Stock Review: TATA Steel

Turnaround show puts co on strong wicket

EXPECTATIONS of a better September 2010 quarter results have catapulted the stock price of Tata Steel, India's largest private steel manufacturer, by 25% in the past one month. This is significantly faster than the 12% increase in the benchmark Sensex.

   The company is expected to perform well given the higher international steel prices, lower raw material cost and the decision to sell Teesside Cast Product for $500 million, which will help the company reduce its debts.

   The turnaround in Tata Steel Europe (TSE) is expected to continue in the coming quarters with the parent company taking aggressive backward integration initiatives to improve margins. Tata Steel management has set a target of 40% integration for its European subsidiary. Joint ventures like Riversdale in Mozambique and direct shipping ore (DSO) project in Canada should also help the company improve the profitability of its European business.

   On the revenue side, steel prices are expected to remain strong in Europe led by a better-than-expected demand for automobile and consumer white goods sector. Recent moderation in the international iron ore and coal price can help the company negotiate lower raw material prices in the coming quarter giving boost to the company's margins.

   The decision to sell Teesside Cast Product could sharply ease liquidity concerns. Further, it should not affect the company's operating earnings since the plant was not expected to begin production in the medium term due to its unviable economics.

   As for the domestic operations, Tata Steel's own iron ore and coal mines insulate the company from fluctuations in the raw material prices. The captive production caters to its entire iron ore requirement and about two-third of the coking coal consumption. In contrast, JSW Steel is mostly dependent on outside sources for its iron ore and coking coal requirements.

   In the first quarter of FY11, Tata Steel was able to sell higher volumes of flat products compared to its peers. The company's 2.9 million tonne per annum (MTPA) brown field project is progressing on schedule and is expected to go steam by this December. These capacity additions can help the company cash in on the growing demand in domestic steel sector.

   As per ETIG calculations, the company is expected to post consolidated net profits of around 2,240 crore in the September quarter, which would take its trailing 12-month earning per share (EPS) to around 83 after September. At a current market price of 674, the company is trading at eight times its post-September expected EPS. This is relatively low compared to most of its peers. The stock of Tata Steel has started moving up in tandem with the expectation of good September numbers.