Recommendation from Iron & Steel/Interm Sector

This column gives you script chosen by the research team during the fortnight that is fundamentally strong and expected to give good capital appreciation over a time period of 1 year.

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STEEL YOUR PORTFOLIO WITH TATA SPONGE IRON

Tata Sponge Iron

Company Overview: A subsidiary of Tata Steel, it is in the business of producing and marketing sponge iron which is used in steel making. It also generates 26 MW power as a by product, which it exports to its parent company. Moreover, the company also produces power through waste heat recovery boilers (WHRB), enabling it to help reduce carbon emissions and earn carbon credits. Tata Sponge has its manufacturing facility at Bilaipada in Orissa which produces 3,90,000 MTPA of sponge iron or direct reduced iron (DRI). Just a few months ago, the company has received an approval from the Ministry of Environment, Forest and Climate Change for enhancement of DRI production by 35,000 MT taking its new capacity to 4,25,000 MTPA .

Industry Overview: Depending on the demand, the sponge iron industry operates at 60-70 per cent of its full capacity since the sponge iron plants are relatively easy to close and easy to restart. Using this to their advantage, the industry operates mainly on a profitability scenario. Interestingly, Tata Sponge last year operated its plant at full capacity achieving record production. The government has also initiated favourable measures to restrict imports and to strengthen the industrial base of the country. This augurs well for the sponge iron industry as the spurt in demand for steel will in turn create higher demand for sponge iron. Moreover, with the fall in international prices of iron ore and coalthe main raw materials- the cost of production of sponge iron will come down.

Also, China has shut 42.39 million tonnes of crude steel capacity in the first half of 2017, which is equal to 84% of its yearly capacity. This is a golden opportunity for Indian steel makers to go global.

On the financial front, Tata Sponge reported encouraging figures. Although its turnover came down from Rs63.3 crore in FY16 to Rs61.6 crore in FY17, its EBITDA increased from Rs23.96 crore to Rs61.66 crore in FY17, an increase of 157.35 per cent. The profit after tax surged from Rs31.89 crore in FY16 to Rs58.64 crore in FY17, showing an 84.2 per cent increase. For the quarter ended June 30, its profit augmented three-fold to Rs30.5 crore. Its revenue from sponge iron segment rose to Rs176.86 crore from Rs107.17 crore in the year-ago period. Income from power segment too rose from Rs15.26 crore in Q1FY17 to Rs18.75 crore in Q1FY18.

Another factor in favour of Tata Sponge is its raw material security and proximity. Tata Sponge sources iron ore, the most important raw material, fully from the mines of Tata Steel, its parent company. It also generates its own power, eliminating uncertainty in power availability from external sources. Also, the company's plant is situated near one of India’s richest iron ore reserves. On the Valuation Front, the stock of Tata Sponge is currently trading at PE ratio of 15.99x as compared to industry PE of 15.01x. The company’s ROE and ROCE stood at 6.79 per cent and 6.95 per cent in FY17, respectively.

Considering the shutting down of Chinese steel plants, expected improvement in domestic steel demand due to infrastructure push and buoyant steel prices, we recommend our reader-investor to BUY Tata Sponge Iron.