Tata Steel - Regaining strength?

Early signs of a recovery in demand along with measures to improve profitability at Corus indicate that Tata Steel may bounce back into the black.

Tata Steel reported its second consecutive consolidated quarterly loss last week. The poor operating performance of its European business, lower metal prices and slow pick up in demand were among prime reasons for the losses and remain key concerns going ahead. Not surprisingly, the company expects the next few quarters to be challenging.

On the positive side, to deal with these challenges, the company has already taken several initiatives, which are aimed at bringing its operations, particularly European, on track. The company’s recent $500 million GDR offer should also ease some funding concerns and provide fuel for the company’s expansion plans, mainly the highly profitable domestic facilities. While the stock has been in the limelight for the wrong reasons, there are early signs of recovery which indicate that it the going ahead could be better. Here is an analysis of the recent events and the future outlook for the company.

Corus dents profit, once again
Tata Steel’s global operations weigh heavily on its overall performance as almost 80 per cent of its total capacities are based in the overseas markets. Its European operation alone, which comes under Corus, accounts for 75 per cent of the total capacity. The impact was clearly seen in June 2009 quarter. While Tata Steel’s standalone EBIDTA was Rs 1,789 crore, on a consolidated basis it reported an operating loss of Rs 29.9 crore; consolidated net loss stood at Rs 2,240 crore. The performance was weak on account of lower volumes and realisations at its European operation as the global economic slump shrunk demand. This in turn meant that Corus was able to utilise only 53 per cent of its capacity; its volumes dropped to 3.3 million tonnes in June 2009 quarter as compared to 6.2 million tonnes in June 2008. This along with high cost of opening inventory of raw material (iron ore and coal) impacted its operating performance.

The company, thus, reported a loss of $117 per tonne at the operating level as against a profit of $123 per tonne in June 2008 quarter.

Ready to bounce back?
In the current environment, to achieve a breakeven level at its European operations, analysts estimate that the capacity utilisations is required to move beyond 75 per cent levels, which is likely to happen in the second half of 2009-10 on the back of a pickup in demand. The company has already reached a 70 per cent capacity utilisation during the month of July 2009. They estimate that steel demand in Europe is stabilising and steel output is increasing along with de-stocking of inventory. According to the data provided by the World Steel Organisation, sequentially the demand in the European regions has increased from 9.42 million tonne in the month of April 2009 to 11.24 million tonne in July.

“As far as Corus is concerned, by December 2009 we could move to a breakeven level or a positive side, mainly helped by the combination of three components viz., lower raw material cost, additional cost savings and higher volumes,” says Koushik Chatterjee, Group CFO, Tata Steel.

Analysts also reckon this. “While 2009-10 will be challenging for Corus, we expect sequential improvement in prices and volumes as well as cost savings of $1.2 billion to lead to improved profitability,” says Edelweiss Securities’ analyst in a recent note. “We expect Corus to return to profitability, as steel prices in Europe are already $100 per tonne higher than the average price of $460 per tonne seen in quarter ending June 2009,” says Rakesh Arora, who tracks the metals sector at Macquarie Securities.

Trimming costs
Higher utilisation, better steel prices and improving volumes would be the key triggers, but only in the second half of 2009-10. On its part, the company has envisaged a cost saving of about Rs 6,200 crore for 2009-10 on the back of initiatives like ‘Weathering the Storm’ and ‘Fit for Future’. Under these initiatives, Corus has already achieved savings of Rs 2,200 crore during the June 2009 quarter. These initiatives include securing long-term captive supplies of raw materials like iron ore and coal.

In the near-term, expect inventory costs to also come down. Till June 2009 quarter, the company had high-cost inventory of raw materials. It now hopes to sign new contracts at the lower rates thus, leading to substantial savings in the coming quarters. Like in the case of coal, the average cost for Corus was about $300 per tonne as against the current prices of about $170 per tonne. The company is now negotiating new contracts at lower prices, which if signed would lead to substantial cost savings.

For the long-term, the company is looking at overseas mines. For instance, during 2009-10, Corus had captive sources of raw material to the extent of about 25 per cent of its requirements, but now it is eyeing new mines (acquisitions, equity stake) to take this figure to 50 per cent by 2015. Besides raw materials, Corus is also planning to reduce its staff cost by lowering its employee count from 40,000 to 35,000 in 2009-10. Thanks to these initiatives, analysts expect Corus’ EBIDTA to improve to $480-490 million in 2009-10 itself.

The lesser impacted
Tata Steel’s Indian operations have provided great support. Although here too, realisations have fallen, volumes have been growing on the back of steel demand in the country, particularly for long products from the infrastructure sector. Domestic sales volume grew by 22.4 per cent to 1.42 million tonne in June 2009 quarter. Even on the margins front, despite lower realisations, the company reported strong operating profit margins of 32 per cent due to its lower cost of production.

While domestic steel prices have recovered by about 10-12 per cent from their lows in April 2009, steel production has grown at 4.25 per cent in July 2009 on a year-on-year basis. Since Tata Steel’s domestic business figures among the top three cost-efficient steel operations globally, expect its performance to improve further on the back of higher sales volumes and better realisations in the coming quarters.

IMPROVING NUMBERS
	FY 09	FY 10E	FY 11E
Capacities (in million tonne)
Tata steel	5.23	6.7	7.22
Corus	19.7	17	18.9
Others	3.5	3	3.1
Total	28.43	26.7	29.22
in Rs crore
Avg. realisation (Rs/Tonne)	51,811	37,343	38,420
Consolidated sales	147,300	99,707	112,263
EBIDTA	18,130	11,624	15,795
Consolidated net profit	4,950	2,963	5,921
Consolidated EPS (Rs)	61.9	35	68
PE (x)	7.1	12.5	6.4
Source: Analyst estimates and Bloomberg

Easing liquidity
Tata Steel increased its domestic steel capacity to 6.8 million tonne last year. It intends to take this further to 10 million tonne by mid-2011. However, analysts were worried about the funding and consequent increase in debt levels. But, with the completion of its recent $500 million GDR issue, which the company will utilise for capital expenditure in India, acquisition of new mines in overseas markets and prepayment of debt at Corus, these concerns are easing out. Last week, it equipped itself with shareholder approval to raise additional funds worth Rs 5,000 crore, though the route has not been spelt out. Meanwhile, as at the end of June 2009 quarter, the company’s consolidated net debt stands reduced by Rs 3,891 crore to Rs 49,170 crore.

Outlook
Tata Steel’s major concern remains to be its international business where the improvement is only expected after September 2009 quarter. Meanwhile, as it is taking steps to bring down cost, there are early signs of demand picking up in the European region, which should help improve Corus’ utilisation levels. This along with the benefits of higher international steel prices should mean better profitability in the coming quarters. However, the full benefits of the initiatives and recent developments should only be seen from 2010-11, through a strong recovery in earnings believe analysts. “We think Tata Steel has reached the bottom of its earnings cycle, and we expect a sharp recovery from the December 2009 quarter,” says Arora. The stock, which is trading at 6.5 times estimated 2010-11 earnings, is partly factoring in a recovery, the sustainability of which will only get confirmed over the coming months. In this light, experts believe that investors can consider the stock on dips but with a 2-3 year perspective