Buy Tata Steel; target of Rs 818: HDFC Securities

HDFC Securities's research report on Tata Steel

Tata Steel Europe (TSE) and thyssenkrupp Steel Europe (TKA-SE) will merge their assets into a 50:50 JV. The resultant entity will be the 2nd largest European steelmaker with vertically integrated operations in Port Talbot (UK), Ijmuiden (Netherlands) and Duisburg (Germany), driving significant consolidation.  Synergies  of  EUR  400-600mn  are expected by FY20, driven mainly  from the optimization of duplicate functions like admin, sales, and procurement,  in  addition to efficiencies in logistics and bundling of R&D functions.

Outlook

For Tata Steel, the JV implies significant derisking of its operations from volatility in Europe and reduction in net debt (EUR 2.5bn). thyssenkrupp moves another step towards shedding all its materials/commodity businesses. Further,  the  valuation of its equity stake in the deal (~EUR 2.0bn in our estimate)  is  accretive  straightaway  (invested  capital  of ~EUR 5bn and liabilities of EUR 4bn shifted off balance sheet) We  value  the JV at 6.0x EV/EBITDA (including synergies at the midpoint of the  guided  range)  to  arrive at an equity valuation of EUR 3.0bn for the each  JV  parent. Our SoTP for Tata Steel increases by Rs 131/sh to Rs 818. Of this ~Rs200/sh comes from debt reduction, while valuation of Tata Steel Europe reduces by Rs67/sh due to farm out.

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