Tata Sponge Q2 review: Profitability to improve, valuations remain attractive

Tata Sponge continues to see better earnings on higher sponge prices, which in turn was led by strong industry demand. Realisations in Q2 FY19 was close to Rs 22,000 per tonne against average realisations of Rs 21,500\t earned in the preceding quarter. This along with the marginal improvement in volumes led to an increase in sales. The latter grew 29 percent year-on-year to Rs 216.2 crore.

However, this growth did not materially translate into improving profitability. During the quarter under review, it reported a mere 1.8 percent increase in operating profit and earnings before interest, tax, depreciation and amortisation (EBITDA) margin shrank 560 basis points led by higher iron ore pries and other expenditures.

Iron ore cost increased 15 percent YoY as its dependence on the open market for iron ore increased. During Q2, maintenance cost rose to Rs 10 crore as against Rs 4 crore YoY. This is precisely the reason net profit remained flat at Rs 27.63 crore.

Majority of the expenditure relating to maintenance has now been incurred and the management expects iron ore cost to ease as its procurement from parent Tata Steel increases. That apart, it expects environmental clearance soon to produce more sponge iron. It has sought regulatory approval to increase production to 4.60 lakh tonne annually as against its current capacity of 4.25 lakh tonne.

Once the approvals are in place, it expects volume growth to be better in coming months. Considering the current sponge iron prices, realisations are expected to be in the region of about Rs 23,500/t in Q3FY19 as against Rs 22,000/t in Q2. Higher volumes and better realisations would mean the company is on track to deliver a positive set of numbers in the current fiscal.

Moreover, the stock has corrected and currently trades at an attractive valuations of about 9 times its FY19 estimated earnings. What is more interesting is the cash on its books of close to Rs 700 crore, or about 55 percent of its current market capitalisation.

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