further deterioration in European macro situation.

Source : Equity Bulls

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