Tata Steel Share Price: Kotak Institutional Equities reiterates BUY Rating and revised fair value to Rs 800 (from Rs 700 earlier). Record high steel prices led by strong demand recovery and global tightness in iron ore helps TATA Steel more than peers. Steel spreads in Europe too are catching up after lagging behind Asia in the initial leg. Kotak expects spot spreads to moderate in FY2022E but the current strength helps reduce leverage and drives earning upgrades. Europe divestments, if successful, could re-rate close to our Bull case value of Rs 1000/share.
Focused on Europe exit, finish line is now visible:
Kotak believes the Netherlands divestment to SSAB has a better chance of getting regulatory clearance than the Tata Steel’s earlier merger attempt with Thyssen. IJmuiden and SSAB do not have a geographic overlap within Europe and have limited product overlap. With completion of due diligence, the MOU should be announced in 4QFY21. The deal at a potential EV of US $ 2.5- 3 bn would add Rs 100/share to our fair value and a rerating would provide further upside. Tata Steel management is also working with the UK government to find a sustainable solution for Port Talbot and is resolute on not giving funding support to UK losses.
Tata Steel India business – Growth concerns could become a thing of the past:
Over the past 12 years, TATA Steel has lagged JSW Steel in capacity growth (4.7%/6.3% CAGR). Earnings volatility and cash losses in Europe have cost management bandwidth, balance sheet flexibility and impacted the pace of growth in India. After a potential exit from Europe, India business would generate Rs 130-140 bn FCF before growth capex in FY2022E/23E. With 20% FCF yield, growth plans would not increase leverage.
Tata Steel Domestic earnings to reach record high levels in Second half of FY21 and accelerate deleveraging:
Domestic steel prices are up by Rs 6,500-7,000/ton qoq in Q3 FY21E and exit prices of Q3 FY21 are Rs 4000/ton higher. Supply issues, both, in India and global markets, have driven a Rs 2000/ton or 78% hike in iron ore prices versus Q2 FY21 average. TATA Steel does not get impacted given its backward integration. Kotak estimates EBITDA/ton of Rs 19000/ton in 2HFY21 moderating to Rs 14100/ton in FY2022E with lower steel prices. Steel spreads in Europe too have increased by US $112/ton in Q3 FY21 which would sharply reduce cash losses in Europe.
Inexpensive valuations and re-rating triggers make TATA Steel an attractive BUY (FV revised to Rs800):
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Kotak increases Tata Steel EBITDA by 6%/4%/4% for FY2021/22/23E with 1-2% higher steel prices. According to them, Fair Value increases to Rs 800/share from Rs 700/share on higher earnings and rolls forward to September 2022E from March 2022E. Kotak presents their bull case value of Rs 1000/share factoring divestment of Netherlands at Rs200 bn and re-rating by 0.5X EBITDA. Risk-reward is skewed on the upside in case steel price strength sustains for longer. Maintain BUY on Tata Steel.