Tata Steel proves mettle; will it see further upside?

Tata Steel came out with robust set of consolidated numbers. Its net sales were at Rs 311.5 billion for the quarter; EBITDA was at Rs 49 billion (EBITDA margin 15.7%) and adjusted net profit was at Rs 20.8 billion. Adjusted fully-diluted EPS for the quarter was Rs 24.1. This can mainly be attributed to the increase in steel price realization.

There has been an exceptional actuarial gain of Rs 41 billion due to the increase in the bond yield held in the various pension funds of Corus and that is the reason for reported PAT to be higher than EBIDTA.

The stock has been on an upmove since past few sessions on the back of strong numbers and firming steel prices. But how much upside can we see in the stock more?

In terms of valuation, the stock can be valued in terms of EV/EBIDTA, where the future EV i.e the Enterprise Value (Market value of debt+ Market Value of the equity) is not known. Therefore we can assign a multiple to EV/EBIDTA, depending on the peer valuation and industry trends and multiply it by the expected EBIDTA. International industry average of 6-7x forward multiples.

After getting the EV value deduct the debt to get the equity value and divide it by the number of shares (post any kind of dilution) and derive price per share.

We can individually forecast or estimate the EBIDTA of Corus and Tata Steel and assign the EV/EBIDTA multiple and get the EV of the company

Corus, after posting EBIDTA of USD 750 million in Q1FY08 is expected it to post EBIDTA of USD 2.8 billion in FY09 and Tata Steel which registered net profit of USD 450 million is expected to post EBIDTA of USD 2.2 million in FY09. CLSA has assigned an EV/EBIDTA multiple of 5X. This translates into EV of USD 24.6 billion, the company has consolidated debt of USD 8.3 billion.

When debt is deducted from the EV the company's equity value comes to USD 16.3 billion or Rs 670 billion. This translates into Rs 777 per share and Natsteel snd Millenium Steel per share stands at Rs 22 per share and embedded value per share in listed investments at Rs 36, adds to SOTP target price for Tata Steel at Rs 835.

Or in simpler terms, the stocks currently trades the stock trades at 5.3x FY09E revised EBIDTA on EV/EBIDTA multiple, which is seen to be inexpensive compared with the international industry average of 6-7x forward multiples. Prabhudas Lilladherhas has upgraded the stock to buy, as it expects good upside potential from the current level on the long-term basis.

Also one of the major strengths of the company is that it is relatively protected from increases in the prices of key raw materials since it meets 100% of iron ore and around 70% of coal requirements from its captive mines 

Firming steel prices works in favour of the company. Hot Rolled Coil prices in US have shown first signs of recovery as prices have been reported to increase by USD 5/t as compared to the USD 65/t slide in the past three months. Cold Rolled Coil prices have also registered their first increase by USD 5/t after reporting a USD66/t slide in the last 3 months. Currently average HRC prices in US are reported at USD565/t and CRC prices are at USD658/t.

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