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Tata Steel plunged on the subdued report card, guidance and export duty

Tata Steel may face capacity constraints in FY23, but is on the way to adding another 10MT production capacity by FY30

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Tata steel plunged almost -35% after the subdued Q4FY22 report card in early May and the government moves to impose export duties on finished steel and various allied products to rein in domestic price rise (inflation) in late May. Overall, Tata Steel tumbled over -46% from its lifetime high of 1534.50 (Aug’21) to June’22 low of 827.00 and is currently trading around 905. Tata Steel as well as other steel companies/metal scrips recovered from recession panic lows after China announced a $75B infra fund on 5^th July to stimulate the economy from the COVID slump.

Apart from subdued report card and guidance amid higher raw material and energy costs, Tata Steel as-well-as other major Indian steel companies like JSW Steel were also dragged by lower global steel prices amid the Chinese slowdown (recurring lockdowns under ZERO COVID policy) and the chorus of synchronized global recession, especially in Europe and also in the U.S. amid hotter inflation and faster monetary policy tightening by Fed, ECB, BOE and other major G20 central banks (except China-PBOC and Japan-BOJ).

On 21^st May, the Indian Government slashed additional excise duties on petrol & diesel and cut customs/import duties (tariffs) on various plastic products, and essential raw materials/intermediaries for Iron & steel products to rein on surging inflation. And to increase domestic supplies/availability with stable prices, the Indian government also increased/imposed export duties on iron ore and various finished products of iron & steel.

On 21^st May, to control domestic inflation, the Indian government imposed a 15% export duty on finished steel, which put pressure on export realizations and impacted domestic prices. Also, there will be a 20% additional export duty on iron ore and 45% export duty on iron pellets, while the import duty of cocking coal was reduced to 0% from 2.5% (small 700/- per ton benefit). All of these are negative for the Indian iron & steel industries. Subsequently, Tata Steel and JSW Steel plunged. But user industries (direct/indirect), like Real Estate, Cement, infra Consumers Durables, and Automobiles may benefit going forward if domestic iron & steel prices go down as expected because of possible higher domestic supplies amid ‘unattractive’ export prices.

Europe is now the main exporting market of Indian steel manufacturers after Russia invades Ukraine and subsequent sanctions on Russian steel exports. But even before the Russian invasion of Ukraine, Indian steel exports to Europe were quite attractive due to higher price realizations (profitability) amid lower supply from China (de-carbonization regulation back home) and higher energy costs in Europe.

Overall, 57% of consolidated sales of Tata Steel are from India and 43% overseas (35% from European and 8% rest of the world). But Tata Steel exports around 14%, while JSPL 35%, JSW Steel 31%, and PSU SAIL 9% from their Indian operations. The Modi admin is imposing a windfall tax on Indian steel as well as refined petroleum products to shore up revenue and to ease skyrocketing inflation back home, especially on steel and related products. But if such a windfall tax lingers, it may have a major negative impact on Indian Steel and oil/refining Industry (RIL, ONGC). In any way, the price of domestic steel is dependent on effective import cost (landed cost), not on export price realizations.

Highlights of Q4FY22 report card: Tata Steel (Consolidated)-Restated

 

 

·         Operating revenue around Rs.69.324B vs 60.783B sequentially (+14.05%) and Rs.49.977B yearly (+38.715)

·         Operating expenses around Rs.54.294B vs 44.889B sequentially (+20.95%) and 35.793B (+51.69%)

·         EBITDA around Rs.15.030B vs 15.894B sequentially (-5.44%) and 14.184B yearly (+5.96%)

·         Net interest payment around Rs.1.099B vs 1.532B sequentially (-28.32%) and 1.866B yearly (-41.14%)

· Core operating profit (EBTDA=EBITDA-INTT) around Rs.13.931B vs 14.361B (-2.99%) and 12.318B yearly (+13.10%)

·         Core operating EPS Rs.114.08 vs 117.60 sequentially (-3.00%) and 102.85 yearly (+10.91%)

·         EBITDA margin 21.68% vs 26.15% sequentially (-447 bps) and 28.38% (-670 bps)

·         Core Operating (EBTDA) Margin 20.10% vs 23.63% sequentially (-353 bps) and 24.65% yearly (-455 bps)

Overall, despite higher operating revenue, the sequential EBITDA, as well as EBTDA, was lower due to higher operating expenses mainly driven by elevated energy (Cocking coal) costs. Thus there was a decline in core operating margin despite lower raw material (Iron ore) costs

 

