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Euro zone woes cast shadow over Tata Steel's prospects

Weak demand for its Europe operations will partly offset the gains at its Indian and Southeast Asian operations

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Tata Steel’s March 2012 quarter performance saw positives in the form of Europe (TSE) regaining profitability at the operating level, after losses in the December 2011 quarter. Southeast Asian operations, too, saw volume growth after floods in Thailand impacted volumes and profitability in the previous quarter. And, Tata Steel India’s performance remained strong and profitable.

Though the brought respite, challenges persist in the medium term, especially looking at the European crisis. While Tata Steel has taken various measures to improve European profitability and continues its pursuit, the demand environment is not conducive and FY13 is likely to be a year of transition before benefits start accruing. Emkay Global’s analysts, which have an ‘accumulate’ rating on the stock with a price target of Rs 451, said in a note, “Concerns on European operations continue, with the uncertainty in European economic and political scenario that are likely to impact overall demand.” Indian operations, on the other hand, will continue to add to the consolidated performance, aided by the commissioning of Jamshedpur’s expansion.

For the stock, after its underperformance since August 2011, as well as the recent correction, valuations have turned reasonable, factoring in most negatives. Given the expected gains from modernisation and improving fuel security at TSE and higher contribution from Indian operations, many analysts are positive from a year’s perspective, even as they have tweaked their target prices lower to sub-Rs 500 levels (average Rs 485).

TSE: Improved show
After a disastrous December 2011 quarter, when TSE had seen a loss of $153 million at the operating level, its earnings before interest, tax, depreciation and amortisation (Ebitda) in the March 2012 quarter came in at $29 million. The respite came from declining raw material costs, especially of coal, which at $463 a tonne was lower by $45 a tonne compared to the December 2011 quarter ($508 a tonne). The performance was also aided by higher volumes at TSE — sales of 3.55 million tonnes (mt) in March 2012 was better than 3.35 mt in the December 2011 quarter.

Europe: Challenges continue, but gains as well
However, the challenges haven’t faded and will persist in FY13. The European demand that had grown five per cent in CY2011, is likely to decline by one per cent in CY2012. Demand in emerging economies and North America may grow five per cent. Tata Steel, looking at the challenges, has been taking steps. It had mothballed and closed operating assets that were non-profitable, as well as cut manpower (1,600-1,700 in Europe). Among ongoing measures, TSE is rebuilding its blast furnace-4 at Port Talbot that will help improve efficiency; the benefits will accrue from the second half of FY13.

On the raw material side, the start of the Benga project in Mozambique, will provide partial security on coal supply (25 per cent of requirements), given that TSE does not have captive resources. The plant was officially inaugurated on May 3. Around 850,000 tonnes of coking coal and 200,000 tonnes of thermal coal will be evacuated in FY13. The Canadian iron ore project is also likely to start operations by end-FY13, all of which should support profitability.

MARGIN GAINS IN FY13
In Rs  crore Q4FY12 FY12 FY13E
Revenue 33,860 132,257 129,921
% change 1.20 12.90 -1.76
Ebitda 3,040 11,774 15,791
Ebitda (%) 9.00 8.90 12.15
Adjusted PAT 433 3,452 5,234
% change -81.10 -48.90 51.61
EPS (Rs ) 4.02 54.28 52.46
PE (x) 7.41 7.67
E: Estimates Consolidated numbers Source- CapitaLine plus, Bloomberg, Analyst reports 

India: More gains ahead
Tata Steel India’s sales at 1.77 mt in the March 2012 quarter were higher by three per cent on a year-on-year basis and nine per cent sequentially. For 2011-12, sales at 6.63 mt increased around four per cent. The performance of long products was good, with retail distribution sales growing 43 per cent, crossing the million mark to 1.112 mt. As the ratio of relatively lower-margin semi-finished steel (or semis) declined in the portfolio, best ever sales of flat products (used in auto and consumer durables, among others) were recorded in FY12 (3.74 mt in FY12, growing 5.6 per cent over FY11) and aided margins.

Though realisations during the quarter improved and raw material costs declined, benefits at the operating levels were limited by increasing employee costs (higher provisioning due to a new wage agreement effective January 2012) and forex losses. The combined impact of the two at Rs 520 crore restricted Ebitda per tonne at Rs 16,921 crore ($336 a tonne), a growth of just four per cent sequentially.

Prospects for steel demand in India remain strong. It grew four per cent in CY2011 and is likely to grow at seven per cent during CY2012. Tata Steel has also completed its three-mt expansion at Jamshedpur. The coke oven batteries will also start by November 2012. The expansion is likely to lead to an additional one mt production in FY13 and 2.5 mt in FY14 in the India business, which contributes 75 per cent of profits.

Outlook
Tata Steel’s performance is likely to be driven by domestic operations in the near term and some contribution from Southeast Asia, as outlook for Europe, which accounted for 64 per cent of consolidated sales and 13 per cent of Ebitda, still remains weak. Analysts at Citi see the profitable India business to report volume growth of 16 per cent in FY13. However, they add the medium-term Europe outlook is uncertain as demand is weak; passenger car sales are falling and construction should recover only in 2013. Ravindra Deshpande at Elara Capital, too, sees domestic growth to be good and believes that after the recent correction, the stock is trading at a discount to global peers and, hence, sees an upside.

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