Tata Steel and Vedanta poised for better growth

Near-term trigger is strong March-quarter numbers; stocks have more steam left

Vedanta and Tata Steel saw a turnaround in their operating performance in the March quarter. Tata Steel’s operating profit grew more than threefold over the year-ago quarter, while Vedanta’s operating profit more than doubled. Not surprising then that their stocks have nearly doubled over the past year, and analysts seem confident about their prospects.

Tata Steel and its peers in the domestic steel sector benefitted over the past year from improving domestic realisations. While the implementation of minimum import price (MIP) and other government measures helped domestic realisations, a rebound in international steel prices, too, was a factor.

Further, Tata Steel benefitted from European restructuring. The company is now on the verge of reducing UK pension liabilities that had also been perceived to be a major stumbling block for company’s joint venture in Europe. While the company has already sold some loss-making assets in the UK, pension liabilities restricted to employee contributions only would reduce future liabilities of the company.

Though more benefits will flow in the longer run, analysts feel they could provide $12-13 a tonne savings in cost. After European restructuring and better steel realisations, the company has already seen European per-tonne operating profit improve to $103 in the March quarter, its best since 2008.

In the domestic segment, improved realisations over the last year as well as expansions at Kalinganagar in Odisha have helped and will continue to drive earnings. Better international steel prices led to increase in exports. Overall domestic operating profit per tonne at ~10,228 grew three times from ~3,477 seen in the year-ago quarter. Consolidated per-tonne operating profitability, therefore, grew more than three times to $154 (March 2016 quarter, $47).

While rising raw material prices might put pressure on profitability in the first half of FY18, European operations are in a better position now than in the past. Abhisar Jain of Centrum Broking believes that Europe woes are behind and overall operations are well placed to deliver steadily growing earnings which would lead to more deleveraging from FY18. Analysts at IIFL say European business performance would remain strong on the back of restructuring exercise, superior product mix, currency tailwinds and cost rationalisation, and hence they have an upgraded stock to buy with a target price of ~557.

For non-ferrous companies, a rebound in base metal prices has helped. Average prices of aluminium, copper, zinc, lead during the March’17 quarter remained 16-65 per cent higher on the London Metal Exchange (LME). This was positive for natural resources major Vedanta. Its subsidiary

VEDANTA AND TATA STEEL SAW A TURNAROUND IN OPERATING PERFORMANCE IN MARCH QUARTER. TATA STEEL’s OPERATING PROFIT GREW MORE THAN THREEFOLD OVER A YEAR AGO, WHILE VEDANTA’s OPERATING PROFIT MORE THAN DOUBLED

Hindustan Zinc, with best-ever volumes and a decade-high realisation, has been a strong driver of performance as aluminium segment volumes and realisations helped further. Other segments such as copper, lead, silver, iron-ore, too, supported as some rebound in profitability was also seen for oil and gas. Overall, the company’s operating profit at ~7,350 crore more than doubled from ~3,472 crore seen in the year-ago quarter and was the highest in the past sixteen quarters.

Expansions in the aluminium segment will drive growth moving forward, as also the prospects for zinc and the oil and gas segment. FY18 capex on zinc and oil & gas business and improving free cash flows are expected to help reduce debt. The company has already repaid a debt of $1 billion helped by a huge dividend payout by Hindustan Zinc, say analysts who expect lower debt to improve credit ratings, thereby reducing finance costs.

Analysts at IDFC Securities say access to cash from Cairn India merger is a positive for Vedanta as it starts pursuing its growth plans to unlock value without stretching its balance sheet. Analysts at Credits Suisse feel that with the strong volume-driven operating profit growth, Vedanta’s balance sheet should strengthen meaningfully and they also see dividend yield/ buyback to keep the stock price at higher levels.