Shares of Tata Steel Ltd have underperformed their sector by 19.1% in the past year, falling 16.7% during this period. From the January 2023 high of ₹119.25, the stock is down 10.77%. Further, so far this calendar year, the stock is down 5.5%.
However, Kotak Institutional Equities in its report said that the correction in the stock price has been overdone. It has upgraded the stock to 'buy' from 'reduce' citing attractive risk reward, and has also revised the fair value to ₹130, up 13%.
Let's look at the four main reasons the brokerage cited for upgrading the stock.
Domestic margins to recover to mid-cycle levels
The brokerage claims that the company's India steel margins have bottomed in 2QFY23 and that, following a mild recovery in 3QFY23, margins will continue to improve in the following quarters due to recent price increases, stable raw material costs, and operating leverage on higher output.
"We are factoring standalone earnings before interest, taxes, depreciation, and amortisation (EBITDA) at ₹14,135/14,500/ton in FY2024/25E versus ₹9,997/ton in 3QFY23," added the brokerage.
Upcoming projects to aid earnings
When fully operational in FY2024E, the company's 6 million tonnes per year (mtpa) pellet plant at KPO will completely replace market purchases of pellets while lowering costs. Additionally, the KPO's 2.2 mtpa CRM mill should start operating in 2HFY24E, helping to boost profits on value addition.
"The ramp-up of 1 mtpa Odisha-based Neelachal Ispat Nigam steel plant would aid in volumes growth in FY2024E. The 5 mtpa KPO Phase II is likely to commission in FY2025E, increase the company's capacity to 24 mtpa and drive a steep jump in volumes from 2HFY25E. We estimate volume growth of 4%/3%/11% in FY2023/24/25E," said the brokerage.
Europe will continue to be under strain, but its importance is waning
Due to a drop in demand-driven prices over the past six months, Europe's profits have drastically decreased. The brokerage anticipates EBITDA losses to persist for a number of quarters before progressively improving from 3QFY23 levels. The firm has been gradually selling its pension ownership of the UK assets as they near the end of their useful lives. Upside risks include the possibility of the UK company being shut down or sold.
For re-rating, capital allocation continues to remain essential
The company is well positioned in the Indian steel market and has the potential to increase its capacity at its current plants by low-cost brownfield expansions to 40 mtpa.
"We expect the company to announce the next phase of growth investments in the coming 6-12 months. Any incremental investments in Europe, particularly from the India entity, is a key downside risk to our investment thesis," said the brokerage.