Tata Steel share price falls over 2% as Kotak downgrades the stock to 'reduce' from ‘buy’. Here are 5 reasons why

Tata Steel share price fell over 2 per cent in intraday trade on on Wednesday, January 3, following a downgrade from brokerage firm Kotak Institutional Equities. In its report dated January 2, Kotak downgraded Tata Steel's stock rating from 'buy' to 'reduce' but raised the target price (fair value) from 140 to 145.

However, despite raising the fair value, the downgrade emphasised the substantial surge in the stock's value over the past two months. Tata Steel share price jumped 9 per cent in December, following an 8 per cent gain in November. Overall, for the year 2023, Tata Steel share price rose about 24 per cent last year, outperforming the benchmark Sensex which rose 19 per cent.

The stock, however, underperformed the BSE Metal index which rose over 29 per cent last year. On Wednesday, Tata Steel share price opened at 139.65 against the previous close of 139.55 and touched its intraday high and low of 139.65 and 136.05 respectively. Around 12:35 pm, the stock was 2.26 per cent down at 136.40.

Kotak believes that the nearly 20 per cent increase in Tata Steel's share price in the last two months, led by market buoyancy, has minimised the potential for additional upward movement as fundamentals do not look supportive. "We note that the fundamentals have deteriorated at the margin, (i) with raw materials outperforming steel prices, suggesting downward pressure on India’s spreads from Q4FY24, (ii) persistent pressure in Europe’s steel spreads, and (iii) the risk of delay in the UK’s resolution and completion of the KPO II 5 mtpa expansion," said Kotak.

1. Margins under pressure Kotak pointed out that high inventory at mills and distribution channels and rising imports are exerting downward pressure on prices. Higher raw materials and weaker steel prices suggest downward pressure on steel margins from Q4FY24. "Domestic demand remains robust at 15 per cent in eight months of FY24, but Tata Steel would benefit only partially due to lack of new capacity," Kotak said.

2. Europe business in distress Kotak pointed out that Tata Steel's Europe business has been reporting sharp losses since Q3FY23, with an average EBITDA loss of $109/ton, led by (1) weak spreads and (2) a major maintenance shutdown in the Netherlands. "We expect losses to continue, given weak spreads.

UK assets are approaching the end of life and media reports suggest negotiations with unions on job cuts and new investments face opposition. We forecast EBITDA of $19/51 per ton in FY25/26E versus the loss of $155 in Q2FY24," Kotak said. Also Read: 3. KPO II expansion may face delays Kotak observed that Tata Steel’s new 6 mtpa pellet plant and 2.2 mtpa CRM mill should start contributing to margins in the second half of the financial year (H2FY24E).

Moreover, the 5 mtpa KPO Phase II, which is expected to be commissioned by March 2024, could face delays of 3 6 months and meaningful volumes may only come in FY26E, according to the brokerage firm. "A step up in volumes led by KPO II should be back ended in FY25E. We estimate standalone volume growth of 7 per cent, 9 per cent and 11 per cent in FY24, FY25 and FY26, respectively, but see a downside risk to FY25E estimates," Kotak said.

Also Read: 4. Europe may slow down expansions in India "Tata is well positioned in the Indian market, with a potential to reach 40 mtpa capacity (from 24 mtpa in FY2025E) from low cost brownfield expansions. However, we see Europe continuing to consume management bandwidth and India’s balance sheet for new investments in the UK.

Thus, Europe could potentially slow down expansions in India and we see it as a key de rating risk," said Kotak. Also Read: 5. Risk reward turns unattractive "The stock trades at 5.7 times EV/EBITDA FY26E, close to our target multiple, suggesting a limited upside," said Kotak. Read all market related news Livemint tops charts as the fastest growing news website in the world to know more.

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