Earnings turnaround at Corus; Upgrade to Buy

Worst is behind; upgrade to Buy with revised TP of INR540/share
We have upgraded Tata Steel to Buy (see our Alert of earlier today), with the upgrade premised on three key factors: (1) our overriding view that the worst is over for Corus and that each quarter at Corus should be incrementally better, following the record negative EBITDA of US$387mn in 1Q’FY10, (2) 132% CAGR in consolidated EPS over FY10-12E, and (3) what we see as attractive valuation – the stock currently trades at a FY11E EV/EBITDA of 4.9x, an 18% discount to the average valuation of its global peers.

Earnings turnaround at Corus – a compelling catalyst for investors
The tempest in the global steel industry – which has savaged profitability of almost all world steel majors – now appears to be in retreat. Worries over long-drawn earnings uncertainty at Corus have been a key stock overhang since late last year. Nascent recovery in steel consumption in Europe, a rising capacity utilization rate and a decline in coking coal prices should drive an EBITDA turnaround at Corus. We forecast Corus EBITDA to rise at a CAGR of 260% over FY10-12.

Contribution from high-margin Indian operations to increase
Tata Steel’s India operations (among the most competitive in the world) look set to benefit impressively from aggressive organic growth. EBITDA at Indian operations is likely to rise at 21% CAGR over our forecast period. Increasing production in India should result in Indian operations constituting an overwhelming 67% of consolidated EBITDA by FY12 from 46% in FY08 when Corus was acquired.

Raising TP to INR540/share; Upgrade to Buy
Our TP of INR540 is based on a SOTP valuation: Indian operations valued at FY11E EV/EBITDA of 6.4x, UK ops valued at FY11E EV/EBITDA of 5.1x, Asia ops valued at FY11E EV/EBITDA of 2x. Our TP translates into a blended FY11E EV/EBITDA multiple of 5.4x. Key risk: Delay in steel demand recovery.

To read full report see attachment: TATA STEEL