Steel consolidates

The ongoing resolution of insolvent steel companies is giving the larger players an opportunity to acquire the stressed assets of the debt-laden firms. We look at what this means for shareholders

Fortunes of Indian steel manufacturers have been looking up over the last two years due to favourable global conditions resulting from capacity cuts by Chinese steel plants and increasing demand for the metal globally. Favourable regulations and government spends have further helped domestic demand.

According to the World Steel Association, India produced 26.68 million tonnes of crude steel in the first three months of 2018, translating to 3.7 per cent growth compared with the same period a year ago. Finished steel is projected to grow 5.5 and 6 per cent in 2018 and 2019 respectively.

But the picture was quite bleak for steel makers across the globe, a few years ago. Excess capacity and output from China, coupled with contraction in demand, made steel prices crash, eroding the profitability of steel makers. Companies in India were not spared either. Relatively smaller players which went on an expansion spree between 2005 and 2010, piling on large debt to fund their projects, took a hard knock as the steel cycle reversed, with many of them turning insolvent.

 

That’s probably why 5 out of 12 companies that were referred by the RBI to NCLT (National Company Law Tribunal) in the first list, are steel companies.

The five companies — Bhushan Steel, Bhushan Power and Steel, Essar Steel, Electrosteel Steels and Monnet Ispat & Energy — which are going through the NPA resolution process constitute more than one sixth (~22 million tonnes) of the total crude steel capacity in India. Here’s a closer look at the resolution process to understand what the deals under the Insolvency and Bankruptcy Code (IBC) mean for different stakeholders.

Tata-Bhushan Steel

Tata Steel’s ₹35,132 crore resolution plan to take over Bhushan Steel’s assets may emerge as the flagship for the entire IBC resolution process.

The resolution process which was carried out through Tata Steel’s wholly-owned subsidiary, Bamnipal Steel, has been issued 79.44 crore shares at a face value of ₹2 by Bhushan Steel, amounting to ₹158.89 crore. This will enable Tata Steel to own 72.65 per cent stake in Bhushan Steel. Tata Steel is also advancing an inter-corporate loan of ₹34,973.69 crore to Bhushan Steel.

Stronger product portfolio

Tata Steel’s overseas operations are struggling to stay profitable in difficult conditions, with operating profit in both Europe and South-East Asia declining in FY-18 compared with the previous fiscal. However, in India, sales volume grew 10.7 per cent to 12.15 million tonnes compared with 7.9 per cent growth in domestic steel demand. Higher steel prices in India also aided revenues. The company’s consolidated and standalone operating profit stood at about ₹8,725 and ₹13,000 per tonne respectively in FY-18.

On the other hand, Bhushan Steel has been crushed by the debt of about ₹55,000 croretaken to finance its capacity expansions. Higher interest costs, accounting for almost 36-40 per cent of the revenues, have been a drag. The company, however, managed to show operating profits on an average of about ₹4,000 per tonne in FY-18.

Though the bid for Bhushan Steel was termed aggressive by many, Tata Steel believes that this is a value-accretive acquisition based on replacement cost. It values Bhushan Steel at about ₹44,000 crore (replacement cost + present value of expected earnings), which is way higher than its bid of ₹35,200 crore.

Bhushan Steel, which operates at nearly 3.5 million tonnes per annum (mtpa), has an installed capacity of about 5.5 mtpa. In addition, there are downstream facilities like the cold-rolling mill of around 2 mtpa that includes galvanising units for value-added products. It caters mainly to the auto industry and consumer durable makers through facilities spread across Odisha, Maharashtra and Uttar Pradesh.

Post-acquisition, the installed capacity of Tata Steel India will be close to 18 mtpa. Bhushan Steel, which is significantly a flat steel producer, will help Tata Steel consolidate its position as one of the top flat steel makers.

As debottlenecking of Tata Steel’s capacities at Jamshedpur — which can increase the capacity by 1 mtpa — and expansion plans of Kalinganagar plant to 8 mtpa from 3 mtpa, is expected to take place only after two to three years, acquisition of Bhushan Steel’s plant, which is already operational, will help meet the increasing demand in the near future. Especially with Tata Steel India’s current capacity utilisations at already beyond 90 per cent, immediate boost to capacity will help.

Tata Steel expects to start utilising Bhushan Steel’s capacity in FY-19 and ramp-up operations to full capacity in three years. The company targets operating profit of around ₹10,000 per tonne from Bhushan Steel initially.

