Tata Steel - UK Restructuring: £500 Million Grant A Positive First Step: Axis Securities

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Axis Securities Report

Grant of £500 million positive:

Tata Steel Ltd. has finally struck a deal with the UK government to provide support for green steel transition at its UK-based Port Talbot facility. The upstream (3.5 million tonne blast furnace and coke oven facilities) in the UK are coming near their end of life. Tata Steel will transition to a 3.0 mt electric arc furnace replacing the old 3.5 mt blast furnace wherein the UK government has agreed to grant £500 million for the transition while Tata Steel will infuse the remaining £750 million (from internal equity) of the total capex of £1.25 billion required for the EAF steelmaking.

The EAF will reduce the carbon footprint of the asset to 0.4 tonne per tonne of crude steel versus the current level of 2.16 tonne per tonne of crude steel. The EAF is expected to be operational within 36 months after all relevant approvals.

Positive Investment case for transition to EAF:

The UK operations posted an Ebitda loss of £123 million in FY23 and £39 million in Q1 FY24 and were a drag on the performance of Tata Steel Europe). The blast furnace to EAF shift will lead to cost savings in the range of £150-170/tpnne which includes a potential reduction of employee and carbon cost (£70-80 million/year). The management has not asked for specific opex support from the UK government.

However, the government will be the critical enabler for this transition with its broader policy towards reducing network power costs and developing a global scrap support system in the UK. As the UK generates ~10 million tons of scrap annually, scarp security will not be a constraint for the EAF operations.

Negotiations with employee union to determine full restructuring cost:

We expect the capital support from Indian operations will be needed for Tata Steel UK on account of-

• Employee severance cost: Currently, UK operations employ over 8,000 employees. As per the media reports, this will come down to 5,000 employees as EAF is less labour-intensive. Tata Steel will need to incur severance pay for the 3,000 employees once the UK consultation with the employee unions is over in the next 45-60 days. The management said it will be able to quantify the full restructuring cost post consultation with employee unions,

• Operations during the project phase: In the meantime, during the transition phase, UK operations will import steel for its downstream operations and fulfil customer orders. The cash flow profit/(loss) is not yet clear on the operations using steel substrate. The group will restructure its balance sheet with the potential elimination of the current cash losses in the UK operations and non-cash impairment of legacy investments in the UK.

Valuation and recommendation:

We revise our rating and target price post the removal of the overhang of the UK business restructuring. We value the company now using SoTP and ascribe one-year forward enterprise value/Ebitda multiple of 7.0 times (from 6.4 times), 5.0 times, and 4.0 times (from 3.5 times) to India standalone, other operations (excluding standalone), and Europe respectively on FY25 Ebitda to arrive at a 1-year forward target price of Rs 145 (From Rs 125). The target price implies an upside of 10% from the current market price. We revise our rating on the stock from 'Hold' to 'Buy'.

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