Tata Steel: Getting stronger

After staying in the market doghouse for a long time, Tata Steel came back roaring since late 2015 — the stock has been on a steady rise, nearly tripling over the past two years. A few factors fuelled this rally — the company’s exit from a portion of its loss-making European business, strong growth and expansion of its Indian business, import protection measures by the Indian government and rising steel prices.

At ₹701, the stock now trades at more than 50 times its trailing 12-month earnings. But this seemingly high valuation is largely due to the write-offs and losses in the European business that dragged down consolidated earnings. With restructuring and the proposed joint venture with Thyssenkrupp AG likely to take off in the next fiscal, the European business should do much better in the coming years.

Tata Steel should also continue doing well in India with the company well-positioned to capture an increasing share of the growing market. The threat of steel exports from China also seems to be waning. On FY-18 estimated earnings, the stock trades at a reasonable 11.5 times. While higher than the three-year average of forward earnings of 10 times, the current valuation does not seem expensive, given the company’s healthy growth prospects. Investors with a long-term perspective can buy the Tata Steel stock. The recent weakness in the stock after the lower-than-expected September quarter results provides a good entry point for investors.

Over the past two years, Tata Steel has been hiving off parts of its debt-laden, loss-making European business that was bleeding the consolidated financials. While biting the bullet has meant financial pain, the company’s decision to cut losses and focus more on profitable businesses such as India has improved investor sentiment.

The efforts at restructuring its European business have got a shot in the arm from the proposed 50:50 joint venture (JV) with Germany’s Thyssenkrupp AG. The non-cash deal, expected to be closed in the next fiscal, will see the flat steel business of the two companies being merged.

The JV will take over significant debt from the books of the two companies and is expected to have cost synergies of about €400-600 million per annum. While the company’s consolidated sales will come down, the JV is also expected to cut the consolidated debt burden of Tata Steel by about €2.5 billion and improve leverage levels.

The prospects of the merger going through have brightened with the separation of British Steel Pension Scheme (BSPS) from Tata Steel UK.

While this entails payment of £550 million and offer of 33 per cent stake in Tata Steel UK to BSPS Trustees, it frees Tata Steel UK from pension liabilities of about £15 billion and improves the company’s prospects.

Meanwhile, Tata Steel’s India business, the major profit contributor, is on a strong footing with good growth in volumes and price realisations. The first phase (3 mtpa) of the technologically-efficient Kalinganagar steel plant, that started commercial operations in May 2016, is now operating at full capacity. The company’s domestic capacity is now around 10 mtpa and 3 mtpa at Jamshedpur and Kalinganagar, respectively. Further expansion of the Kalinganagar plant’s capacity to 6 mtpa or 8 mtpa, likely the latter, has been planned. Also, there are plans to increase the Jamshedpur plant’s capacity by 1 mtpa. These expansions over the next few years will add to Tata Steel’s heft in the domestic steel market which is expected to continue growing at a good pace. The company is also exploring opportunities of acquiring distressed debt-laden steel companies that are now on the block. The restructuring of the European operations should give the company more scope for leverage to fund its expansion plans in India.

While private investment activity in the country remains sluggish, the government’s thrust on infrastructure development should keep demand for steel ticking. The company’s volumes have been growing much faster than domestic consumption, helping it up its market share. The uptrend in steel prices has also helped revenue growth. There seems to be more scope for improvement in realisations for Indian steel-makers with prices still relatively low compared with international prices. The government’s moves to contain cheap steel imports from China have also helped. With significant closure of steel capacity reported in China, the threat from Chinese imports seems to have receded.

Besides, unlike many of its domestic peers, Tata Steel’s India operation has an advantage of meeting its major iron ore requirements from captive mines.

After deterioration for many years, primarily due to its woes in Europe, Tata Steel’s financials have been improving over the past year or so, thanks to restructuring and cost-control efforts in Europe, and improving realisations and volumes in the domestic market. On a consolidated basis, revenue grew about 10 per cent y-o-y in 2016-17 to about ₹1.1 lakh crore, while adjusted loss (after extraordinary items) reduced about 17 per cent in 2016-17 to ₹2,622 crore.

There has been a marked improvement in the half-year ended September 2017, with consolidated revenue growing 22 per cent y-o-y to about ₹62,000 crore and the company posting adjusted profit of about ₹2,300 crore compared with loss of ₹3,200 crore in the year-ago period. In the recent September quarter, Tata Steel’s consolidated revenue rose about 24 per cent y-o-y and the company posted adjusted profit of ₹1,038 crore from loss of ₹63 crore in the year-ago period. EBITDA per tonne rose 32 per cent y-o-y in the September quarter and consolidated operating margin increased to 14.6 per cent from 11.4 per cent in the year-ago period. This was driven by increased deliveries (up 15 per cent y-o-y) and better realisations in the Indian market.

The September quarter results, while good, were below market expectations due to lower realisations in Europe and higher-than-expected costs in India. The management expects the company to post better results in the second half of the year and deliveries in India to be around 12.4 million tonnes for the full year 2017-18 from 10.97 mt in 2016-17. Lower coking coal prices should also help.

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