Highlights of the post-earnings presser: Tata Steel (Q4FY22)-As per the company statement

·         Highest ever consolidated EBITDA of Rs.63,830 crores with an EBITDA per ton of Rs.21,626

·         Profit after tax stood at Rs.41,749 crores

·         Consolidated Free Cash Flow was Rs.27,185 crores despite an increase in working capital of Rs.9,618 crores, capex of Rs.10,522 crores, and taxes of Rs.11,902 crores

·         Gross debt stood at Rs.75,561 crores with net repayments of Rs.15,232 crores. Net debt declined to Rs.51,049 crores. Net debt to EBITDA improved to 0.80x; Net debt to equity improved to 0.52x

·         The 6 MTPA Pellet plant at Kalinganagar will be commissioned in 3QFY23 followed by the Cold Roll Mill complex and the 5 MTPA expansion

·         India operation

·         Achieved the highest ever annual crude steel production of 19.06 million tons (MT), with a growth of 13% YoY

·         Highest ever deliveries of 18.27 MT despite COVID 2^nd wave related disruption early in a financial year

·         Broad-based improvement in sales volume was witnessed across segments. Automotive was up 27% YoY

·         Branded Products and Retail was up 11% YoY while Industrial products & projects were up 11% YoY

·         EBITDA stood at Rs.52,745 crores, which translates to an EBITDA per ton of Rs 28,863

·         Europe operations:

·         Revenues increased by 54% YoY to £8,876 million

·         EBITDA stood at £1,199 million, which translates to an EBITDA per ton of £133

·         The Board of Directors recommends a dividend of Rs. 51 per fully paid equity share and Rs 12.75 per partly paid equity shares

·         A 10:1 stock split is also recommended

 

Overall, as per the company statement, Q4FY22 India EBITDA/Ton was Rs.24469 vs 28116 sequentially and 26179 yearly. Also, consolidated EBITDA/Ton was Rs.18937 vs 22610 sequentially and 18253 yearly. In brief, the stated EBITDA/Ton in Q4FY22 was quite subdued. Subsequently, Tata Steel stumbled.

Management Comments:

Mr. T V Narendran, Chief Executive Officer & Managing Director:

“Tata Steel has again demonstrated its ability to deliver stellar results despite heightened complexity in the face of

COVID as well as geopolitical tensions; Our Indian business showed broad-based growth across our chosen segments due to our sustained focus on customer relationships, our distribution network, and our portfolio of brands supported by our agile business model. Our European operations delivered robust performance as the transformation program undertaken helped to leverage the strong business environment. We have pursued several initiatives to de-risk the business, particularly across procurement and supply chain, and continue to invest in technology and digitization to drive productivity and improve our resilience. Kalinganagar expansion is progressing well and will drive cost savings as well as product mix enrichment. The acquisition of Neelachal Ispat Nigam Limited will be closed in 1QFY23 and we will scale it up rapidly to drive the expansion of our high-value retail business. I am happy to share that Tata Steel has been recognized as Steel sustainability champion for the fifth year in a row by the WorldSteel.”

Mr. Koushik Chatterjee, Executive Director, and Chief Financial Officer:

“We have closed the financial year with consistent and record operating and financial performance for the year, surpassing the previous best in FY21, with EBIDTA being 2x and Profit after Tax being >5x the previous year. This is despite the significant surge in international coal prices and the inflationary impact of various commodities. Our full-year consolidated revenues stood at Rs 2,43,959 crores and EBIDTA was Rs 63,830 crores which work out to a margin of 26% and EBITDA per ton of Rs 21,626.

Our cash outflow for the capex in the year was Rs 10,522 crores, which is well within our earlier guidance. We continue to focus on deleveraging while advancing our strategic growth priorities – our focus is on the completion of the Kalinganagar expansion. Tata Steel has generated strong free cash flows of Rs 27,185 crores for the year despite higher working capital, taxes, and capex.

While the Indian business continued to perform strongly with an EBITDA margin of 39% and an EBITDA per ton of Rs 28,863, our European business generated the highest ever EBITDA of £1,199 million (Rs 12,164 crores) which translates to an EBITDA per ton of £133. We have repaid Rs 15,232 crores during the year. As a result of the strong financial performance, our Net Debt to EBIDTA has further improved to 0.8x and our financial metrics continue to be well within an investment grade level. As part of the overall policy to reward the shareholders the Board has recommended a record dividend of Rs 51 per share and have also recommended the splitting of the shares to Rs 1 per share face value in a 10:1 split.”

