We have downgraded our estimates for Tata Steel Limited to account for the greater-than-expected downturn in the global economy and the subsequent fall in steel prices.
With the downturn in the global economy and the subsequent fall in investment and consumption, we believe the demand for steel will slow down significantly in the near term.
Consequently, Corus has already announced a 30% cut in production; Natsteel and Tata Steel Thailand are also expected to follow suit. Also, we believe that steel prices, after falling around 50% from their highs, will fall further in the coming quarters.
Thus, with lower volumes and a substantial decline in prices, Tata Steel’s profitability will be significantly dented in the short run.
The company, meanwhile, has launched a number of initiatives to improve its cash flow. It is working towards saving more than GBP 350 million at its UK operations and Rs9 billion at its Indian operations through performance improvements, tightening of the working capital, and a revision of its CAPEX plans in FY09.
Regarding debt, Tata Steel does not have any repayment liability before December 2009, and we believe it will be able to refinance its debt (when required) given its long-term potential and the Tata Group’s goodwill.
However, the company may face some cash flow problems in the near term due to the falling sales volume and plummeting prices.
We have valued Tata Steel by using the DCF methodology. We have assumed a WACC of 12.3% and a terminal growth rate of 5%. Based on our assumptions, we have reached a target price of Rs255 for Tata Steel’s stock.
Our target price suggests a potential upside of 17% from the CMP of Rs217.9. Hence, we have upgraded our rating from Hold to BUY.