| Tata Steel Ltd (TATA IN) EUROFER further increases Europe steel consumption forecasts for CY14-15E with Q1 stronger than expected | Overweight Price: Rs418.90 17 Apr 2014 Price Target: Rs550.00 PT End Date: 31 Dec 2014 | |
Europe’s steel association (EUROFER) in their latest quarterly update has upped steel consumption forecasts for CY14-15E vs. its previous forecast released in Jan-14. As per EUROFER, Q1CY14 also turned out to be stronger than expected, with apparent steel consumption now expected at 4.2% v/s 3.3% earlier forecast. CY14 apparent steel consumption growth is now estimated at 3.4% (vs. 3.2% earlier) and CY15 at 3% (vs. 2.9% earlier).
· We believe investors are underestimating TATA’s leverage to a European recovery and there will likely be large upgrades to consensus earnings estimates through CY14. JPM is at the highest end of Bloomberg consensus estimates for FY15-16E. TATA remains our top pick in Indian Metals and Mining.
· Domestic demand driving in Europe: As per EUROFER, in Q4CY13 gross fixed capital formation increased 1.4% y/y, and importantly, it expects this to increase by 2.8% in CY14 and 3% in CY15. EUROFER believes domestic demand would also be supported by moderate growth in private consumption and government expenditure. Importantly, EUROFER commented that ‘domestic demand is seen strengthening, primarily driven by a rebound in investment in machinery and equipment but also owing to a modest recovery of construction equipment’.
· What drove the strong March quarter in Europe? As against its previous forecast (Jan-14), growth forecasts for most of the sub segments were increased, with construction (35% of steel consumption) seeing a seasonal rebound. Autos (18% of steel demand) was also stronger than forecast.
· Flat products imports declined y/y in Jan+Feb 2014: Interestingly, flat steel imports declined in Jan+Feb 2014, with flat product exports out of China having fallen.
· Key segment wise outlook
o Construction (~35% of steel consumption): As per EUROFER, construction is expected to bottom out in Q2CY14, before resuming its upturn. This follows a 7-year period where total construction activity declined by 18%. The improvement is expected to be driven by residential construction, with continued growth in Germany, UK and Sweden and recover from low levels in other countries.
o Automotive (~18% of steel consumption): As per EUROFER, automotive is expected to continue its moderate growth trajectory with automotive demand expected to increase with an improving economy.
Table 1: EUROFER Forecast for European Steel Consuming sectors (April 2014)
As of Apr-14
|
%of total Consumption
|
CY 2012
|
CY 2013
|
Q114
|
Q214
|
Q314
|
Q414
|
CY 2014 F
|
CY 2015 F
|
Construction
|
35.0
|
-5.1
|
-3.0
|
3.2
|
-0.2
|
1.1
|
1.9
|
1.4
|
2.2
|
Mechanical engineering
|
14.0
|
-0.5
|
-3.7
|
3.1
|
2.4
|
2.8
|
3.6
|
3.0
|
4.4
|
Automotive
|
18.0
|
-4.6
|
1.3
|
6.5
|
3.2
|
2.3
|
2.0
|
3.5
|
2.3
|
Domestic appliances
|
3.0
|
-1.3
|
-0.2
|
1.5
|
2.5
|
2.2
|
5.6
|
2.9
|
4.0
|
Other Transport
|
2.0
|
2.7
|
2.4
|
4.4
|
5.1
|
4.5
|
4.0
|
4.5
|
4.7
|
Tubes
|
13.0
|
-6
|
-4.7
|
0.4
|
4.8
|
6.6
|
8.0
|
4.8
|
3.8
|
Metal goods
|
14.0
|
-2.7
|
0.1
|
3.0
|
2.6
|
2.4
|
2.5
|
2.6
|
3.8
|
Miscellaneous
|
2.0
|
-2
|
-1.0
|
3.0
|
3.5
|
3.5
|
4.0
|
3.5
|
3.3
|
Total
|
100.0
|
-3.7
|
-1.8
|
3.4
|
2.1
|
2.4
|
3.1
|
2.7
|
3.1
|
Real Steel Consumption % YoY
|
-5
|
-2.7
|
3.0
|
1.4
|
1.9
|
2.4
|
2.1
|
2.4
| |
Apparent Steel Consumption % YoY
|
-10.1
|
-0.4
|
4.2
|
5.3
|
1.6
|
2.4
|
3.4
|
3.0
|
Source: EUROFER.
