Analyst corner: Retain ‘buy’ on Tata Steel with revised PT of Rs 680

Tata’s 2Q ebitda rose a strong 60% year on year (YoY) and was a 35% beat vs JEFe led by better-than-expected margins across businesses. India ebitda/t should expand further in 2H as full benefit of recent steel price hikes flows through. Potential sale of Netherlands plant can drive value unlocking and reduced exposure to Europe can aid valuations. We upgrade FY22-23E EPS by 22-25% and retain ‘buy’ with a revised Rs680 PT. Our bull case PT is Rs900, 83% upside.

Big turnaround and deleveraging. Tata’s Q2 ebitda was up 60% YoY (12x QoQ) and 35% beat. Standalone and BSL delivered strong results with volumes rising 21-23% YoY (partly destocking) and ebitda/t up ~Rs7K QoQ (~2-4x QoQ). TSE ebitda/t also improved QoQ but remained negative, partly pulled down by carbon provisions. Q2 net profit was at Rs15 billion vs. Rs44 billion loss in Q1. 1H free cash flow was strong at Rs129 billion, resulting in net debt falling by 8% (Rs72/sh).

Further margin expansion in second half. Indian spot flat steel prices are ~Rs6.5K above Q2 average and contract prices are getting revised upwards too, which should boost 2H ASPs (Tata expects Rs4-5K Q-o-Q rise in 3Q). Access to captive iron ore is a positive amid elevated ore prices. We expect Tata’s 2H standalone ebitda/t to expand to ~Rs16K. TSE margins should also improve in the second half but the broader outlook remains weak due to subdued demand in Europe, import pressures and tightening carbon regulations.

Europe asset sale can unlock value. Tata is in discussions with Swedish steelmaker SSAB for sale of its Ijmuiden plant in the Netherlands. Tata produced 10.3mt steel in Europe in FY19-20 (~9.5mt sales) with ~7mt at Ijmuiden.

While TSE margins are currently under pressure, Ijmuiden is one of better assets in Europe with high exposure to autos and packaging. Assuming a normalised ebitda/t of US$60-80 on 6.5mt sales, it has ebitda potential of $390-520 million. At 5-6x EV/ebitda, the asset could get transaction EV of ~ $2-3billion. Tata’s UK plant has very weak profitability, but zero EV would likely be the trough asset value especially if capital support from Tata remains limited. Our SOTP has $0.8billion EV for TSE, and we estimate Ijmuiden sale can drive net value unlocking of ~$1.2-2.2billon (~16-30% of market cap).