Tata Steel Update

Tata Steel
Research:Merrill lynch
RAting:buy
CMP:Rs 782

Merrill Lynch estimates that Tata Steel is trading at 7.8x FY09E. This is at a 38% discount to Steel Authority of India (SAIL), its closest Indian peer, and in line with Arcelor Mittal, its closest European peer. Tata Steel’s stock price already discounts Corus’ lack of raw material integration, but it ignores the potential upside from synergy benefits which will unfold over the next 12-18 months. Steel prices are likely to rise 6-7% in FY09 in India and Europe.

This will be just about adequate to pass on the higher iron ore and coking coal costs. Notwithstanding fears of a US slowdown, recent positives such as inventory restocking in the US, expectations of higher export taxes in China and continuing strong demand in China and India may boost steel price outlook. Merrill Lynch estimates that a 1% change in steel price may increase Tata Steel’s EPS by 9%. Tata Steel’s high risk profile (owing to lack of raw material integration) is cushioned by potential synergies to some extent. Merrill Lynch has built in synergy benefits of $150 million in FY09E.

This amounts to 3% of the group EBITDA. The management has indicated synergy benefits of over $450 million over the next three years. There is potential for upside on the synergy benefit. However, the key risk is that steel prices may increase less than Merrill Lynch’s forecast of 6-7%. In addition, recent media reports indicate that iron ore prices may increase by 70%.