Rising carbon costs in Europe are a vital concern:(TATA)’s FY21 Annual Report highlights the ambition of the company to maintain leadership in volumes, price, and sustainability. While the near-term outlook for TSE is strong, driven by higher prices, then structural increase in costs from tightening emission norms and Brexit is a longer-term concern for sustained profitability and cash-neutrality. With improved cash flows, the focus is on growing the , aiming to double capacity to 35–40mt by 2030.
On Tata Steel Europe (TSE), the administration palpably appears concerned about the tightening, rising carbon credit costs, and the resulting lower competitiveness against imports to Europe, which pose a crucial challenge in the longer term. However, it plans to tread cautiously on this path as debt repayment remains the focal point for the management. While we expect deleveraging to continue on the prices, rising carbon costs and the burden of sustainability capex in TSE are vital concerns, in our view. Thus, we assign a Neutral rating, with a TP of Rs 1,210.
Rising carbon costs and Brexit to structurally increase TSE’s costs: While the near-term outlook for TSE is strong, driven by, then structural increase in costs from tightening emission norms and Brexit is a longer-term concern for sustained profitability and cash neutrality.
Withtrading at €52/t (135% YoY) and the growing need for carbon credit purchases, we believe the burden of carbon costs on TSE will likely increase in FY22 and beyond. While a part of this increase should be offset by the carbon surcharge of €12/t recently levied by Tata Steel UK, the sustainability would depend on demand-supply tightness.
Valuation and view: With the availability of captive iron ore, TATA’s India operations are a play onwhich we believe should stay higher for longer. We, therefore, expect margins to remain high in the medium term (with standalone EBITDA/t likely at a new lifetime high of Rs 33,000/t in 1QFY22). TSE’s margin should also be strong in FY22 (we expect >USD100/t), though the sustenance of the same. We expect consolidated revenue/EBITDA/PAT to grow 36%/94%/2.9x to Rs 2,134b/ Rs 592b/Rs 326b in FY22. Deleveraging should capex. We a further Rs 204b to Rs 621b in FY22. We arrive at our TP of Rs 1,210/sh on FY23E EV/EBITDA of 5x for its Indian operations and 4x for Europe.
Our TP implies EV/capacity of USD902/t, a 30% premium to the past five-year average of USD700/t, to factor in the benefit from likely deleveraging from the current upcycle. Given limited upside, we, however, rate it Neutral.