Highlights of Q4FY22 analyst concall: Tata Steel

·         The global commodities/steel market was very volatile in Q4FY22 amid Russia-Ukraine geopolitical tensions and recurring Chinese COVID disruptions

·         But volatility and supply shortage also brings new business opportunities for Tata Steel in Europe

·         Cocking Coal prices were quite volatile and high around $500/T

·         Western (Europe/U.S.) demand was strong against sluggish Chinese demand

·         Domestic/Indian demand was robust, rose +4% sequentially (Q/Q) on the revival of automotive production led by passenger and commercial vehicles and steady infrastructure spending

·         India production touched 19MT in FY22, while Q4FY22 was close to 5MT; highest ever deliveries at 5.12MT in Q4FY22

·         Better net realizations of around –Rs.1500/T against the guidance of –Rs.3500/T amid broad-based performance led by auto, branded, and retail products coupled with industrial, projects, and engineering segment

·         Downstream portfolios across tubes, wires, tinplate, etc. are doing extremely well with good expansion

·         Europe is doing well with EBITDA over £1.2B; deliveries up +9% in Q4FY22 sequentially; steel prices remain elevated and net realization was up £53/T sequentially, which is better than the guidance and related European benchmark amid better product/contract mix despite some cross currency headwinds

·         The Netherlands is doing well than the U.K. because of a better product/contract mix in favor of packaging and the auto sector

·         Kalinganagar Plant for 6MT pellet will be commissioned by Q3FY23, which should have a beneficial impact on costs. This expansion along with the early commissioning of cold rolling mills and other relevant projects

·         The Neelachal acquisition will provide access to 6000 acres of land between Neelachal and Kalinganagar, which could pave the optionality to build a 25MT complex in Kalinganagar

·         Looking ahead, with the mix of iron ore and recycling-based production across East/South and West India, Tata Steel is aiming for 40MT capacity by 2040 with a sustainable EV-friendly manner

·         FY22 consolidated EBITDA around Rs.63.830B with a margin of 26%

·         Q4FY22 Consolidated EBITDA was around Rs.15.174B, marginally lower sequentially and yearly due to cross currency headwinds, higher raw material, energy costs, and inventory liquidation (volatile end product prices) but partly offset by lower royalty costs; excluding exceptional FX gain of Rs.0.597B, adjusted EBITDA Rs.11.766B, which translates to an EBITDA/T around Rs.23690.00

·         Tata Steel Europe (TSE): Better EBITDA margin at around 16% against 13% sequentially as material costs were up by around £40/T against steel realization by around £53/T

·         TSE material costs were up due to higher inventory liquidation, higher energy prices, and employee-related costs, while partially offset by lower raw material costs and other expenses; higher cocking coal prices were adjusted by lower iron ore prices

·         TSE Q4FY22 EBITDA around £430M, which translates to an EBITDA/T higher by around £45 sequentially

·         TSE has a strong free cash flow of around Rs.13.971B despite higher WC (working capital)

·         Overall, better working capital management has led to a decline in inventory holding days, and going forward the company is confident to maintain the same

·         FY22 gross capex was around Rs.10.522B, well within the guidance of Rs.10.00-12.00B

·         Q4FY22 Finance costs were around Rs.1.099B lower by around Rs.0.434B due to prepayment of TSE in Q3

·         Q4FY22 taxes paid around Rs.2.00B, lower due to a tax credit in Europe

·         Acquisition of Neelachal Ispat would be done by TSLP through the issuance of non-convertible redeemable preference shares to limit the cash burden on TSLP B/S

·         The intense deleveraging effort led to achieving the investment grade rerating by H1FY22

·         Paid back around Rs.15B (~$2B) loan in FY22 against a target of Rs.7.5B (~1B) per year

·         The net debt/EBITDA ratio further improved to 0.8x

·         Overall consolidated liquidity position remains strong at around Rs.37.470B with around Rs.24.500B of cash/cash equivalents

·         The company is holding higher cash due to the impending acquisition of NINL as well as a higher dividend payout at 51/share

·         Cocking coal prices were up by around $50/T in India and €50/T in Europe in Q4FY22 sequentially; for Q1FY23, it would be further up by around $100/T and €55/T respectively

·         TSE is adequately hedged against volatile energy costs in Europe

·         Higher input/production costs because of widespread global inflation are also being offset by higher realized prices of the finished product in the market and also by selling/exporting more in the market like Europe, where final realized prices are comparatively higher (because of Russian/Ukrainian/Eastern Europe) short sully

·         Tata steel has adequate pricing power both in Europe and India despite higher production costs