Our take

With capacity expansion plans in India and restructuring activities in Europe, Tata Steel is well-positioned to show a strong earnings trajectory, post-2020. Until then, there could be some pressure on earnings due to weak market conditions overseas, transitional uncertainties and increasing interest cost. The stock of Tata Steel is, thus, a good buying opportunity for long-term investors.

The share of public shareholders in Bhushan Steel was reduced to 12 per cent from the earlier 56 per cent, post-acquisition. The additional issue of shares to Tata Steel has led to earnings-dilution, thus hurting minority shareholders. That said, the worst could already have been factored into the stock price. With Tata Steel planning to significantly ramp-up Bhushan’s output, coupled with healthy demand in domestic market, offloading the shares now may not be a good idea. Long-term investors can hold onto the stock and review the performance of the company periodically.

Vedanta-Electrosteel Steels

The resolution plan submitted by Vedanta for Electrosteel, which was auctioned to recover about ₹14,117 crore of unpaid loans, was first among the 12 large stressed accounts to get approval from the NCLT under the IBC.

Electrosteel issued 176 crore shares to Vedanta, amounting to ₹1,765 crore. This gave Vedanta 90 per cent stake in Electrosteel through a wholly-owned subsidiary, Vedanta Star. Vedanta also gave a loan of ₹3,555 crore to Electrosteel, taking the entire acquisition cost to ₹5,320 crore.

Electrosteel has operating capacity of 1.5 mtpa. The capacity expansion, that was in progress, will augment the capacity to 2.5 mtpa. The company produces long steel products such as pig iron, billets, TMT bars and ductile iron pipes in the State of Jharkhand.

Electrosteel’s troubles began with its plan to set up a greenfield plant at a cost of ₹11,000 crore project in Jharkhand, Bihar. The project ran into regulatory delays, leading to cost over-runs and further downturn in the steel price cycle eroded the company’s capability to service the large debt. Mounting losses over many years has completely eroded its net worth.

Vedanta, a diversified metal and mining company, will be complementing its portfolio by adding a steel plant to its group. Acquisition of Electrosteel by Vedanta will be a forward integration in steel-making for the latter. Vedanta now has licences to mine iron ore in Goa (currently shut down) and Karnataka.

As per the Vedanta management, this acquisition satisfies the requirement that iron ore mined will be utilised in the country. Vedanta is confident of turning around this acquired asset by ramping up production to 1.5 mtpa and, subsequently, to 2.5 mtpa with synergies from iron ore costs.

Our take

This acquisition offers some cheer to investors of Vedanta, which has been in the news for all the wrong reasons recently. With its previous experience of turning around the acquired loss-making assets, it is expected to turn Electrosteel profitable in a short span of time. Being a new steel plant, Electrosteel has the potential to contribute more than ₹1,000 crore per year to the operating profit of Vedanta group.

The liquidation value of Electrosteel, as determined by the Resolution Professional, is nil. However, as per the resolution plan, Vedanta will pay the public shareholders of Electrosteel Steel ₹0.19 per equity share.

The resolution plan included reduction in the face value of Electrosteel’s shares from ₹10 to 0.20 paise and, then, consolidating 50 shares to 1 share with face value of ₹10. Vedanta plans to delist the shares of Electrosteel by offering ₹9.5 in lieu of each consolidated share with face value of ₹10.

Effectively, shareholders of Electrosteel get just 19 paise for each share they held before the takeover, which is next to nothing. The stock of Electrosteel now trades at around ₹13, offering 30 paise for each pre-takeover share. Those who have not written-off this investment can sell the shares in the open market at a slightly higher price.

JSW- Monnet Ispat & Energy

While the above deals are complete, resolution for Monnet Ispat & Energy, which was admitted for claims close to ₹11,400 crore, is expected to take a little longer, as approval from NCLT is awaited. However, the committee of creditors has selected JSW Steel-led consortium with AION Capital as the winner, with bid for about ₹3,700 crore.

Performance of Monnet Ispat has been hampered from 2011, when it added to its debt to fund capacity expansion. The company’s debt stood at ₹12,262 crore towards the end of FY-17. It has been consistently recording losses since FY-15, thus eroding its networth. A silver-lining is that the recovery in steel industry has helped reduce the losses in FY-18 by 17 per cent to ₹1,759 crore over the previous year.

Assuming that the bid by JSW Steel is approved by NCLT, Monnet Ispat’s 1.5 mtpa of finished steel making capacity near Raipur, Chhatisgarh, gets added to the JSW Steel’s 18.1 mtpa, taking its total capacity to 19.6 million tonnes. The management of JSW Steel is confident of producing 0.5 million tonnes of TMT bars in three to four months, but it expects that ramping up to its full capacity may take longer.

