Going gets better for Tata Steel

Higher prices, falling costs and recovery in demand to keep sentiment elevated

Never in recent times have things been looking so good for Tata Steel. The Street realises the ongoing and potential improvements in the business, seen in the stock price. The stock hit a 25-month high of Rs 468.95 in trade on Wednesday.
 
Tata Steel’s stock, along with peers like Jindal Steel and Steel Authority of India (SAIL), has lagged JSW Steel over longer time periods of two and five years but it has caught up with JSW Steel in the past one year. Versus a return of 85.5 per cent for JSW Steel, Tata Steel has almost doubled in the past 12 months; SAIL is up about 42 per cent and Jindal Steel 28 per cent. Analysts though believe there is more room on the upside for Tata Steel. 
 

For one, there are hopes of its British pension funds liability getting resolved. While there was news suggesting a UK financier was reviewing an offer to take over Tata Steel Europe’s (TSE) pension plan (though it will mean some hit for Tata Steel as well), consultations are also ongoing with employees to take a cut, said an analyst.
 
Pension obligations have been the biggest block in TSE’s merger talks with Germany-based ThyssenKrupp. These obligations to the £15 billion scheme also remain a drag on TSE’s profitability in the low-margin UK business.
 
Tata Steel wants to limit UK pension liabilities to the level of contribution and not beyond. Analysts at ICICI Securities say pension and pay restructuring could offer structural cost reductions. The restructuring of British Steel pension liabilities alone could provide $12-13 a tonne of cost savings, with another $6-7 per tonne in employee cost, given the reduction seen in FY17 itself.
 
TSE’s operating profit were about $67 a tonne in the September quarter. Analysts at Religare Institutional Equities anticipate this to fall 11 per cent sequentially to $60 a tonne on lower spreads in the December quarter. However, with global prices on the rise, they expect this to improve for the March quarter. And, coal prices have seen a sharp fall. The Australian export price of premium hard coking coal was $172 a tonne on Friday, compared to $309 a tonne at end-November.
 
The benefit of higher global prices have also flown to the India operations, which have gained from curbs on cheaper imports.
 

Of late, domestic steel demand, after being  impacted by demonetisation, has  started to recover. After a 14 per cent month-on-month decline in demand in November, volumes in December were up 17 per cent over the previous month. On a year-on-year basis, December volumes were up 5.2 per cent. For the India business, analysts at Motilal Oswal Securities estimate per-tonne operating earnings at Rs 9,086, from Rs 7,297 in the September quarter. Volumes should also get a leg-up as its Kalinganagar plant ramps up.
 
Analysts remain positive on the longer term prospects of the domestic steel industry. Those at Reliance Securities say demand is set to grow, with considerable investments expected in construction, infrastructure and manufacturing. They do not rule out higher realisation and lower imports in the coming quarters, due to continued protectionist measures.
 
Taking into account higher operating earnings at Tata Steel Europe during FY18 and FY19, analysts at ICICI Securities have arrived at a target price of Rs 531 for the share. On Wednesday, Morgan Stanley came out with a report maintaining its ‘buy’ rating on Tata Stel, with a target price of Rs 530.