Fairwealth Research Desk rates the Follow-on Public Issue (FPO) of TATA STEEL LTD a subscribe for value pickers. The issue opened on Jan 19, 2011 an is closing on Jan. 21 2011. The face value is Rs 10 per share and the price band for the issue is Rs. 594-610. It is a 100% book building aggregating up to Rs 3477 The FPO proceeds will be used to fund its brown filed expansion of Jamshedpur plant amounting Rs 1875cr while Rs 1090cr will be used to pay redeemable non-convertible debentures.

TATA Steel the flagship company of Tata Group, is among the top ten global steel companies with an annual crude steel capacity of over 28MTPA. It is now the world's second-most geographically-diversified steel producer with operation in 26 countries and a commercial presence in over 50 countries.

Valuation:

We expect the company to deliver higher volume growth post completion of its 2.9MTPA, Jamshedpur plant coupled with various backward integration measures undertaken by the company. At EV/EBIDTA of 6.3x and 5.78x of FY11E and FY12E, the stock is attractively valued. We thus recommend to "SUBSCRIBE" the issue with the price target of Rs 710.

KEY INVESTMENT RATIONALE:

Escalation prospective from domestic operations:
To raise RoE, the company has aggressively expanded domestic capacity even during the downturn witnessed in steel industry during 2008-09. It is on track to add 3mt by Jun ’11, taking domestic capacity to 10mt.

TATA Steel merger with Corus:
Corus joined the TATA Steel family in April 2007 in a transaction that created one of the world largest steelmakers, with a major presence in Europe as well as in Asia. Corus is Europe second largest steel producer. Corus supplies steel and related services to the construction, automotive, packaging, mechanical, engineering, and other market worldwide. The combined enterprise has an aggregate crude steel capacity of more than 28mt and approximately 80000 employees across four continents.

Robust performance:
In FY 2009-10, the steel division of the Indian operations registered an increase of 20% in their saleable steel from 5.37mt to 6.44mt. The production from the larger furnaces were maximized with better productivity and lower coke consumption while increased vessel life in the steel melting area enhanced the production level. There were several best ever performances recorded by many units in the Steel Works of the Company:

The Ferro Alloys and Minerals division registered an increase of 22% in their saleable production (1302K tonnes during 2009-10 over 1064K tones in 2009-09)

Chrome Alloys export and Manganese Alloys sales also scaled new peaks during 2009-10

Sales in the bearing division registered a growth of 23%, while its production increased by 8%.

Expansion project:
Tata Steel India is executing its plan to increase its crude steel capacity from 6.8mt per annum to 9.7mt per annum at its Jamshedpur Works by 2011-12. The company has entered into a Memorandum of Understanding with Nippon Steel Corporation (NSC), Japan for setting up a Continuous Annealing and Processing Line at Jamshedpur, India with 0.6mtpa capacity.

TATA Steel Europe’s coking coal venture is significant:
TATA Steel Europe plans to source coking coal from the Banga Project, joint venture between TATA steel and Riversdal, located in the Tele Province of Mozambique. TATA Steel expects to produce 5.3MT of coal by 2011. The Banga coal has reserves of 502mt and the company is planning to augment production from the Banga project to 20mtpa gradually. The total capex remaining for the Mozambique project Rs 700-800cr.

Highly Integration levels for TATA Steel to boost Earnings:
Tata Steel is in the process of developing a coking coal mine in Mozambique and an iron ore mine in Canada to enhance integration level of TSE. The project is expected to be commissioned by 1QFY12. We expect this backward integration project at Mozambique and Canada to boost Tata Steel's earnings substantially.

Brownfield expansion on track:
Tata Steel's 3mt brownfield expansion programme is on track and expected to be commissioned by 2HFY2012. Till September 2010, the company has incurred capex of Rs. 5732cr and plans to incur Rs. 2963cr in 2HFY2011. The product mix constitutes 2.5mt of HRC and 0.3mt of slabs.

Captive iron ore project:
TATA Steel has planned to protect raw material supply for its European operation by taking a stake in New Millennium's Direct Shipping Ore (DSO) projects. Tata Steel owns 27.4% share in New Millennium mining company. Project has probable mineral reserve of 64.1mt for the DSO project and the production is expected to commence in 2011. The company would have 100% off-take rights to the produce of the mine of a specified quality. The iron ore from the project will be supplied to Tata steel group's facilities located in Europe. This project will involve capex of CAD 350mn. It is expected that the European operations would secure 20-25% backward integration by the end of FY12.

Value Creation Strategy:
The element of its value creation strategy is selective growth in emerging markets where the group has a competitive advantage. The Group therefore continues of selectively invest for the future with an aim to strengthen its position in emerging markets like India and increase the level of raw material integration and energy self-sufficiency across the Group.

The company has also increased its focus on finished or premium steel segment; its currently enjoys 40% of the autograde steel and is setting up a continuous annealing line in a joint venture with its long standing technical partner Nippon Steel of Japan.

Steel demand expected to grow in near future:
India's finished steel demand is expected to grow at 12% CAGR over FY10-13, led by strong growth from Automobiles, consumer durables and Engineering sector. India will remain a net steel importer over FY11-13, as demand likely to outpace supply. Emerging market like India, China, Thailand, Korea will likely to remain robust in future.

FPO will deleverage the balance sheet:
As on September 30, 2010, its debt equity ratio stood at 2. Post paying off its NCDs its debt to equity ratio is likely to come down to 1.76.

ISSUES AND CONCERN

Global price volatility:
Global price of the steel is not constant. It is highly volatile and varies on the basis of the raw material cost. Steel prices also depend on the global economic scenario. Steel prices depend on the demand growth from Automobiles, Consumer Durable and Engineering sector. Another important concern regarding coal and iron ore is the rising price of coal and Iron ore in the past few years and the expectation is that the cost of acquisition of coal for the steel indutry will continue to increase.

Supply bottlenecks to lift iron ore/coking coal prices:
Steel industry has to face the supply side bottleneck of the raw material like iron ore and coal. Shortage of supply can push up the prices of raw material upside. Coal is one of the most significant aspects of Steel industry and limited availability of coal will always be a key concern and issue for Tata Steel. Another important concern regarding coal is the rising price of coal in the past few years and the expectation is that the cost of acquisition of coal for thermal power projects will continue to increase.

Cyclical Industries:
Steel industry is cyclical in nature. It is highly affected by the world economic condition. At time of the economic downturn, the demand of the steel reduces significantly.

Government regulation:
Steel industry is the regulated industry and regulated by steel ministry. Steel companies have to take approval from the environmental and mining ministry to develop a plant and also affected by the EXIM policy.