Tata Steel rating: Buy — A suboptimal Q1 but outlook is good

Tata Steel has reported adjusted consolidated Ebitda of Rs 10.4 bn against consensus of Rs 12.9 bn. While standalone numbers were broadly in line, Tata Steel Europe (TSE) disappointed with Ebitda loss of $42/te (expected Ebitda loss of $6/te). TSE Ebitda has gains on account of sales of emission rights and wage support from European and UK government, while exchange fluctuations impacted. Lower volumes in standalone operations (down 30% y-o-y) impacted Ebitda. Management did highlight Rs 20 bn in costs remain unabsorbed due to lower volumes, i.e operating leverage impact.

FCF generation has been very impressive at Rs 7 bn for the group broken into Rs 16.8 bn in India and Rs 9.8 bn overseas. This has helped maintain net debt q-o-q. Tata Steel remains our top pick, as earnings tailwind (domestic price increases + impending price increase in Europe) and elevated net debt to market cap augurs well. Maintain Buy.

Indian operations reported an in-line print: Q1FY21 sales volumes in India declined 27% q-o-q due to nationwide lockdown; exports were significantly ramped up to 1.46mnte. Auto volumes fell to 0.08mnte from a quarterly run-rate of 0.5mnte. Crude steel output fell by 37% q-o-q as capacity utilisation was curtailed in Apr’20, before gradually ramping back from mid-May’20 onwards.

Overall deliveries in June’20 improved significantly to ~115% of FY20 average monthly overall deliveries; domestic deliveries in Jun’20 reached ~75% of FY20 average monthly domestic deliveries. Exceptional items in Q1FY21 primarily include gain in fair valuation of preference shares held at Tata Steel BSL, amounting to `20.3 bn.

European Ebitda disappointed: Oversupply in European steel markets led to fall in revenue and profitability. Continuous improvement from transformation programme, careful cost management and wage support from European and UK governments helped limit the Ebitda loss at £67 mn while forex created a negative contribution of ~$13/te as per our calculation. Steel demand recovery in EU is slower.

Maintained flat net debt q-o-q; maintain BUY: Q1FY21 was exceptional and Tata fared poorly vis-à-vis peers in its cost control efforts and faced the highest adverse impact of mix deterioration due to high dependence on autos. TSE remains as unpredictable as ever, yet tailwinds exist in the form of impending price hikes in the region. Growth capex has been curtailed. With reviving domestic prices, improved mix, resilient iron ore prices and sanguine balance sheet management can help Tata meaningfully outperform peers (JSWS, JSPL).