Oversupply in China & Europe leaves little room for price upside
We believe the global steel price rally in December (following a correction in the previous months) amid the challenging steel backdrop was driven by restocking; a breather in a tough steel environment. Most global steel stocks have delivered positive returns in the past three months; multiples have expanded (1-year fwd average EV/Ebitda (enterprise value/earnings before interest, taxes, depreciation and amortisation) is 6.5x (times) vs 5.5x in Sep-12). We continue to forecast a muted steel outlook and believe oversupply in China/Europe leaves little room for more price upside in 2013.
However, we remain positive on Tata Steel, raising our target price 18% to R508, given inexpensive valuations (6.2x EV/Ebitda vs. global peers at 6.5x), a likely bottom for Tata Steel Europe in Q3FY13, and leveraged position allowing more upside in a global uptick scenario. We downgrade SAIL to Sell (from Neutral) post its 12% rally in the past three months.
Muted demand; pricing likely capped: We do not expect a significant uptick in domestic steel demand and prices. India?s steel consumption rose 4% year-on-year during Apr-Dec (10.6% in FY11 and 5.5% in FY12). Steel companies are facing an inventory buildup. HRC (hot-rolled coal) prices have corrected from R36,000/tonne in Apr12 to R32,000-33,000/t now. While producers have announced hikes of R1,000/t in Jan13, they are unsure about being able to push through the hike given demand trends. Pricing upside is capped as imports (+ 15% y-o-y in Apr-Dec12), particularly from China/FTA (free trade agreement) countries, are high?and could worsen if China increases exports/export rebates. While we expect players like Tata Steel to be able to push volumes, our pricing outlook is more conservative vs earlier.
China: Perpetual overcapacity: Our Chinese steel analyst Scarlett Chen expects the demand/supply picture to worsen for 2013 vs. 2012, as capacity additions overwhelm demand growth. End-user demand is weak, as represented by PMI (Purchasing Manager’s Index) below 50 for Nov. and Dec.12. We expect a very short spike for seasonal reason by Mar-13, followed by a drop. The median of the PMI index has trended down continuously, as China deviates away from investment-driven growth.
Citi estimates China steel demand to reach 742mt in 2013e (estimates) (+3.9%), with the assumption that flats grow at 2.5% and longs increase by 5.0%. We see 40-50mt of capacity to be under construction in 2013 based on channel checks, and channel checks almost always underestimate instead of overestimating capacity additions.
Global steel price trends: European HRC prices corrected from their peak of $720/t in Apr12 to $590/t in Nov12 and have now rebounded to $675/t. Chinese export prices corrected from $645/t in Apr-12 to $505 in Sep-12 and have now rebounded to $590/t.
With the surge in imports into India, Indian producers have been pricing steel in line/at a discount to import parity prices. Current HRC prices in India are in the range of R32,000-33,000/t vs R35,000-36,000/t in Apr-May12. We do not expect steel prices to rise much from current levels.
Valuations less attractive: Steel stocks globally have delivered positive returns in the last three months as steel prices rose (potentially a re-stocking rally). Global EV/Ebitda multiples are 5-7x vs. 4-6x earlier. TSL?s (Tata Steel) valuations are at 6.2x FY14 EV/Ebitda look more attractive relative to SAIL at 7.3x.
We raise the target multiple for TSL India from 6x to 7x; for TSE (Tata Steel Europe) from 5x to 5.5x in line with the global re-rating. We believe the Indian operations warrant premium valuations to global peers given raw material integration; a steadier earnings stream.
We value SAIL at 6.5x EV/Ebitda (vs. 6x earlier). We raise the multiple as global steel stocks have re-rated from 5.5x in Sep12 to 6.5x currently. We no longer ascribe a premium to SAIL vs. global peers given the uncertainty around volume/price trends.
Reiterate buy on Tata Steel, leveraged to an uptick: Valuations look inexpensive at 6.2x FY14 EV/Ebitda (global average 6.5x) after a 7% underperformance vs. Sensex in three months. Further, Q3FY13 is likely to be a trough for TSE despite expectations of low utilisation levels/ volatile demand in Europe in 2013. We cut earnings for TSL India; but are relatively more confident on earnings visibility vs. other India steel producers. TSL is essentially an option on any European recovery/improvement?a $5 Ebitda/t swing in TSE impacts consolidated earnings by 11%.
TSL India warrants premium valuations to global peers given raw material integration; steadier earnings. At our new TP (target price) of R508, TSL would trade at 6.8x FY14e EV/Ebitda; 1.8x P/B (price-to-book value).
TSL India?s earnings should be buoyed by volume growth of 19% in FY14 (8.7mt sales) as the 2.9mtpa expansion ramps up. We expect Ebitda/t to sustain $280-285/t; 100% iron ore integration; 35-40% captive coking coal. Low coking coal prices benefit SAIL vs. TSL India as SAIL?s coal integration is only 5%. With limited downside to coking coal prices, we prefer TSL India to SAIL given better visibility on earnings/volumes.
Bengal coal started production in Mar-12. New Millennium mining should start by Q1FY14. The Orissa expansion (3mtpa, R230 bn) should be commissioned by FY15. TSL?s overall capex is estimated at $2bn in FY14. Every 1% change in steel impacts consolidated PAT by 18%; a 1% change in Rs/$ rate impacts PAT by 14%.
Sail in irons, downgrade to sell: SAIL?s stock is up 12% in the past three months, largely discounting expectations of margin improvement in FY14 (higher volumes; lower coking coal costs). At 7.3x FY14e EV/Ebitda (global average at 6.5x), valuations seem stretched?limited upside to steel prices; downside risk to volumes (three successive years of declining volumes, inventory buildup); cost concerns (uncertainty on wages). Lacking visibility on upside triggers, we downgrade to Sell.
SAIL?s sales are largely in the domestic market. We do not expect a significant uptick in domestic demand and prices (upside capped as imports are high). India?s steel consumption rose 4% y-o-y in Apr-Dec12; inventories have been on the rise. HRC prices have corrected from R36,000 in Apr-12 to R32,000/t now (discount to import parity). While a price hike has been taken in Jan-13, there are concerns around sustainability.
We lower estimates on trends so far; cut sales volumes by 4-7%; realisations by 2-4%. We expect sales to fall 4% to 11mt in FY13 but rise 14% to 12.6mt in FY14.
We now expect FY14 coking coal costs (imports) to be $174/t vs. $200/t earlier. We forecast FY13 Ebitda/t at $100 ($115 earlier); $125 for FY14 ($126 earlier). Lower PAT by 24%/15% for FY13/14.
We value SAIL at 6.5x EV/Ebitda (vs. 6x earlier). We raise the multiple as global steel stocks have re-rated from 5.5x in Sep-12 to avg. 6.5x currently. We no longer ascribe a premium to global peers given the uncertainty on volume/price trends in India.
SAIL plans to raise saleable steel capacity from 12.5mtpa in FY12 to 20.2mtpa in FY14 at a capex of $13bn (including raw material augmentation). We estimate FY13 capex at Rs106bn ($2 bn); expect net D/E (debt-equity ratio) to rise from 0.25x in FY12 to 0.4x in FY13 and 0.55x in FY14. SAIL has 3.8bn tonnes of iron ore reserves. Its captive mines meet 100% of ore requirements. It has 5% captive coking coal; imports 70%; purchases the rest from Coal India.
Every 1% change in HRC prices results in 9% change in FY14e PAT. A 1% change in R/$ rate impacts PAT by 7%. Key upside risks: higher steel prices/volumes; rupee depreciation; lower coal/wage costs.
Citi
