Tata Sponge Q1 review: Stock to find support from cash in books

Tata Sponge Iron posted a healthy set of numbers this week despite capacity constraints that limit its ability to increase volumes significantly.

The company reported 49 percent growth in revenues to Rs 260.9 crore in June 2018 quarter. This was driven by higher realisations, better cost management and optimisation of capacity.

During the quarter under review, the company’s realisations grew by 31.3% to Rs 21,384 per tonne, which along with 16.8% growth in sales volumes led to strong growth in revenues. Moreover, because of huge operating leverage and better cost control, the company was able to post 56 percent growth in operating profits to Rs 60.3 crore.

During the quarter, EBITDA margins stood at 23.1%, up by 100 basis points as against 22.1% in the corresponding quarter last year. Strong growth in sales along with the improvement in the operating margins let to higher profitability. The company posted close to 50% growth in profits to Rs 45.6 crore.

The company aims to achieve better volumes and continues to be optimistic about the pricing outlook. It has applied for clearances from the Environment Ministry to increase the capacity at its existing plants further so that it can drive higher production.

In FY19, the company has guided for volumes of about 4.25 lakh tonnes as against 4.07 lakh tonne in FY18, which is a growth of about 4.4%. In the event of environmental approval, the company could up its utilisation and drive volume growth further in 2020.

Considering the strong demand from the steel industry and low cost of production, Tata Sponge should continue to benefit thanks to a conducive environment. Meanwhile, it is sitting on cash and cash equivalent of close to Rs 700 crore (not including a government due of Rs 200 crore) which it intends to use for forward integration plans, which is currently at an advanced stage of finalisation. As part of this, the company plans to build a 1.5 million tonne long steel manufacturing plant.

As of Thursday close, Tata Sponge was trading at 919 a share, which is about 9 times its earnings. While the company lacks strong growth visibility at least for the next two years, valuations are quite supportive particularly in the light of cash in the books, which is almost 50% of its current market capitalisation of about Rs 1,400 crore.

It is one of the lowest cost producers of sponge iron in the country and generates strong core returns on equity. Moreover, as the company puts forward its integration plans into action, the market will incrementally start to build these expectations into the valuations, which are not yet reflected presently.