| Tata Steel : A Source of opportunity Tgt Rs 705
We reiterate our Buy rating on Tata Steel and add it to our Conviction List on improving risk-reward, post the recent underperformance. In our view, the current price does not reflect Tata Steel's strong growth trajectory (46% FY10-FY13E EBITDA CAGR) and improving return profile, driven by robust profitability at India operations (72% of FY11E EBITDA) and sustainable recovery at Tata Steel Europe.
At current price levels, the bad news, if any, is more than priced in, and the market is assigning unjustifiably low (negative) value to the European business, which we believe is in a much better operating position to weather adverse industry dynamics. Catalyst Tata Steel Europe quarterly earnings, leading to consensus upgrades: With current valuations implying a quarterly loss for Tata SteelEurope, any positive surprise on earnings would drive up the stock price. We are 18% above consensus on FY11 earnings. Rising spot steel prices: Tata Steel's earnings are highly levered to prices—a 1% rise in steel prices would increase FY11E EBITDA by 5.6%.
Valuation
We revise our 12-month TP to Rs705 from Rs661 on a target P/B of 2.2x (based on P/B ROE regression framework, reflecting our raised book), implying 40% potential upside. Our TP implies FY11E EV/EBITDA of 6.3x, in line with historical mean and at a discount to peer avg. of 7.0x. The stock trades at 1.6X FY2011E P/B, a discount to the sector avg. of 1.7X, despite sector leading FY11E ROE of 26% (sector ROE: 20%). Tata Steel looks attractive on our risk reward analysis with bull/bear case scenarios implying upside/ downside of 66%/15% respectively. We revise up FY11E EPS by 13% to account for higher margins in the India business to reflect strong 1Q results and fine-tune FY12E-FY13E EPS. Safe Harbor Statement: Some forward looking statements on projections, estimates, expectations & outlook are included to enable a better comprehension of the Company prospects. Actual results may, however, differ materially from those stated on account of factors such as changes in government regulations, tax regimes, economic developments within India and the countries within which the Company conducts its business, exchange rate and interest rate movements, impact of competing products and their pricing, product demand and supply constraints. Nothing in this article is, or should be construed as, investment advice. |
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