Steel Sector (UBS)

Compelling valuations and fundamentals

■ Regression analysis used to estimate fair value of companies
We believe Tata Steel and SAIL are undervalued based on valuation multiplier through our regression analysis. According to our regression analysis, there is a linear relationship between: 1) EV/t and EBITDA/t; and 2) EV/IC and ROIC. Based on our analysis, we conclude that Tata Steel and SAIL are undervalued.

■ Indian stocks offer value
We lower our India capacity estimates to 70mt (73mt earlier) for FY10E and expect utilisation to remain at around 80% in our base estimates for steel demand to FY12E. We expect Indian consumption to be 52.5mt (up 2.9%) in FY10E. We believe Indian steel companies have been beaten down to 0.3-1x P/BV levels and valuations should correct up given our stable steel price outlook and lower material costs. Stocks have priced in worst-case earnings and consensus estimates should increase, in our view.

■ Steel sector—close to inflexion point
UBS Basic materials strategist, Peter Hickson, expects cyclical opportunity, which could see a potential re-stocking in the space. With steel prices down 12-15% over the past one month in India, we believe there is limited downside from here given further production cutbacks in surplus markets, a moderate pick-up in demand driven by the cyclicality, and infrastructure-led demand growth in India.

■ Valuation: Buy on Tata Steel, SAIL; upgrade JSW to Neutral
We upgrade Tata Steel to a Buy, maintain our Buy rating on SAIL, and upgrade JSW to a Neutral rating. We use DCF to derive our price targets for Tata (Rs275), SAIL (Rs125) and JSW (Rs225), but given weak sentiment we cross-check on EV/tn and EV/IC regression analysis.

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