PL Stock Report: Tata Steel (TATA IN) - Event Update - Tata Steel UK: end of an era of cash losses - BUY
Prabhudas Lilladher Pvt Ltd
Tata Steel (TATA IN) - Tushar Chaudhari - Research Analyst, Prabhudas Lilladher Pvt Ltd
Rating: BUY | CMP: Rs132 | TP: Rs144
Event Update - Tata Steel UK: end of an era of cash losses
Tata Steel has announced a proposal to setup a 3mtpa Electric Arc Furnace at its Port Talbot steel making facility for capex of GBP 1.25bn. The proposed project will get GBP500mn grant (40% of the project cost) from UK government and adequate policy support for smooth transition to green steel making in UK at competitive landscape. While first stage of the process stands complete with this agreement, consultations with unions involved are expected to close in next three months. Capex is planned over next three years post successful consultation and subject to relevant regulatory approvals.
We believe that the Tata Steel UK (TSUK) transition is EPS accretive given a) current cash losses will end, as company will import substrate instead of producing at old facilities, b) one-time cost will exist, but TSUK is expected to be in better situation than earlier case of recurring cash burn, c) volatility in coking coal prices won’t directly affect TSUK earnings, and d) likely fall in energy costs, as UK moves towards renewable sources. We revise our FY25E EBITDA estimates upwards by 5% to Rs411bn and introduce FY26E earnings estimates. Maintain ‘Buy’ at revised TP of Rs 144 (Rs 137 earlier) assigning EV/EBITDA multiple of 5x for FY25E EBITDA for TSE.
Cash losses to end: The proposed project would also involve TATA’s balance sheet being restructured with potential elimination of current cash losses in TSUK operations and non-cash impairment of legacy investments. Current TSUK operations are deteriorating its balance sheet with FY23 EBITDA losses of GBP 127m. TSUK has ~USD 2bn accumulated losses on balance sheet.
Usage of scrap to reduce carbon emissions: Usage of scrap in EAF will save costs, as dependence on coking coal reduces while improving degree of circularity that can lead to sustainable spread of GBP150-170/t vis-a-vis current ageing and uncompetitive upstream assets. TATA relies on abundant scrap supplies in the UK market (generation of 10mt per year- which gets exported). The proposed investment would reduce Port Talbot site’s carbon emissions by ~5 million tonnes a year; equivalent to ~7% reduction in UK business sector. TSUK carbon emission intensity is to reduce from existing 2.16 to 0.4 tons per ton of crude steel produced.
Journey towards sustainable & profitable future: With this transition, TSUK is expected to be structurally competitive and reap benefits of new greener steel manufacturing. This includes implementation of carbon border leakage controls for which UK govt. began consultations in Mar-23 and mandatory product standards to help market to grow for low carbon products. EU has also outlined the Carbon Border Adjustment Mechanism (CBAM); the transitional phase starts in Oct-23, which is expected to keep steel prices higher across regions.
Valuation & view: We have incorporated TSUK capex of USD1.55bn (GBP1.25bn) over FY25-27E and reduced maintenance capex a bit as old assets won’t require maintenance anymore. With ongoing efforts by TSUK, sustainable EBITDA/t of USD100/t for consolidated TSE (Tata Steel Europe) looks achievable as importing substrate will resume from FY25; Tata Steel Netherlands is profitable; although production from new TSUK project will only come FY28 onwards. We have revised our FY25E EBITDA estimates upwards by 5% to Rs411bn and introduced FY26E earnings estimates. Maintain Buy with revised TP of Rs 144 (from Rs 137 earlier) assigning EV/EBITDA multiple of 5x for FY25E EBITDA for TSE.