Tata Steel FPO Note by PINC Research

Tata Steel FPO Note by PINC ResearchTata Steel's FPO price band of Rs594-Rs610/share is attractively priced at 4.7x-4.8x FY12E EV/EBITDA. At the upper band, the company would raise Rs34.8bn (57mn shares) diluting ~5.5% of its post-issue fully-diluted equity. Post FPO, promoters' stake on fully diluted basis would decline by 1.7% to 29.5%. The proceeds of the issue would be utilised mainly for part-funding of capex at Jamshedpur (Rs18.8bn) and payment on maturity of debentures in FY12 (Rs10.9bn).

Brownfield expansion on track to increase share of profitable Indian operations: Tata Steel is incurring a total capex of Rs163.7bn to raise capacity by 2.9mn tpa in Jamshedpur by FY12 end. This would increase output share of highly profitable Indian operation (FY11E EBITDA/t of USD380 vs consolidated USD141) from current 27% to ~35% post expansion. We believe that this could result in an 18% rise in consolidated EBITDA/t (assuming constant underlying profitability).

Turnaround in Tata Steel Europe (TSE): With improved capacity utilisation and leaner cost structure, TSE has turned around with sustainable EBITDA/t of ~USD50. With expected partial raw material integration by FY12-end (Benga coking coal project in Riversdale and DSO iron ore project in New Millennium), we believe that TSE's profitability would improve further FY13 onwards.

Financial deleveraging: FPO proceeds would reduce company's net D/E from current 1.2x to 1.0x (fully diluted, incl. VoI). We expect further decline to 0.6x by FY12. An improved balance sheet would aid the company in meeting its debt covenants and expedite future expansion projects in Orissa, Chhattisgarh and Karnataka.

VALUATIONS AND RECOMMENDATION

Contract prices for Q4FY11 has settled at higher level due to increased spot prices. Coking coal spot price continues to strengthen, as floods in Australia disrupt supply. We believe high raw material prices would exert further pressure on steel processing margin in FY12. However, integrated operation of Tata Steel India would benefit from rising steel prices on cost push.

At FY12E EV/EBITDA of 4.8x and 4.9x at upper band of FPO and CMP (Rs632) respectively, the stock is attractively valued. We maintain `BUY' on the stock with a revised target price of Rs817 (blended 6.1x FY12E EV/EBITDA). Recommend `SUBSCRIBE' to FPO.