Steal the rights

Shareholders can pick up the the rights issue that is priced attractively to the current market price

Shareholders of Tata Steel can subscribe to the rights issue of ₹12,800 crore , given that it is priced attractively relative to the current market price of the company. The company offers four fully paid-up and two partly paid-up shares for every 25 ordinary shares held by a shareholder as on the record date — February 1, 2018.

Nearly 75 per cent of the proceeds will be utilised to repay the existing debts and the balance for general corporate purposes. Each fully paid-up and partly paid-up share is being offered at a price of ₹510 and ₹615 respectively. In the case of partly paid-up shares, nearly 25 per cent is to be paid on application and the balance on full and final calls that will be made by the company within 12 months.

Clearly, the price at which rights issue is made by the company is attractive when compared to the current market price.

If an eligible shareholder subscribes to both the fully and partly paid up shares, the average cost for right shares would be ₹545 per share.

Even in this case, the offer is reasonably at a discount to the current market price. It is a good opportunity for an investor who bought the stock at higher prices to bring down the overall cost of investment . However, the rights issue will dilute the EPS (earnings per share) of the company in the near term.

Apart from pricing, the company’s prospects in the near-to-medium term look positive, with its focus on Indian operations, possession of captive iron ore and coal mines, restructuring activities at Europe and the prevalence of favourable steel markets domestically and globally.

At ₹677, the stock now trades at 35 times its trailing 12-month earnings. This seemingly high valuation is largely due to the write-offs and losses in the European business that dragged down consolidated earnings. According to Bloomberg’s estimated earnings for FY18, the stock trades at a reasonable 13 times, which is attractive when compared to other major steel players in the market that trade at over 16 times.

It is to be noted that the PE figures calculated based on estimated earnings have not factored in the debt repayment out of the proceeds of rights issue, which therefore will not alter the interest payment for calculating the EPS.

India going strong

Tata Steel’s India business, the major profit contributor, is on a strong footing with good growth in volumes and price realisations. This has been aided by increasing global demand, including from China and the production cuts there. 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 board has recently approved the five million tonnes per annum (mtpa) capacity expansion at Kalinganagar port at a total estimated project cost of ₹23,500 crore.

In addition, Tata Steel is also planning to acquire the stressed steel assets such as Electro Steel, Bhushan Steel and Bhushan Steel and Power. These acquisitions, if successful, are expected to help the company in strengthening its operations in India.

However, Tata Steel will have the pressure of high debt levels if stressed assets are acquired at higher valuations. Its net debt stood at ₹78,000 crore by September 30 , 2017.

Captive mines would ensure that the company will not be impacted by the raw material fluctuations in the market.

Europe solution

The recent agreement with Thyssenkrupp AG to restructure the European steel business is expected to bring good tidings to the company. The company expects cost synergies to the tune of €400 million to €600 million from the joint venture . About €2.5 billion of debt from the group’s balance sheet will be transferred to the joint venture.

However, the benefits from this arrangement are expected to be realised only from FY2020.

Improving financials

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.

The recent quarter has also been good for the company. The overall EBITDA margins have improved from 12.4 per cent in the September quarter to 17 per cent in the December quarter with revenue growth of 15 per cent Y-o-Y.

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