India business to offset impact of Tata Steel Europe deal falling through

Domestic prospects remain firm, but Street will still be watchful of deleveraging and incremental cash generation

As Tata Steel’s plans for a European joint venture between Tata Steel Europe (TSE) and ThyssenKrupp got called off, concerns were bound to mount. On one hand, the merger would have helped Tata Steel cut its consolidated debt, and on the other, it would have improved prospects of TSE, looking at the business challenges the European region faces. Not surprising, Tata Steel’s shares, which lost over 6 per cent on Friday, extended their fall on Monday, losing another 3.2 per cent.

Tata Steel, after the acquisition of steel capacities of Corus (now TSE) in Europe in 2007, had faced challenges. The Lehman crisis, the European slowdown leading to soft demand and realisations, and rising cheap imports into Europe all impacted its profitability and in turn its debt. While Tata Steel continued working on restructuring its European operations, a joint venture (JV) with ThyssenKrupp, a leading European steel player, had raised hopes on TSE’s prospects. For one, the merger would have led to Rs 20,000 crore of TSE’s debt being transferred to the JV, besides significant synergy benefits. The European Commission’s requirements that could not be met, however, has dashed hopes of a JV.

While the development is a setback, TSE has overtime also transformed. Exit from many unprofitable or unsustainable operations means its European capacity has reduced from 18 million tonnes (MT) to 10 MT. The 7 MT plant in the Netherlands is itself sustaining, says the company. While pension fund issues related to 3 MT capacities in the UK have been resolved, the longer-than-expected transformation of its blast furnace and higher energy costs have impacted performance.

While TSE expects its operations turning cash positive soon, challenges remain on the profitability and cash flow fronts given the worries over the global trade war and the slowdown in demand in Europe. Analysts at Motilal Oswal Securities say steel spreads in the European Union have halved since the recent peak due to demand weakness and high raw material prices, and that they now expect TSE generating per tonne profitability of $60 in FY20 (versus about $85 in FY19). Apart from sustaining reasonable profitability, TSE needs to take care of capex and debt.

“TSE operations require sustainable capex of $300 million and interest on debt ($2.3 billion) will be $125 million. Hence, required breakeven Ebitda is likely to be $450 million,” estimates Edelweiss.

India biz lending support

While it remains to be seen how TSE performs, Tata Steel’s Indian operations have grown stronger and provide significant support. Around two-thirds of its business is now India-based and reports strong profitability and cash flows. Tata Steel generated consolidated Ebitda or earnings before interest, tax, depreciation and amortisation of Rs 29,770 crore (Ebitda excluding exceptional items at Rs 30,734 crore), against net debt of Rs 94,879 crore at end of FY19. TSE’s Ebitda stood at Rs 5,414 crore (up 45.8 per cent year-on-year) during FY19, and debt at ^2.2 billion (Rs 17,300 crore) versus ^3 billion in 2014.

With all this, analysts remain cautiously positive. Analysts at Edelweiss say that they are upbeat on Tata Steel’s domestic story and estimate Ebitda per tonne of Rs 11,500-Rs 12,000 through FY21 with a decent possibility of incremental capex being funded via own cash flows. However, in light of the JV being called off, they have downgraded the stock to neutral and cut their target price from Rs 600 to Rs 520.

Those at IDFC Securities say that the development does not hamper growth plans for the growing and profitable India operations and FY20 net debt/Ebitda of 3.2x is not a major concern, as the domestic operation is expected to contribute 85 per cent of operating profits in FY20. Their target price is Rs 635.

After deducting fair value of the JV, analysts at JM Financial arrive at a fair value of Rs 615 given a sharp/quick turnaround of Bhushan Steel, Indian operations getting more prominent and raw material led price increase —ideal for captive players (like Tata Steel).

Overall, the Street would still be keeping an eye on TSE’s performance and progress on deleveraging and cash generation. Tata Steel has said that options for seeking other partners for TSE are open. Any progress here would be welcome.