Jefferies upgraded FY22-23E EPS by 22-25% of Tata Steel and retained Buy with a revised price target of Rs 680. (Bull case price target is Rs 900, 83% upside). Jefferies expects Tata Steel's second half standalone EBITDA to expand to Rs 16K per ton. Margins should also improve in the second half but the broader outlook remains weak due to subdued demand in Europe, import pressures and tightening carbon regulations.

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Key Takeaways:

Tata Steel's Q2 EBITDA rose a strong 60% YoY and was a 35% beat vs estimates led by better than expected margins across businesses. India EBITDA/t should expand further in the second half as full benefit of recent steel price hikes flows through. Potential sale of Netherlands plant can drive value unlocking and reduced exposure to Europe can aid valuations.

Big turnaround and deleveraging:

Tata Steel's Q2 EBITDA was up 60% YoY (12x QoQ) and 35% beat. Standalone and BSL delivered strong results with volumes rising 21-23% YoY (partly destocking) and EBITDA/t up Rs 7K QoQ (2-4x QoQ). EBITDA/t also improved QoQ but remained negative, partly pulled down by carbon provisions. Q2 net profit was at Rs15 bn vs. Rs 44 bn loss in Q1. First half free cash flow was strong at Rs 129 bn, resulting in net debt falling by 8% (Rs72/sh).

Further margin expansion in second half:

Indian spot flat steel prices are Rs 6.5K above Q2 average and contract prices are getting revised upwards too, which should boost second half ASPs (Tata Steel expects Rs 4-5K QoQ rise in Q3). Access to captive iron ore is a positive amid elevated ore prices. Jefferies expects Tata Steel's second half standalone EBITDA/t to expand to Rs 16K. Margins should also improve in the second half but the broader outlook remains weak due to subdued demand in Europe, import pressures and tightening carbon regulations.

Europe asset sale can unlock value:

Tata Steel is in discussions with Swedish steelmaker SSAB for sale of its Ijmuiden plant in Netherlands. Tata produced 10.3mt steel in Europe in FY19-20 (9.5mt sales) with 7mt at Ijmuiden. While Tata Steel’s margins are currently under pressure, Ijmuiden is one of better assets in Europe with high exposure to autos and packaging. Assuming a normalized EBITDA/t of US $60-80 on 6.5mt sales, it has EBITDA potential of US $390-520mn. At 5-6x EV/EBITDA, the asset could get a transaction EV of US $2-3bn. Tata Steel's UK plant has very weak profitability, but zero EV would likely be the trough asset value especially if capital support from Tata Steel remains limited. Jefferies SOTP has US $0.8bn EV for Tata Steel and Jefferies estimates Ijmuiden sale can drive net value unlocking of US $1.2-2.2bn (16-30% of market cap).

Some re-rating potential too:

Tata Steel's European exposure has come down sharply with share of Tata Steel in total volumes down from 54% in FY13 to 35% in FY20, and can fall further to 15% post sale of Ijmuiden plant. Rising share of higher margin India capacity and a renewed focus on domestic operations should drive some valuation re rating for Tata Steel. A 0.5x higher EV/EBITDA for India business can drive Rs113/sh higher fair value.

Retain Buy:

Jefferies upgraded FY22-23 EBITDA by 9-10% and EPS by 22-25% on higher steel prices. After a 41% YoY EBITDA decline in FY20, they saw 15-38% growth in FY21-22. Stock is up 40% since end September, outperforming Nifty by 25%; however, its 5.6x FY22E EV/EBITDA and 0.7x FY22E PB are still below historical averages. Retain Buy with Rs 680 price target based on 6.5x and 4.0x FY22 EV/EBITDA. Jefferies bull case price Target is Rs 900 (83% upside) based on 7.0x FY22 EV/EBITDA for India, US $2.5bn EV for Ijmuiden plant sale and zero EV for UK plant.