UK deal helpful but sector snags may weigh on Tata Steel: Pros

Chintan Mehta, metals analyst at Sunidhi Securities feels the Tata Steel stock is trading at unreasonable valuations and it is advisable to reduce exposure. He does not expect the European business of the company to generate cash flows. Below is the verbatim transcript of Akash Gupta & Chintan Mehta's interview with Latha Venkatesh & Sonia Shenoy on CNBC-TV18.Latha: Debt hasn't come down but we understand cash burn on daily basis has fallen. What is your math? How much did the company save by selling off the unit without palming off the debt? Gupta: We do not have further details on the company. The company hasn't disclosed what the exact losses were at this unit, but all we could say is that the losses would reduce substantially. There were some news reports saying that the UK operation as a whole, they lose about 1 million pounds per day. So this operation so to say is slightly less than half of that in terms of capacity, so you could say that this would be about half of that figure that I just mentioned.Latha: They would save about a 150 million a year you think?Gupta: I am just guessing, of course we don’t know the numbers yet.Sonia: The stock has already rallied significantly in anticipation of this deal. One part of the deal has now gotten completed, so would you expect to see profit taking and considering that the long-term debt is still high, the pension liability still remains with the company, do you think that maybe from hereon, the risk reward doesn’t look that favourable?Mehta: You are right. At current prices, the stock is trading at around more than 1 lakh enterprise value -- 1,04,000 -- which translates with the kind of multiples with states give 6-6.5 EBITDA multiples. The backward calculation is 16,000 crore of EBITDA on consolidated basis, which looks quite unreasonable because considering 6,000 that they made last quarter, even out of the price hikes of Indian operations and 12 million tonnes, the best estimate is Rs 13,000 crore for Indian operations. It is a blue sky scenario for Indian operations whereas European operations are concerned, they are loss-making. So it is difficult to justify the valuation at this point of time. So definitely we are advising our clients to reduce position on Tata Steel or book profits on Tata Steel at this point of time.Latha: Wasn't all this known. We have CLSA and Credit Suisse giving a price target of Rs 170 and Rs 180 and UBS, Bank of America Merrill Lynch, Morgan Stanley, all of them giving a price between Rs 330 and Rs 380 for the stock. What is your price target?Mehta: Before this deal and before minimum import price (MIP) we had Rs 180. However, after MIP, we need to review considering the price hikes which Indian operations have taken out. However, I am trying to figure out that there is Rs 70,000 crore debt in the book and the company has to repay those debt with European operations not making any kind of profits, the whole burden is on Indian operation. The only good thing about this deal is that the company is making USD 25 EBITDA per tonne losses on consistent basis - that will reduce but still the cash flows coming from Europe and operations, doesn't look a possibility and even when these assets were for sale, we have been talking about who will be the buyers for these assets with the debt. So they got rid of that.Latha: What is your price target?Mehta: We are looking at is Rs 180. We are yet to revise after MIP. We will definitely upgrade it post MIP.Latha: The MIP has been extended so I should expect you to extend your price target?Mehta: Absolutely. The MIP has held the thing out so it is coupled with international prices. So clearly Rs 5,000 they have taken a price hike so Q1 will be the best quarter for Indian operations. So definitely price hike will be on the cards but this deal won't affect anything per se.Sonia: How high is the possibility of the stock seen more on the upside purely because MIP if it gets extended through FY17 and FY18 and if Port Talbot also gets sold perhaps at an enterprise value per tonne of maybe USD 50 -- that is what a lot of people are assuming -- then do you think that there is more upside for the stock and would you expect to see more upgrades on FY18 EBITDA for example?Gupta: It won't be appropriate for me to comment on upside to stocks but in terms of what we have seen so far obviously the government has intervened and brought in the MIP, extended the safeguard duty and Tata themselves have tried to address their profitability issues especially in UK. So I do see these being positive for the company. However, from our side we also see certain risks to this recovery being sustainable. So, from our side, we are still looking out for demand growth indicators and also how Indian supply, which is all the major players have been expanding over the past year or so, how that would result in terms of price realisations because of increased competition to maintain their utilisation rates.Latha: What is a good working price for steel when you are making your debt calculations? For the rest of 2016, are you expecting current prices to hold both globally and at home?Gupta: In terms of our assumptions, we are working with 3 percent higher average prices for FY17 compared to last year.