IIFL puts buy on Tata Sponge Iron

RESEARCH: IIFL

RATING: BUY

CMP: 392

IIFL recommends a ‘Buy’ rating on Tata Sponge Iron with a price target of 413. Sponge iron prices have commenced their ascent over the last two months led by an uptick in scrap prices globally and rising input costs. Over H12010, the spread between scrap and sponge iron widened to about 5,000/tonne; this is expected to decline going ahead. Following the rise in Chinese domestic steel prices, scrap prices too have moved higher over the last one month. IIFL estimates average sponge iron prices to be about Rs16,500/tonne in FY11 and FY12.

Tata Sponge has three sponge iron kilns of 0.13 mtpa each and two waste heat recovery power plants with a combined capacity of 26 MW. Over the last two years, it has sold about 69% (125 million units) of total power produced to the grid. IIFL expects average power realisation of 3.5/unit and revenues of 45.1 crore in FY11 and 49.1 crore in FY12.

With steady cash flows, cash per share is to rise from 60.5 in FY10 to 145 in FY12. With raw material linkages already established, TSIL should post profit CAGR of 11% over FY10-12 E. At the CMP (current market price), the stock is trading at 2x FY12E EV/EBIDTA and at a FY12E P/B of 0.9x, which is at a steep discount to its peers.