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Tata Steel: Where is it headed? - Views on News from Equitymaster
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Tata Steel: Where is it headed?
Oct 14, 2008

What a year it has been! In a span of just few months, we have witnessed two extreme sides of Mr. Market. While he was full of greed not very long back, he is shell shocked currently and is displaying a deep sense of fear. And just as his emotions, the pendulum of valuations for companies has also swung wildly. While they were valued for continued prosperity during the good times, they are being priced currently as if most of them are either headed straight for bankruptcy or are in for a permanent decay. During such times, one of our favourite exercises is to try and get a fix on the kind of fundamentals or future growth rates that are embedded in a company’s stock price. In other words, rather than forecasting future growth rates and then arriving at a valuation of a company, we reverse the situation and ask ourselves, “What kind of growth rates does the current stock price imply?”

How about performing this exercise on one of the world’s largest manufacturers of steel, Tata Steel? A blue-eyed boy of investors not until long back, the stock has corrected by nearly 70% from its 52-week high!

For metal companies and more so for integrated manufacturers like Tata Steel, steel prices are one of the most important determinants upon which hinges the profitability and hence the intrinsic value of a company. Even in the recent correction, most of the decline in the company’s stock price has come from fear that steel prices are in for a substantial decline.

Hence, let us try and find out what kind of decline in steel prices are embedded in the company’s current valuations. But first few assumptions are in order. We have assumed the domestic demand for steel to continue to grow at a reasonable CAGR of 7% between FY08 and FY11. We have also assumed that the company will be on track with respect to its other plans, mostly on the capex front.

Different price scenarios have been laid out in the table below. Considering the current stock price of Rs 320 or thereabouts, it can be inferred that even a 20% decline in average realisations on a compounded basis for three years and P/BV multiple of slightly greater than 1x could lead to decent returns from a FY11 perspective.

Steel prices decline (FY08-FY11) FY11 Stock price when P/BV is 0.5 FY11 Stock price when P/BV is 1 FY11 Stock price when P/BV is 1.5
5.0% 229 458 687
10.0% 216 432 648
20.0% 196 392 588
*Decline on a compounded basis

Just to put things in perspective between FY02 and FY08, the company’s realisations (saleable steel) have grown at a CAGR of 13% and the average P/BV multiple has stood at 2.2x. It could be argued that while the global scenario has changed considerably and the company’s own business model has undergone a significant change, a question that begs itself is, “Has it deteriorated as much as the current stock price is implying?” Unfortunately, there is no clear answer. But if history is any indication, the stock seems to be trading at attractive levels.

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