For Q1’09, Tata Steel’s consolidated net sales increased 39.6% y-o-y to Rs435.1 billion on account of improved realizations and a higher sales volume.
In addition, adjusted net profit jumped 91.8% y-o-y, supported by a lower interest expense and net profit margin rose 260 bps to 9.5% on the back of a lower effective tax rate.
International steel prices have started to trend downwards as the demand for the alloy has declined on account of the adverse global economic conditions.
The IMF has further reduced its forecast for world GDP growth in 2008 from the earlier 4.1% to 3.7%. With inflation at record levels, high interest rates, and the downturn in the global economy, infrastructure development across the globe will be adversely effected.
In our opinion, developers will delay the procurement of steel especially in the view of the recent downtrend in prices. Further, supply is expected to improve as China, which had curtailed production because of the Olympic Games, resumes production.
We expect steel prices to witness a sharp decline before settling at $700–$750 per tonne by the end of FY09E. In FY10E, prices are expected to fall further.
Contract prices of key raw materials such as iron ore and coking coal have increased by around 65% and 200% yoy, respectively. Nevertheless, till now steel manufacturers have been able to maintain margins as they were able to pass on the increase in costs to the customers due to the strong demand for steel.
Going forward, however, a weak global demand scenario will result in falling steel prices. Moreover, the full impact of higher raw material cost will only be witnessed from Q2’09 as new contract prices came into effect from June’08. Thus, we believe that EBITDA margin will reduce from 13.7% in FY08 to 13.3% in FY09E.
At the current market price, the stock is trading at a forward P/E of 4.6x and 6.1x on its FY09E and FY10E earnings, respectively. We have valued Tata Steel at a P/E of 6.5x its FY10E EPS, and arrive at a target price of Rs605. Based on our valuation and result analysis, we downgrade our rating on the stock to HOLD.