Table 1: EUROFER Forecast for European Steel Consuming sectors (Jan-2014)
As of Apr-14
|
%of total Consumption
|
CY 2012
|
CY 2013
|
Q114
|
Q214
|
Q314
|
Q414
|
CY 2014 F
|
CY 2015 F
|
Construction
|
35.0
|
-5.1
|
-2.9
|
2.4
|
0
|
1.5
|
1.7
|
1.3
|
2.4
|
Mechanical engineering
|
14.0
|
-0.5
|
-3.6
|
3.1
|
2.1
|
3
|
3.5
|
2.9
|
4.4
|
Automotive
|
18.0
|
-4.6
|
0.7
|
5.4
|
3
|
1.2
|
2.4
|
3
|
2.5
|
Domestic appliances
|
3.0
|
-1.3
|
1.1
|
2.5
|
2.9
|
3
|
3.1
|
2.9
|
3.7
|
Other Transport
|
2.0
|
2.7
|
2.1
|
4.3
|
3.7
|
4.4
|
5.2
|
4.4
|
3.8
|
Tubes
|
12.0
|
-6
|
-4.4
|
0.2
|
2.8
|
4.2
|
5.8
|
3.1
|
5.2
|
Metal goods
|
14.0
|
-2.7
|
0
|
2.6
|
2.4
|
2.9
|
2.9
|
2.7
|
3.4
|
Miscellaneous
|
2.0
|
-2
|
-0.6
|
2.9
|
3.1
|
3.2
|
3.4
|
3.1
|
3.3
|
Total
|
100.0
|
-3.7
|
-1.8
|
3
|
1.8
|
2.3
|
2.9
|
2.5
|
3.3
|
Real Steel Consumption % YoY
|
-5
|
-1.9
|
2.5
|
1.1
|
1.8
|
2.2
|
1.9
|
2.4
| |
Apparent Steel Consumption % YoY
|
-10.1
|
-0.5
|
3.3
|
4.1
|
1.2
|
3.9
|
3.2
|
2.9
|
Source: EUROFER.
Investment Thesis
TATA remains our top pick despite the stock being up 50%+ since mid-August vs. the SENSEX up 8% over the same period. In our view, expectations of a potential improvement in European metals demand are positive for TATA’s European operations. We believe an improving Europe over the next two years implies further a re-rating of stock. In addition, we believe domestic demand should remain stable with limited new capacity addition from major players. Potential investment sales to de-lever could provide further upside.
Valuation
Our PT of Rs550 is based on FY15 estimates. We use a target multiple for TATA Europe of 6x EV/EBITDA, given the visibility in Europe steel demand. We estimate TATA is trading at a significant discount to MT on headline FY15E estimates (TATA trades at 5.2x FY15 EV/EBITDA vs. MT at 5.8x (using Bloomberg consensus estimates for MT) and the discount widens if we were to adjust for a) the CWIP sitting on the books relating to Orissa and b) the TATA Motors stake. Adjusted for CWIP, TATA trades at 4.2x FY15E EV/EBITDA. In our view, the discount between TATA and MT should narrow, given TATA is also levered to a European recovery.
FY 15 EBITDA (Rs bn)
|
Multiple (x)
|
EV (Rs bn)
| |
Europe
|
6.0
|
45.7
|
274
|
India
|
5.7
|
136.4
|
778
|
Asia
|
5.0
|
9.2
|
46
|
Total EV
|
1,098
| ||
Net Debt
|
615
| ||
CWIP
|
116
| ||
Pension Deficit
|
43
| ||
Derived Equity Value
|
556
| ||
No of Shares (MM)
|
1,013.8
| ||
Target Price (Rs/share)
|
550
|
Source: Company reports and J.P. Morgan estimates. Note: Adjusted for CWIP.
Risks to Rating and Price Target
Key risks (other than macro economic weakness) include a sharp decline in India profitability, weakness in steel price and a decline in European demand.
