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MOSL: TATA STEEL - High time to reassess TSE valuation - Disconnect in actual cash generation and valuation




Motilal Oswal Securities Ltd.


29 Nov 2013





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TATA STEEL: High time to reassess TSE valuation Disconnect in actual cash generation and valuation Tata Steel Europe (TSE) is likely to benefit from operating leverage as the European region exits recession and demand starts to grow albeit at a slower pace. However, the business environment is far more challenging now. Certain operating costs will return with volume growth. TSE took many steps but did not suffice TSE took many initiatives to cut costs, mothballed certain surplus capacities and sold non strategic assets. Yet, specific fixed cost rose due to sharper loss in volumes. Company has been trying to move up the value chain by increasing the proportion of differentiated products. However, the process will remain very gradual and lot more needs to be done to justify the world’s highest specific labor cost. Business environment turns more challenging Increased import pressure led by global oversupply, cheaper freights, withering of annual raw material contract advantage and stricter emission norms are posing new challenges. TSE failed to cover capex by operating cash flows over last 14 years TSE and other subsidiaries (TSE&OS) together have not been able to generate positive cash flows as the sustenance capex requirements have outstripped the cash flow generation from operations. Over FY2000-13, company generated EBITDA per ton of USD43, while the sustenance capex alone takes away USD50 per ton. Therefore, EV/EBITDAx valuation is erroneous. High time to reassess TSE valuation While there is no long term growth in the western world, sustenance of asset is expensive. We believe it is high time to re-think how this asset should be valued. It will be prudent to use EV/EBIT ratio to value TSE (or TSE&OS) as EBIT better represents the cash generation potential of the company. Thus, we switch the method to value TSE&OS at EV/EBIT of 7x (v/s EV/EBITDA of 5x). Adjust SOTP method, maintain Sell We also revise the consolidated FY15E EBITDA by 9% due to revised price assumption for TSI (+4%) and input cost of coking coal. Based on our assessment of industry channel checks and past track record, we push back the commissioning of Odisha project by a year to end-FY16. As a combined effect of the above adjustments, the target price is lowered to INR307 (earlier INR312). Tata Steel’s (TATA) equity value is highly sensitive due to the high leverage. Debt to market cap ratio is nearly 2x. Maintain Sell.

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