Tata Steel's June quarter cheers analysts

But, for the stock to get re-rated, the demand environment in Europe and India needs to improve

After the announcement of its June quarter results on Tuesday evening, a host of analysts have turned positive on Tata Steel. This is reflected in the company’s share price, which jumped about six per cent to Rs 255.40. Analysts believe the Street was overly concerned about the company’s prospects and a lot of negative news was already built in the share price. The share price has fallen almost 45 per cent since January, compared to the Sensex’s 0.3 per cent fall.

“Overall, we found the results encouraging and management commentary balanced. We expect upgrades to earnings estimates elsewhere on the Street. We continue to see Tata Steel as potentially a solid beneficiary from its ongoing restructuring,” said Vipul Prasad of Morgan Stanley.

Since the stock is trading at 10 times its earnings and one times its book value, based on FY14 estimates and given the possibility of earnings upgrades, most analysts have a buy rating (after the results) on the stock. "We increase our EPS (earnings per share) estimates by 27 per cent and 13 per cent, respectively, for FY14 and FY15 (primarily on a lower tax rate), and our Ebitda (earnings before interest, taxes, depreciation and amortisation) estimates by three and four per cent. Thus, our June 2014 price target rises to Rs 500 a share," said Pinakin Parekh, who is tracking the company at JP Morgan.

Bloomberg says of the 20 analysts’ recommendations after the results, 14 have a Buy rating on the stock, four have a Sell and two are Neutral, with the average target price being Rs 305.

Operating performance
During the June quarter, due to higher volumes in the India business and better realisations in Europe, the company reported strong performance on a consolidated basis. Although consolidated net sales fell three per cent to Rs 32,805 crore, net profit jumped 91 per cent to Rs 1,139 crore. Though tax outgo fell 61 per cent and boosted profit growth, the good part is that operating profits also increased eight per cent compared to the year-ago quarter. Regarding the latter, the biggest contribution came from the European business, which despite lower volumes (down 2.2 per cent to 3.14 million tonnes) reported a 100 basis points (bps) improvement in the margins. Ebitda per tonne at the European business came to Rs 2,473 in the June quarter as compared to Rs 1,947 last year. Due to this, the contribution of Europe in consolidated operating profit went up 300 bps.

Better cost management, higher volumes of value added products and efficiency gains in the European business has led to new optimism. "The Q1 Ebitda per tonne at the European operations was Rs 2,475 tonne (38 per cent up on a Q-o-Q basis and 29 per cent up on a Y-o-Y basis) compared to our estimate of Rs 935 a tonne. Management commented that the new Port Talbot Blast Furnace No 4, refurbished, Blast Furnace No 7 in Ijmuiden and other efficiency improvement initiatives are showing positive results and this is likely to recur," said Sandip Bansal of UBS Securities.

Outlook
The challenges remain in both the domestic and international markets. Particularly in the domestic market, weakness in both the automobile and construction industries will be key to watch. That apart, from September, its long products facility will go for a 60-day planned shutdown. In Europe, too, the demand outlook is expected to remain subdued for the next few months. This is also why the management is focusing on gains from internal improvements, rather than the external environment which remains challenging. Thankfully, the domestic business should see higher volumes and be able to compensate for the benign pricing environment.