In this article we will try to analyze Tata Steel Ltd. based on previous six years of financial statements viz Balance sheet, Profit and Loss statement and Cash flow statement. With this fundamental analysis we will try to gain insight into the financial health, operating efficiency and profitability of the company and finally try to derive the intrinsic value of the stock using Discounted Cash Flow method and the price at which the stock becomes attractive for long term investment.

Dated: 26 Aug 23
Company: Tata Steel Ltd.
CMP: Rs. 117.10
Market Capitalisation: Rs. 1,43,034.02 Cr.

Intrinsic Value of Tata Steel Ltd.

Tata Steel Ltd. is an Indian multinational steel manufacturer with headquarters in Mumbai. It is one of the worlds largest steel producers and has its operations across 50 countries and employs over 80,000 people. It offers wide range of products including hot rolled coils, cold rolled coils, galvanized sheets, bars, rods, wires and structural sections etc. In addition the company is also diversifying into related sectors mining, engineering and services.

Note: Here we are carrying out only the quantitative fundamental analysis of Tata Steel Ltd. as the qualitative analysis is more subjective and individual views may vary vastly.

Before we enter into the calculation of Intrinsic value of Tata Steel Ltd. we have to make some logical assumptions based on the previous six years financial statements and ongoing yield for 10y Government Of India bonds.

Assumptions:

• Terminal growth rate is assumed to be 0%.
• Discount rate is assumed to be 12%.
• The increase in Free Cash Flow is assumed to be Rs. 1664.40 crores per year for the first five years and then Rs 832.20 crores from sixth to tenth year. The growth rate is projected based on the past growth of Free Cash Flow (refer to figure below). In the past Free Cash Flow has increased at the rate of Rs. 3328.80 crores per year, however, with a moderate outlook we have taken 50% of that figure for the first five years and 25% of that for the next five years.

• Increase in Revenue is assumed to be Rs. 11817.33 crores per year for the first five years and then Rs 5908.66 crores per year for the next five years. This growth rate is based on analysis of previous year’s revenues (refer to figure below). In the past revenue has increased at the rate of Rs. 23634.65 crores per year, however, with a conservative outlook we have taken 50% of that figure for the first five years and 25% of that for the next five years.

• Free cash flow will be 10% of revenues in future. The FCF/Revenue ratio for the period under consideration has an average of 0.10. We assume that this ratio will hold good for future.

Based on the above assumptions we have arrived at two levels as intrinsic value of the firm. One is based on extrapolation of Free Cash Flow and the other is based on Free cash flows derived from extrapolated values of revenues. Both the methods only differ in how the input values are derived; in both the cases the present value is arrived at using Discounted Cash Flow Method.

Free Cash Flow Growth Model
Intrinsic Value:  Rs. 106.55
Stock Entry price with 25% margin of safety: Rs. 79.91

Revenue Growth Model
Intrinsic Value: Rs. 204.14
Stock Entry price with 25% margin of safety: Rs. 153.10

The average of the above two stock entry prices works out to be Rs. 116.51. When the stock starts trading below this price it becomes attractive for long term investment.

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Fundamental Analysis Of Tata Steel Ltd.

Leverage Ratios

Observations:

1. The company has managed to bring down its debt levels and is maintaining a good interest coverage ratio.
2. In absolute terms also the debt has come down during this period while revenue has improved which is a good sign.

Operating Ratios

Observations:

1. Tata Steel has been operating with negative working capital with few exceptional years. A negative working capital means the company may face short term cash crunch to meet its day to day operational needs as the current assets are not sufficient enough to meet current liabilities.
2. There is remarkable improvement in receivable turnover ratio.

Profitability Ratios

Observations:

1. Year 2022 was exceptionally good in terms of PAT, EBITDA and respective margins.If we ignore that and compare with year 2021 then we can see a decline in PAT, EBITDA and respective margins as compared to pre COVID levels. This indicates that market has not yet recovered fully after the pandemic and there is added pressure from competition.
2. We can observe the same pattern in rest of the ratios ROE, ROCE and ROA.

Author
Jibu Dharmapalan
Fundamental Analyst

Disclaimer:
This article is for educational purpose only. Investment in securities market is subject to market risks. Please consult your Financial Advisor before investing.

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References:
https://www.bseindia.com/stock-share-price/tata-steel-ltd/tatasteel/500470/financials-annual-reports/
https://www.tatasteel.com/investors/financial-performance/financial-results/

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FAQs

What is Intrinsic Value?

Ans: When someone invests in an asset, he does so in order to earn money from the business. The investor gets paid over a period of time as long as he is invested in the asset. Now intrinsic value is the present value of all such future cash flows generated by the asset. So logically one should not invest in any asset if the ask price is more than the intrinsic value of the asset.

How is Intrinsic Value of a company calculated?

Ans: For calculating the intrinsic value of a company all its future cash flows are extrapolated based on the past performance of the company, assumptions about the future growth of the company and its terminal value. Once all these are calculated these are brought to the present date based on appropriate discounting rate. The sum of all these gives the intrinsic value of the company. It may be more or less than the market capitalization of the company. If it is more than the market capitalization of the company then the company is said to be undervalued and is a good bet as a long-term investment and vice versa.

How is Intrinsic Value of a share calculated?

Ans: Once intrinsic value of a company is calculated as explained above, it is divided by the total number of outstanding shares of the company. This gives the intrinsic value of a share.

What is Discounted Cash Flow?

Ans: When we have cash flows that are spread over a period of time then Discounted Cash Flow method is used to calculate present value of all such cash flows. The present value depends on the discounting rate used. Usually 10 year Government bond yield rate(risk free rate of return) is used as the discounting rate.