·         Expecting sequentially higher realizations around Rs.8000-8500/T in Q1FY23 in India and €60/T in Europe

·         Longer-term contractual prices will not tally spot prices often due to various factors, but in Europe, both are now elevated and closer due to the Russia-Ukraine war, while contract prices in India are presently lower than spot prices in India; but in India, most contracts are lower than 30-days; longer-term contracts are usually with automobile companies for 3-6 months and is an ongoing process

·         Tata Steel’s 40MT production/capacity target by 2030 from 25MT in 2023 is aspirational and the company will take calibrated measures considering demand, supply, cost, EV impact, and cash flow

·         The company believes that it can grow organically as well as inorganically along with ongoing deleveraging; i.e. Tata Steel believes it can generate enough cash to take care of growth and deleveraging in the coming years coupled with higher return to shareholders/higher dividend

·         Tata Steel is also diversifying into ‘new materials’ like reinforced polymers, medical materials, graphene, etc along with steel

·         Tata Steel will also expand its captive mining capacity from present 30-35MT to 60-65MT to support a higher steel production plan

·         Provisional Guidance for FY23 capex is around Rs.12B

·         Actively pursuing green steel transition in the Netherlands, but constraint/sanction of Russian gas may be a headwind going forward; U.K. operation is looking for a transition to use scrap steel (recycling) as raw materials rather than using iron ore, but the company may need OPEX support by the British government

·         Tata Steel will continue to pursue organic as-well-as inorganic expansion without taking any fresh debt because of the huge cash flow being generated

·         Tata Steel will spend capex including green transition for future growth along with deleveraging strategy in a prudent way

·         As there is now less probability of Chinese dumping as well as from Eastern Europe (Russia/Ukraine), global steel prices will be stable even after falling to some extent from the presently higher side

·         Tata Steel is now confident of maintaining a minimum 20% EBITDA margin with a huge base

·         Apart from China, and India, there is no significant steel production capacity being added globally; thus there will be a demand-supply imbalance going forward if global production capacity not being added further

·         Although, global steel consumption is slowing down in AEs including China, looking ahead demand may increase because of infra stimulus and EV/green transition. Also demand from India and SE Asia is robust and even Africa is now catching up. Right now, global steel consumption is around 1000MT; in 2021 global steel production was around 1951MT against estimated consumption of 1834MT

·         Tata Steel is adopting a three-pronged strategy (triangulation) of continuous deleveraging, higher return to shareholders, and prudent capex to support future growth amid the transition of new techs and business model

·         The stress is on organic expansion and strategically good inorganic expansion with next-generation technology in an EV sustainable way

·         European operations (Netherlands and U.K.) are expected to expand and transform (EV) in a sustainable way through internal profit and cash-flow generation

·         Steel prices in Europe are robust currently and the company has no plan to hive off European assets in a haste

·         New 5MT Kalinganagar Plant will have a cost impact in FY23, while the revenue impact will be from FY24 (expected)

·         In India, Tata Steel uses around 25% captive Cocking Coal (in-house) and 75% external/bought out. In Europe, it’s 100% external/bought out; going forward, although Tata Steel planning to increase captive Cocking Coal production by double, it’s also planning to increase steel production by double; so the ratio of captive Cocking Coal would be almost same

·         Apart from domestic coal, Tata Steel also imports a large quantity of coal for captive power generation; thus production was not impacted due to recent domestic coal shortages, but some secondary users were impacted due to power cuts/crises in some states and Tata Steel is actively watching the situation for any demand issues

·         Provisional Guidance for FY23: sales around 30MT; i.e. only +0.5MT higher than FY22 due to production constraints (without NINL and 5MT new plant of Kalinganagar)

·         But the company will try to improve margin through significant value addition despite muted volume increase as Kalinganagar cold rolling mill will be soon operational, while effort will be made by enriching sales mix through the more value-accretive (profitable) segment

·         The 1MT NINL (Neelachal) plant will be fully operational FY the end of FY23 as the plant was closed for the last 2-years

·         Will be able to provide more specific volume guidance in Q1FY23 concall

·         The company will reduce debt by a minimum of $1B in FY23 too as per the previous commitment

·         Apart from 2/3 of subsidiaries, all other group subsidiaries are doing well and contributing positively to the consolidated EBITDA

·         Tata Steel will not transact with Russia including buying low-cost Cocking Coal in Europe due to sanctions and also in India due to operational issues; Tata Steel has very limited transactions (buyers of Cocking Coal) even before the Ukraine war

