Buy Tata Steel; target Rs 816: Khandwala Securities

Tata Steel Limited, the flagship company of Tata Group, is the largest manufacturer of steel in India with 25.6 million tonne of steel capacity. The company produce HR and CR coils and sheets, galvanized sheets, tubes, wire rods, construction rebars, rings and bearings.

The company recently acquired Corus Plc Limited, which is nearly 5 times bigger than Tata Steel. This is the biggest acquisition by an Indian company domestically as well as globally. This acquisition has helped Tata Steel to achieve 6th position (erstwhile 56th position) in the world in terms of production with 84,000 employees spread across four continents.

The combine entity is expected to have turnover of USD 32 billion with 40 million tonne of steel production by 2011-12. The EBITDA margin will improve to 25% from 13% in the same period. The company intends to increase its capacity to 100 million tonne by 2015 through organic and inorganic route.

Corus EBITDA margin improved to 9.4% from 6.2% in the first quarter of 2007. The company reported 7.2% EBITDA margin for 2006 as compared to 10.1% in previous year. We expect EBITDA margin of Corus to remain around 10% as it has increased price of all its products by 8%-10% in 2007.

The company has announced gigantic investment plan of almost Rs 1 trillion to increase its capacity from 25 million tonne to 50 million tonne by 2015 through organic route.

The company is expanding its domestic capacity from 5 million tonne to 6.8 million tonne by June 2008 and 10 million tonne by December 2010. Besides this, it would setup five greenfield projects in Jharkhand, Orissa, Chhattisgarh, Vietnam and Iran with the capacity of 12 million tonne, 6 million tonne, 5 million tonne, 4.5 million tonne and 3 million tonne respectively.

Tata Steel has strong presence in South Asian market through NatSteel and Tata Steel Thailand (formerly Millennium Steel). The company recently consolidated its position in South Asian market by acquiring five companies through NatSteel.

The company has taken various initiatives on raw material front like JV with Tata Power and L&T, equity interest in Carborough Downs Coal Project. Apart from these, it has formed JV with BlueScope Steel in India for specialize products, Ferro chrome project in South Africa and titania project in Tamil Nadu.

Valuation:

The company’s standalone EPS is expected to take a hit on account of equity dilution for Corus funding but we expect Corus to add significant value to the profitability of Tata Steel. This acquisition would result in substantial synergies in long term. We have arrived at a target price of Rs 816 (March 2009) on EV/EBITDA model and P/E model. This represents 19.2% annualize return for the investors from current level. Steel prices are expected to remain firm on account of strong demand from emerging countries. Even some of the developed countries like Japan and EU are showing signs of strength. The consolidation in the industry will also help steel prices to remain firm (specially in Europe). We expect Corus profitability to improve significantly on account of firm prices and restructuring programme. The company expects to achieve synergies to the tune of USD 450 million over a period of 3 years. The phased capacity addition and the consequent increase in volumes would drive the revenue growth for Tata Steel. Moreover, the synergies benefit emerging from integration of companies like Corus, NatSteel and Millennium Steel would drive the profitability of Tata Steel. At the current price of Rs. 600, Tata Steel is trading at a P/E multiple of 8.3x and EV/EBITDA multiple of 5.4x for FY2007. Our target price of Rs. 816 (March 2009) is based on average of EV/EBITDA model and P/E model. We have valued major subsidiaries independently on both the models. We have taken 4.5x EV/EBITDA and 6.0x P/E for all companies except Tata Steel (7.5x). Investments and other listed subsidiaries are valued at 15% discount to current market price, while unlisted subsidiaries are valued at book value.

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