Equity Research: Tata Metaliks Ltd

Summary

Tata Metaliks looks strong for further up move of 35 to 38% from its CMP with increasing EBITDA by CAGR of 28% and PAT by 39% by FY24.

Tata Metaliks (TML) is a subsidiary of Tata Steel, which started its commercial production in 1994.  A subsidiary of Tata Steel, Tata Metaliks has its state-of-the-art manufacturing plant at Kharagpur, West Bengal, India which produces the finest quality of pig iron and ductile iron pipes in India. The plant’s annual hot metal production capacity is 500,000 tonnes out of which 200,000 tonnes is converted into Ductile Iron (DI) pipes and 300,000 tonnes into pig iron.TML is currently in process of expanding its DI pipe capacity in two phases and it has a healthy balance-sheet. It is one of the few players in the steel pipe sector having a net cash position on its balance sheet.

Strategic Pillar:

Excessive supply of pig iron in market: A combination of over supplied pig iron and shutdown of both the blast furnace led to 23% yoy decline in pig iron sales at 68ktonnes. Imposition of 15% duties on pig iron exports led to correction in domestic prices due to the supply glut. This led to 10% correction in pig iron prices from the peak levels of Rs63,000/tonne. Shutdown in DI pipe plant led to 8% yoy decline in DI pipe sales at 46ktonnes. The biggest positive was DI pipe realisation crossing Rs60,000/tonne due to RM cost pressure and the deficit market scenario. TML reported revenue of Rs6.66bn; +11% yoy; -18% qoq.

Rising Raw Material Cost impacts margin: EBITDA margins declined steeply in 3QFY22 at 9.8% vs 15.5% in 2QFY22 due to further hike in coking coal/ domestic coke cost and high cost inventories of iron ore which attracted high royalties. Instability of the blast furnace (BF) for one month post the maintenance shutdown further led to high fuel cost. EBITDA declined by 32% qoq to Rs678mn. Effectively, PAT also declined 35% qoq to Rs357mn. With stable BF operations in 1QFY23, we expect fuel rates to reduce along with benefits of low iron ore cost. However, coking coal/ coke cost is expected to rise further in 1QFY23. On a net basis, we expect margins to improve in 1QFY23 supported by higher volumes and realisations.The management has indicated that due to massive spending by government for water projects, the industry is facing demand of 4.8mnt for the next two years vs. supply of 4.4mnt thereby leading to a deficit market. This has led to 40% yoy hike in DI pipe realisation for the new contracts, some of which will start reflecting in financials from 2QFY23. This will be further supported by incremental volumes from the newly commissioned DI pipe capacity (phase 1 in March’22). Gradual ramp up in DI pipe volumes over FY23-24 will also elevate margins due to improvement in product mix.

Upcoming Projects, Order Book & Operations:

1. Order load for DI pipe industry -1.3mnt and new inquiries is 1.3mnt i.e. firm demand is 2.6mnt and other projects which has been sanctioned but the demand is not announced yet is 2.2mnt of demand. This takes the total demand to 4.8mnt for the next 2years. Installed capacity of industry is 2.2mnt at 80-85% capacity per year translating into a supply of 4.4mnt for two years. So there is a deficit in supply of 0.4mnt which has led to 40% rise in prices. The management expects DI pipe demand growth of double digits (10- 12%) over next 5-7years.

2. DI pipe new contract prices have moved up by 40-45% as compared to prices in last year due to the deficit market scenario. Prices are now at Rs70,000-75,000/tonne – landed cost which was Rs50,000/tonne last year.

3. Pig iron prices have moved up by more than Rs2000/tonne in January as compared to Q3 average due to cost push.

4. TML aspires to be a 1mnt DI pipe player in longer term. DI pipe business is tough to be mastered by new entrants as there are high entry barriers both on the technical and market side.

5. Utilisation of high cost inventory of iron ore procured in Q2FY22 led to increase in Q3FY22 Rm cost which is expected to ease in Q1FY23. Royalty charges for Q2FY22 were Rs470mn and Rs500mn for Q3FY22. In Q1FY23, impact of royalty is expected to decline as TML will reduce use of high royalty iron ore.

6. Current order book is 9-10months and 60-70% is older contracts. 9-12months is a reasonable order load to have for DI pipes. TML has been carefully picking orders for DI pipe. RM cost has started rising further, so there may be pent up demand from contractors now to sign up contracts at lower rates. UP has sanctioned large contracts recently but it could see some disruption in execution due to the upcoming elections.

7. Three factors led to poor financial performance. First is 15% of export duty on pig iron which converts in Rs10000/tonne drop in realization which was a loss of Rs40crores on EBITDA. Second reason is low spreads of Pig iron which was between Rs5000-6000/tonne (long term average) turned negative this quarter due to exponential surge in coal price to US$670 in March’22 vs US$120/tonne yoy. This is expected to cost Rs30crore loss. Third factor was the shutdown in both blast furnace and DI pipe plant all in 1st quarter. One of the furnace was not operating effectively which led to high maintenance cost – fuel cost hike and loss of production.

8. New DI pipe capacity - phase 1 is commissioned and it takes 3months for the plant to stabilize. 2HFY23 will see good production of DI pipe from new plant.

9. TML will try to hedge coal inventory to adjust it with DI pipe prices by ordering more coal in favorable price environment. Second is hedging of coking coal on Singapore markets. Third is enforcing WPI on DI pipe prices.

Financials:

Valuation:

TML looks strong due to the structural shift to higher margin profile (on commissioning of the new DI pipe plant), which would further mitigate the commodity price risk and provide stability for the spreads. The government had constituted the Jal Shakti Mantralaya whose primary objective is to work with states to ensure Har Ghar Jal (piped water supply) to all rural households by 2024 under the Jal Jeevan Mission, auguring well for DI pipes demand. Government’s focus on providing drinking water to every household by 2024 and prioritizing development of water infrastructure in the country has created demand 3x the current capacity for DI pipes in India which has in turn led to 28-33% surge in DI pipe realisations. TML’s impeccable capital allocation history and superior corporate governance provides further comfort for initiating buy.

We expect EBITDA to grow at a CAGR of 28% during FY21-24E. Over the next couple of years, we expect EBITDA margin to come in at ~20.3% in FY22E & ~22.4% in FY23E. We expect PAT to grow at a CAGR of 39% during FY21-24E. We expect the price of stock to rise to a level of Rs.1072.