Should you buy Tata Steel shares on current correction?

Shares of Tata Steel are on everyone’s radar as it is not just one of the best performing from Tata’s stable but also the best performing Nifty 50 stock. In the current calendar year alone Tata Steel has skyrocketed 123% compared to just 24% rally in Nifty 50 stocks and 76% rise of the Nifty Metal index. The rally in the stock was driven by the uptrend in steel prices, production cuts from China and improving demand due to increased spending on infrastructure by the governments across the globe.

However, over the recent past shares of Tata Steel have been under some pressure due to sharp drop in iron ore prices. “Globally, steel stocks have seen meaningful compression in multiples as consensus globally expects a sharp correction in steel prices soon,” noted ICICI Securities in a report.

Despite this, the management of Tata Steel has guided for further upside in domestic steel price in Q2FY22 (amid recovering domestic demand, auto contract renewals and iron ore cost pressure). Export opportunities also remain attractive, which could offset near-term domestic demand softness.

Focus on deleveraging

During the Q1FY22 quarterly call the management guided for CAPEX of Rs 10,000-12,000 crore in FY22. For the 5mtpa (million tonnes per annum) Kalinganagar expansion, the initial focus is on a 6 mtpa pellet plant (cost savings) and a 2.2mtpa CRM complex (improved product mix), to be commissioned by H122.

“Timely expansion and forward integration could help spreads even if the cycle softens. Continued deleveraging, with higher spreads and management’s target of further gross debt reduction by more than US$2bn in FY22,” said UBS.

Factoring in the advantage of captive mining and the benefits of cost-saving initiatives, UBS has raised its domestic FY22/23E EBITDA/t (Earnings before interest tax depreciation and amortization per ton) by 35-50% for the company.

The global brokerage firm foresees upside to Tata Steel’s current multiple (it is trading at a 31% discount to long-term EV/EBITDA), as the stock does not seem to price in valuation headwind moderation (such as high leverage); domestic iron-ore integration and a turnaround in its EU operations.

Citing these the brokerage has maintained its consolidated EV/EBITDA (enterprise value to earnings before interest tax depreciation and amortization) of 6.0x (17% lower than its 10-year average) while it raises its price target to Rs 1,800 and reiterates its buy rating on the stock.

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