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Monday, December 10, 2007

Tata Steel - A fundamental play

Tata Steel is one of the lowest cost and most cost-efficient steel producing companies in the world.

After a series of acquisition, Tata steel this year acquired 100% shares of corus group, a 21 million tonne capacity steel producer with plants in UK and netherland. The acquisition of Corus has transformed Tata Steel from a domestic steel producer to an international steel company with global scale.

Even though the acquisition was a very high bid compared to it's initial offer the company seems to be doing things in the right manner. Raw material security is a significant imperative for the long-term sustainability of Steel company success. Tata Steel is actively exploring operations in resource-rich countries for iron ore and coal, as also seeking fresh leases for iron ore and coal at various locations in India. On this path tata recently entered in to JV with riversdale.

The company main challenges ahead is the integration of corus. Currently the combined entity Operating margin is around 13% in compared to it's standalone Operating margin of around 40%. The key is to improve the combined entity Operating margin to atleast around 28%.

Other risks we foresee in the medium term are

1) High debt instrument incurred on account of corus acquisition together with corus existing debts in place.
2) Increase in equity capital to fund the acquisition.
3) Commodities prices including steel has shot up enormously in the past few years. With the world economy seeing a recession the prices of commodity is expected to fall drastically.
4) Demand-Supply in steel seen neutral due to huge steel capacity expansion seen in china.
5) Raw material security has reduced to 17% from 80% with corus acquisition.

At the current market price of Rs. 833/- the stock trades at around 12 times it's fully diluted FY08E EPS of Rs. 68. We are not seeing any exceptional rise in the bottom line current year and at this price the stock seem to have a over run up. We expect the stock to correct and stabilize around Rs. 680/- in the medium term (6-8 months). At around Rs. 680/- we initiate a buy call on Tata Steel with a horizon of 3 years for investor with medium to high risk profile. The stock can turn on to be a potential multi bagger for long term investors.

Expansion Details

1) Tata Steel had initiated steps to establish three green field steel plants with captive iron ore mines in Orissa, Chattisgarh and Jharkhand, which would add an additional capacity of 23 million tonnes. In addition the company is planing to increase these capacities to 56 mpta by 2015.
2) The expansion project in it's Jamshedpur works to produce 6.8 mtpa is expected to complete by June 2008.
3) The company is subsequently increasing it's Jamshedpur crude steel production to 9.7 mtpa by FY2010.
4) The company is setting up a coke (main raw material for steel) making facility, with a production capacity of 1.6 mtpa. The production is expected to commence in 2008.

Other expansion details are not covered as part of our current analysis.

Positives

1) Tata Steel branded products Tata Pipes, Tata wiron, Tata Shaktee, Tata Tiscon, Tata structura, Tata bearings, Tata agrico to add exponentially to it's topline and bottom line growth.
2) Domestic steel demand to fuel up companies topline.
3) Tata Steel is the preferred supplier of steel to major auto manufactures including Toyota, Honda, Hyundai, Ford etc.
4) By 2015, the company plans to increase it's steel production capacity to 50 mpta which is around 8 times it's capacity on a standalone basis.

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Fundamental Analysis

Fundamental Analysis is the cornerstone of Investing. In fact, some would say that you aren't really investing if you aren't performing fundamental analysis.

During fundamental analysis we look at a stock from three aspects

Company

At the company level, fundamental analysis may involve examination of financial data, management, business concept and competition.

Industry

At the industry level, there might be an examination of supply and demand forces for the products offered.

Economy

Fundamental analysis might focus on economic data to assess the present and future growth of the economy.

To forecast future stock prices, fundamental analysis combines economic, industry, and company analysis to derive a stock's current fair value and forecast future value. If fair value is not equal to the current stock price, fundamental analysts believe that the stock is either over or under valued and the market price will ultimately gravitate towards fair value. Fundamentalists do not heed the advice of the random walkers and believe that markets are weak-form efficient.