Centrum in its latest report on Tata Sponge has reiterated buy rating on the company. It has stated a target price of Rs 1,050. Its current market price, check here, When the report was prepared, it seems the market price was in around Rs 670.
Their reasoning is as follows. Management call takeaways - no dearth of ore anymore.
We reiterate Buy on Tata Sponge (TSIL) with a TP of Rs1050 as rerating is likely to be led by triggers such as complete normalization of iron ore supplies from Tata Steel by Q1FY16, fall in domestic iron ore prices and bounce back in margins from FY16E. Recovery of investment (~Rs1.8bn) in its previous coal block and opportunity for acquiring a suitable coal/iron ore mine in auctions are other key triggers. Valuations are attractive at 2.7x FY16E EV/EBITDA and 8.0x FY16E P/E and balance sheet remains strong for pursuing expansions/backward integration projects. We view TSIL as an ideal investment for long term value investors.
Iron ore supply normalization almost certain: TSIL’s iron ore supplies from its parent Tata Steel are set to normalize from Q1FY16E (partial supplies already started from Feb’15) as clearance of MMDR Bill has paved the way for restart of Khandhbandh mine of Tata Steel which was supplying ore to TSIL. Domestic iron ore prices have corrected by 25-30% already in last few months and we see further weakness with restart of more mines. Since TSIL’s iron ore pricing from Tata Steel is linked to market rates, we see sharply lower iron ore costs for TSIL going ahead (refer exhibit4 on page 3 for iron ore cost trend for TSIL).
Coal auctions and MMDR bill provide captive integration opportunity: Ongoing coal auctions and likely auctions of iron ore mines in FY16E (as per new MMDR policy) would provide opportunity for TSIL to secure captive coal and iron ore mines without large upfront investment. We see acquisition of any attractive asset as a key trigger though we do not factor it in our estimates currently. Recovery of company’s investment of ~Rs1.8bn in its previous coal block is also certain as the block has been included in the first round of auctions (for power sector) and auction rules clearly indicate upfront payment for mine infrastructure to previous owners.
Product price fall has hurt, further downside limited: Fall in global steel and scrap prices has been very steep but scrap prices have recovered by ~5% in Mar’15 while steel prices have seen stabilization in CIS & China export markets led by production cuts and cost curve support. We do not expect material downside from current levels and see better domestic demand to support sponge iron prices in FY16E. TSIL’s cash stands at Rs4.7bn+ (~Rs310/share, ~45% of mcap) and though management has pointed towards deployment of cash for expansion in either forward or backward integration facilities in future, nothing has yet been finalized.
Valuation and risks– reiterate Buy: We believe the company will see larger fall in raw material costs vis-à-vis sponge iron prices from Q4FY15 thereby providing support to margins and hence expect smart recovery in EBITDA in FY16E/17E. We value the company at 4x Mar’17E EV/EBITDA and assign 100% value for the company’s carrying value investment of ~Rs1.8bn in the coal block to arrive at a fair value of Rs1050/share. Reiterate Buy. It remains the most efficient sponge iron player possibly at the doorstep of an upturn. Key downside risks are sharp fall in sponge iron prices and delay in resumption of iron ore supplies from Tata Steel.
Do I have a view on this stock. Frankly no view at this point on the business perspective. A bird's eye on the comparative valuation metrics shows the stock is fairly priced. The stock has run up in 2014 following the broader market. It used to be a deep value stock,
p.s. The commentaries are the personal opinion of the author.
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