Tata Steel: A Prime Beneficiary of COVID Fiscal/ Infra Stimulus and Deleveraging

Tata Steel (NS:): A Prime Beneficiary of COVID Fiscal/ Infra Stimulus and Deleveraging Theme; May Scale 1050-1350 by FY22

Tata Steel closed around 863.05 Thursday (1st Apr), jumped almost +6.31% on Biden (U.S.) infra/green stimulus for around $2.25T, positive for higher demand of global steel. Tata Steel was also boosted by recent rating upgrades by various global investment bankers and rating agencies amid improving operating metrics and deleveraging.

Tata Steel soared almost +12.54% last week (ending 28th Mar). Tata Steel was also buoyed along with other Tata group companies after Tata Sons (Ratan Tata) got the favourable verdict in the Mistry case from SC. The SC verdict was also positive for the overall market as it removes uncertainties regarding some vital aspect of corporate governance. The SC said it is allowing the appeals filed by Tata Group and observed that all the questions of law are in favour of Tata Group. India’s top court also dismissed all the pleas of Mistry and also set aside the NCLAT’s verdict to reinstate Mistry as Tata group chairman.

Tata Steel was also upbeat as promoter Tata Sons increased its stake for the company to 33% from 30% and the company shareholders also approved the company’s plan to merge Bamnipal Steel and Tata Steel BSL (formerly Bhushan Steel (NS:)) into Tata Steel.

Overall, Tata Steel jumped almost +13.52% in March and soared over +246% from its corona low 250.85 (Mar’20) to a recent high of 868.90 (1st Apr). Tata Steel outperformed as being a steel producer, it’s a great beneficiary of reflation trade amid the deluge of global as-well-as local infra/green stimulus. Metal prices including , steel have surged to unprecedented levels on hopes & hypes of infra stimulus including green energy. Steel is being used from Electric cars to bridge; i.e. almost everywhere.

Additionally, in India, the government is undertaking various big infra projects along with additional stress on housing as a part of its COVID stimulus (Atmanirbhar/Self-Reliant theme). As a result, India’s domestic demand for steel is now higher than supplies and thus Indian steel majors, including Tata Steel now have the pricing power and are also adding capacities to keep/increase the market share.

In the FY22 budget, the Indian government stressed infra including transport (railways and roadways), manufacturing, healthcare, urban development, and education, while tried to lower various subsidy burdens. Modi admin is planning to unleash a huge infra stimulus of around Rs.111T; i.e. around $1.50T (almost 75% of India’s nominal GDP!) by the next 5-years (FY26). India also aims to be a $5T economy by FY26.

Tata Steel is an Indian MNC and one of the Indian largest iron-and-steel conglomerates. Overall, almost 59% of Tata Steel’s sales are domestic (India), 40% in Europe, and 1% in the rest of the world; almost 53.4% of Tata Steel’s sales are from export. The manufacturing of steel products (HR coil, CR coil, coated sheets, merchant steel, machine wires, and structural products) constitutes almost 94%, while other (tubes, refractory, pigments, and investment activities) contribute around 6%.

In Q2FY21 and Q3FY21, Tata Steel improved its core operating profit (EBTA-Earnings before Tax and Amortization) significantly due to higher operating revenue, significantly higher prices of steel/finished products (Europe), and lower operating cost amid lower prices of imported coal and lower burden of debt interest. This was partially adjusted by higher prices of iron ore at Tata Steel Europe (TSE) and higher employee cost/bonus.

For Indian operations-Tata Steel India (TSI), domestic iron ore prices were not an issue amid TSI’s backward linkage. The entire iron ore needs of TSI were met from captive sources, cushioning the operating profit. After the Indian COVID lockdown, TSI was benefited from huge pent-up and fresh demand for the automobile sector as well as consumer durable goods, construction, railways and various infra projects. Also, government spending (fiscal stimulus), festive demand and easing liquidity (RBI monetary stimulus) helped overall. Indian steel consumption jumped almost +17.8% in Q3FY21 (sequentially) and +10.7% yearly (y/y).

On a consolidated basis, Tata Steel reported the EBITDA/Ton around Rs.13876.00 in Q3FY21 against Rs.8396.00 sequentially (Q2FY21) and Rs.5003.00 a year ago (Q3FY20). On a standalone basis, TSI reported Rs.20175.00 as EBITDA/Ton against Rs.13127.00 for Q2FY21 and Rs.11059.00 for Q3FY20.

At Q3FY21, TSE generated an operating EBITDA/Ton (after adjusting exceptional items) around Rs.2320.00 against consistent negative figure (loss) in the previous 3-quarters amid recurring European full/partial lockdown (resurgence of COVID) and subdued demand due to seasonal winter factor. But TSE, with its 10MT capacity, may see a turnaround in 2022 when the EU is expected to implement its common fiscal/infra stimulus (NGU).

Apart from blockbuster operating performance, the market is also upbeat about Tata Steel’s deleveraging effort, proactive financial management, and commitment to reducing its huge debt by at least $1B each year; i.e. the company is prioritizing deleveraging over CAPEX. As of FY20, Tata Steel had a gross debt of around Rs.1.16T, which was reduced by around Rs.0.08T through 9MFY21 despite COVID disruptions and slated to decrease further by over Rs.0.12T in Q4FY21 amid increasing EBITDA and capital/equity raising. The market is now expecting Tata Steel’s debt/EBITDA leverage ratio may dip below 4.00 by FY21.