Monnet Ispat is also in the business of mining coal and iron ore. However, the output of iron ore from these mines would be marginal and is unlikely to make a significant difference to the cost structure of JSW Steel.

JSW Steel, which has nearly 15 per cent market share in the Indian steel market, has shown a robust performance with 17 per cent and 76 per cent increase in consolidated revenues and profit for the year ending FY-18. The company has plans to expand its capacity to 24.7 mtps (excluding Monnet Ispat’s) by FY 2020.

Our take

Even if the acquisition of Monnet Ispat by JSW Steel is successful, the former is unlikely to contribute to JSW’s earnings significantly before FY-20. With JSW steel’s capacities already running at almost 90 per cent, and with expansion plans in progress, the volume growth for FY 2019 is expected to be flat and may move up only from FY-21.

However, the management assures increase in profitability by focusing on change in product mix and cost-saving initiatives. JSW Steel is a good long-term investment.

With the resolution plan still awaited, it’s difficult to comment on what the deal means for existing shareholders of Monnet Ispat.

Essar and Bhushan Power and Steel

Essar Steel and Bhushan Power and Steel, whose NPA resolutions are still pending, is also a value bet for acquirers. As per reports, while the former owes about ₹49,000 crore, the latter owes around ₹45,000 to its lenders.

Essar Steel, an integrated steel player with 10 mtpa capacity, produces a wide range of steel products that include hot-rolled, cold-rolled, galvanised and colour-coated products. It caters to a wide section of industrial segments that include auto, ship building, white and yellow goods, engineering, power plants and defence among others.

Though debt-laden, Essar Steel, that operates a little above 50 per cent of its capacity, is a decent performer among the stressed steel companies. Taking over Essar Steel will make the acquirer one of the top producers of flat steel in India, apart from providing other operational synergies.

Bhushan Power and Steel — with capacity of three mtpa, has captive non-coking coal, iron ore mines in Orissa and Jharkhand — is another company that could soon find a buyer. These captive mines and power generation capacities reduces the input cost of steel and contribute to long steel products in the product portfolio of acquirer.

While the steel industry consolidates and operational synergies emerge out of these takeovers, huge debt is being transferred to the players acquiring these assets. With steel being a cyclical industry, any downturn in the market will exert immense pressure on acquiring companies’ balance-sheets. Here’s a closer look at the impact of the extra leverage on acquirers.

Carrying the debt burden

Tata Steel

Tata Steel, whose consolidated net debt (gross debt - cash or cash equivalents) stood at ₹69,000 crore as on March 31, 2018, will reduce by ₹20,000 crore once its European operations form a JV with Thyssenkrupp AG. The funding for acquisition of Bhushan Steel will add ₹34,500 (Tata Steel’s debt to increase by ₹16,500 and internal accruals to reduce by ₹18,000 crore) to the net debt.

The net debt of the company now stands at a whopping ₹83,500 crore (₹69,000 crore-₹20,000 crore + ₹34,500 crore).

The current net debt to operating profit of the company is 3.1 times for FY 2018. Going forward, assuming a flat growth in operating profit, the ratio of net debt to operating profit would be close to 3.7 times. The company intends to bring it down to three times over the long term.

The company’s huge debt should, however, not be a problem if the company’s earnings continue to grow at a healthy clip.

JSW Steel

JSW Steel had debt of ₹38,019 crore as on 31 March, 2018 with net debt to operating profit at 2.57 times. The acquisition of Monnet Ispat for ₹3,700 crore will not significantly increase the net debt of the company.

However, the capex planned (₹45,000 crore) to increase the capacities to 24.7 mtpa by FY 2020 will increase the company’s net debt levels.

Out of ₹45,000 crore, the amount financed by debt is expected to be ₹25,000 crore and the balance out of internal accruals. The company aims to maintain the net debt to operating profit within 3.75 times.

Vedanta

Vedanta, a diversified metal and mining company, reported a consolidated net debt of ₹21,958 crore as on March 31, 2018. At operating profit of ₹25,470 crore, the net debt to operating profit is 0.9 times, well within 1, which is considered healthy.

Though there is enough headroom to increase the debt, given the company’s healthy cash flows from various sources, the company’s capex plans are expected to be funded from internal accruals.

The net debt, post-acquisition, would be ₹27,258 crore or about 1 times the operating profit. This deal is not expected to exert any pressure on Vedanta’s balance-sheet.

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