Buy Tata Sponge; target of Rs 795: Centrum

We upgrade Tata Sponge (TSIL) to Buy as spreads have improved and outlook on the sustenance of the same is strong which gives confidence to smart recovery in earnings over FY18-19E. Q3 earnings were weak despite improvement in spreads due to one-off costs on employee and other expenses. Stock trades at FY18E EV/EBITDA of 3.4x and 5 year AOCF/EV yield of 12% which makes risk-reward favorable. We believe that further rerating trigger could emerge if investment plans for growth are finalized and recent management actions give positive indications towards a decision on the same in the near future.

OutlookWe had downgraded TSIL post Q1FY17 results due to low visibility on spread improvement on which we are now much more confident as sponge iron and scrap prices have recovered smartly and visibility on their sustenance is strong. We value the company at 4x EV/EBITDA and assign 50% value for the company’s carrying value investment of Rs1.8bn in the coal block. Rollover to FY19E and upgrade to Buy with a TP of Rs 795/sh. Key downside risks are a fall in sponge iron prices and higher coal costs, while upside risks are quick recovery of cash from the coal block and higher sponge iron prices.