Steel prices are on their way up globally due to the strong demand from emerging markets like China and India and rising input costs of iron ore and coking coal.
Tight supply of these steel making raw materials has resulted in an unprecedented rise in steel prices that have risen by almost 50% this year and are expected to remain firm in the medium-term.
However, the domestic steel players have taken a hit on their margins due to rising input costs as they have been unable to pass on the same due to government’s intervention, which has prevented steel companies from raising prices in wake of the high inflationary pressures.
Tata Steel has, however, been an exception on account of it being the most efficient player owing to the backward integrated nature of its business. The company is largely insulated despite the government dictum as it is the most integrated player in both iron ore and coking coal compared to its peers.
Corus that contributes bulk of Tata Steel’s 28mtpa annual capacity, is expected to drive earnings in the ensuing quarters as the former is able to raise prices and offset the high input costs.
Concerns and valuation
At the CMP of Rs727, Tata Steel is trading at a P/E of 7.6x and EV/EBIDTA of 4.8x FY2010E consolidated earnings.
We believe that the stock is quoting at attractive valuations considering the better-than-expected performance by Corus, higher synergistic benefits ($600mn, earlier $450mn), strong prices in the European markets, diversified markets and scale of operations.
However, the biggest risk to our assumptions are no change in the government’s restrictive attitude towards steel prices and a greater-than-expected slowdown in global economies affecting the demand for steel and consequently Corus’ ability to pass on additional costs to consumers in the medium term. We upgrade the stock from Neutral to BUY, with a Target Price of Rs875.