Tata Steel Rating ‘buy’; India volumes in Q2 a positive surprise

Tata Steel’s Q2FY21 (India) volume of 5.05mt (up 18% y-o-y) is higher than our estimate. We believe resurgent domestic demand in automotive, API and tubes would help the company improve standalone Ebitda/t by 2x q-o-q to Rs 11,900/t in Q2FY21.

We continue to prefer Tata Steel in the ferrous space as its domestic operations are on a sound footing while the performance of European operations (TSE) is set to improve. Besides, debt seems to have peaked out given ensuing capex intensity is low. We also believe the balance sheet restructuring at TSE would demand much less of parent support. Retain Buy with an unchanged TP of Rs 500 (exit 6.4x FY22e Ebitda).

Domestic volume springs back
Tata Steel’s India volume at 5.05mt (up 22% y-o-y)—highest ever—was ahead of our estimate of 4.51mt. Other positives: (i) A lower proportion of exports, down 24% compared with 50% in Q1FY21, would improve blended realisation; (ii) auto shipments improved 10% y-o-y with market share gains; (iii) increased traction in high-margin products such as API-grade plates and tubes. Shipments spiked 23% y-o-y and 50%y-o-y at TS-BSL and Tata Steel-Longs Products, respectively. Additionally, owing to destocking, we expect some working capital release.

Next trigger: Improvement in TSE profitability
Sales volume edged down y-o-y (but up 14% q-o-q) to 2.3mt. While TSE is expected to incur an Ebitda loss of $40/t in Q2FY21, we expect a turnaround thereof as spot spread in Europe has risen $100/t over the past three months. We expect higher spreads to show up in contracts in H2FY21. Additionally, we believe TSE’s balance sheet is more robust now following restructuring of debt and interest cost; this implies the financial support-ask from parent is going to be lower. Furthermore, lower imports and disciplined production cuts in Europe should aid prices.

Outlook: Improvement all around

We remain positive on Tata Steel as:
(i) domestic price uptick q-o-q is likely to increase domestic Ebitda/t by 2x to Rs 11,900/t in Q2FY21; (ii) a higher CRC-HRC spread is likely to benefit the company, being the market leader in the auto space; (iii) TSE balance sheet is much better post-restructuring, and the outlook is improving; and (iv) focus on reducing debt and rationalised capacity expansion aspirations would keep leverage in check.

Besides, Tata Steel (besides SAIL) is best placed in the current operating environment of escalating iron ore prices owing to full integration for India operations. We maintain BUY/SO with TP of Rs 500. The stock is trading at 5.6x FY22e Ebitda.