Tata Steel is enjoying a globally cost-competitive advantage amid vertical integration (in-house production of key raw materials), thanks to its Indian operations. Looking ahead, global steel prices are expected to be strong amid a deluge of U.S. as-well-as European and Asian/Indian infra stimulus. All major steel producers including Tata Steel may be a major beneficiary of this global infra/green stimulus. Tata Steel Europe (TSE) may also be a major beneficiary of common EU infra/green stimulus and ‘Made in Europe’ theme.

As domestic (Indian) steel prices are already around a 10% discount from import parity, looking ahead there is little probability of a sharp correction in domestic steel prices. Robust prices in FY22 may help Tata Steel for more debt & interest reduction (deleveraging) going forward. This along with increasing steel prices in Europe, expansion of Kalinga Nagar/India plant (phase-2), improving iron ore (raw material) supplies from commissioning of new capacities, Tata Steel may report at least 15% CAGR growth in core operating EPS in the coming years. Tata Steel should report around 191.23 as core operating EPS (EBTA). In that scenario, assuming a moderate/fair PE, Tata Steel should have an average median fair value of around 1020-1173-1349 (FY: 21-23). As the market is now discounting FY23 forward earnings, Tata Steel may scale 1350 levels by FY22.

Tata Steel was under stress even before COVID amid synchronized global slowdown due to the Trump trade war and Brexit uncertainty; it made a low around 320.25 in Oct’19. Tata Steel Europe was also a victim of high leveraging amid the huge debt and cross-currency headwinds coupled with muted demand for steel in Europe.

The Indian operation of Tata Steel (Tata Steel India-TSI) was quite profitable on higher tariffs for Chinese steel (MIP) and domestic fiscal/infra stimulus for the last few years soon after the Modi government came to power in 2014. At that time, the entire steel industry in India was on the brink of collapse for various reasons, but timely bailout by the new Modi admin saved the entire industry and also their lenders, although higher steel prices affected the user industry like engineering, automobiles. The Modi government was forced to bail out the steel industry as some of the big steel companies; especially Tata Steel was too big to fall as it would create a systemic crisis in the Indian financial sector like today’s ILF&S.

There were some hopes of deleveraging and a resolution of its huge liability of British pension fund (Tata Steel UK). In early 2018, the British pension regulator approved Tata Steel UK to curtail benefits of the erstwhile pension fund to a new pension fund in return for GBP 550M one-time payment to the scheme. Tata Steel UK will continue to be the guarantor of the new pension scheme, which has almost GBP 14B liability under the old scheme. This removed a long-time hangover for the scrip of Tata Steel.

After the resolution of this long pending British Pension scheme, Germany’s Thyssenkrupp (DE:) and Tata Steel agreed to merge their European steel operations (the U.K., Germany, and the Netherlands) to create Europe’s number two steelmaker. The deal was expected to be finalized in late 2018. But, that Thyssenkrupp deal is now marred with various regulatory hurdles and virtually collapsed.

In mid-May 2019, the European Competition Commission blocked the proposed merger between Tata Steel Europe and Thyssenkrupp. The proposed deal would ensure TSE’s huge debt of around GBP 2.2B to be transferred to the balance sheet of the combined entity; i.e. Tata Steel’s debt liability would be significantly reduced. The JV would be Europe’s 2nd largest steel producer after Arcelor Mittal. The EU Commission had objections to monopoly in electrical, auto and packaging steel operations for the proposed JV.

Thyssenkrupp on its part has filed a complaint in EU court in late Aug’19 against the EU Commission’s decision to prohibit its steel JV with Tata Steel as it does not share the EU Commission’s concern. Thyssenkrupp said the commitments it submitted together with Tata would have been sufficient to remove competition concerns, a claim the EU Commission is not ready to agree yet.

As things stand now, the proposed JV between Tata Steel Europe and Thyssenkrupp may still be a possibility and if happens may pave the way for more consolidation in European steel manufacturing space and may also lead to lower costs over time, it will not result in a dramatic reduction of European steel overcapacity amid various curbs placed by trade unions and local authorities to prevent reducing manufacturing capacity as it will create more unemployment, which is already high in Europe. Moreover, the European market is also being flooded by U.S.-designated steels from various Asian producers (China) as a result of Trump’s foreign metal tariffs of an additional 25%.

In brief, Tata Steel has lost a great opportunity to deleverage its debt-heavy balance sheet, which was mainly created during the historic Corus M&A, involved a debt of $12B and subsequent impairment of $3B for TSE. Certainly, Corus/TSE has been proved very costly for Tata Steel as it was mainly debt-funded and a victim of M&A at the wrong economic cycle coupled with China’s aggression for steel production and export at much lower prices.

Over the years, TSE as well as various other foreign operations are now a huge liability of Tata Steel as Indian operation contributes almost 60% of revenue and 90% of earnings. Although debt refinancing is not an issue for Tata Steel, thanks to the credibility and image of Tata Sons (Ratan Tata), lack of visibility of adequate TSE profits or deleveraging was affecting the company.

Looking ahead, Tata Steel is in the process to restructure its India business into four verticals (long products, downstream, mining & utilities and infra) to ensure scale, synergies and simplification. Tata Steel will also continue to rationalize its European operation by creating two business-Netherlands and U.K. This may help the company amid improving domestic demand, expected higher demand from Europe (infra stimulus) and the thrust on deleveraging. Without TSE, TSI should have a fair value of around 1200 on a standalone basis.

Techno-Funda View: Tata Steel
Technically, whatever may be the narrative, Tata Steel may scale around 1050-1350 by FY22.



P&L A/C Analysis: Tata Steel