·         TSE benefited by around £100M because of the lower cost of iron ore despite the higher cost of Cocking Coal

·         TSI will ensure the best value addition for the acquisition of NINL

·         After the closure of the NINL acquisition process, TSI will focus on overall consolidation play for long products (TSLP) and other subsidiaries including Tata Metaliks

·         TS is confident about maintaining the Q4FY22 EBITDA/T trend in Q1FY23 too despite the higher cost of Cocking Coal by around $100/T as realization is expected to be increased by around  Rs.8000-8500/T (more than $100/T)

·         New material business expected to grow from present Rs.0.5B to over Rs.1B over next few years

·         Downstream business is also expected by healthy double-digit CAGR

·         TSE is currently building adequate slab stocks at the Netherlands plant (for downstream projects) so that overall volume impact is minimized when certain blast furnaces will go for scheduled maintenance; this will also release working capital in FY23 (cash-flow positive)

·         TSE is working closely with the Dutch government on the Russian PNG issues and is ready for the transition into a hydrogen-based plant by the end of 2030 (as earlier scheduled) or earlier as per EU policy/action

·         At present, TS is not exploring selling iron ore outside the group (merchant mining) due to captive production and demand issues; TS is exploring more captive mining of iron ore to meet its planned production target of 40MT by 2030; but after 2030, may consider the same if there is a huge surplus of captive iron ore and no scope for any significant value addition

·         Despite skyrocketing prices due to the Russia-Ukraine war, the demand for steel is not impacted at all except auto sector for semiconductor issues

·         Russia-Ukraine war and subsequent short supply of steel from Russia/Ukraine and other Eastern European countries is an opportunity for TSE as demands remain robust in Europe

·         Due to captive iron ore constraints, TSI will also stress on scrap recycling route including ELV (End of Life Vehicle) to support volume going forward

·         Immediate expansion plan: NINL from 1MT to 4MT; TSLP (Tata Steel Long Products) will add +0.4MT

·         The expansion of NINL from 1 to 4MT will require around Rs.20-25B capex

·         Around Rs.11.500B has been spent so far for the expansion of the Kalinganagar project out of the earlier plan of Rs.23B

Tata Steel, which is a leading Indian MNC and steel manufacturer, having an operational capacity of around 31MT, is now facing a production shortage and thus guided only about +1.70% incremental sales volume in FY23 (+0.5MT) unless Kalinganagar Plant (5MT) and NINL (1MT in FY23) fully come into operations. TSI is aiming for 40MT from the present 20MT by 2030 with adequate captive mining support in India.

Fair Valuations: Tata Steel (consolidated): Rs.1533-1687 by FY24-25

Considering all pros & cons of Indian as-well-as European operations, robust, but volatile steel prices, synchronized global infra/EV stimulus, and production constraints in India, Tata Steel may report a decline of around -20% core operating EPS in FY23 after FY22 ‘Golden Year’ core operating EPS RRs.475.17. But from FY24 onwards, Tata Steel may report around +10% CAGR (at least on an average) in core operating EPS supported by gradual higher production capacity and better operational cost control coupled with robust steel prices.

 

In FY22, Tata Steel reported a core operating EPS of around Rs.475 vs 191 in FY21. Assuming even -20% decline due to production constraints and lower EBITDA/T amid higher raw material and energy costs, but the lower realization, Tata Steel may report Rs.380.13 core operating EPS in FY23. But considering planned production expansion in India and expected elevated local/global demand, Tata Steel may deliver at least +10% CAGR in core opening EPS from FY24 to FY26.

And assuming a bare minimum (nominal) average PE of 3, the fair valuation of Tata Steel should be around 1584/- in FY22 (already scaled 1539) and.1267/- in FY23 (already plunged to around 828/- after imposition of export duty). Further assuming +10% CAGR instead of the normal +20% in core operating EPS growth (due to production constraints), the fair valuation of Tata Steel may be around 1394-1533-1687 by FY: 24-26. As the market always discounts future earnings at least 1-yr in advance, Tata Steel should scale around 1287-1394-1533 and 1687 by FY: 23-25. Having said that, there is upside risk in Tata Steel's valuation, considering very low core operating PE despite the potential of double-digit CAGR and positive cash flows.

Technical Outlook: Tata Steel

 

Looking ahead, whatever may be the narrative, Tata Steel has to sustain over 825-840 levels for 890 and higher as per the above table. On the flip side, sustaining below 800-780, it may further fall to 710-645 and lower levels as above.

 

P&L Analysis: Tata Steel (consolidated)

 

 

 

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