Usha Martin deal expected to be positive for Tata Steel's earnings growth

Margins of acquired assets should improve; gains not at the cost of high leverage

Tata Steel's announcement on acquisition of Usha Martin's one million tonnes per annum (MTPA) steel operations, though small, is expected to be positive for the former's earnings growth. Tata Steel group is among the top global steel companies with 27.5 MTPA capacities at the end of 2017-18.

The company's acquisition of Usha Martin's assets on a slump-sale basis for Rs43-47 billion is at a reasonable valuation of 6-6.5 times the potential Ebitda (earnings before interest, tax depreciation and amortisation) and has an enterprise value per tonne of close to $700, say analysts. 

Though it may be marginally earnings accretive as of now, but can prove to be significantly beneficial in future. The steel plant is integrated with a coke oven, rolling mills and a captive iron-ore mine, which increase the scope of profitability. According to analysts, the assets being acquired had an Ebitda of Rs3.4 billion in FY18. Given the fact that peers with similar facilities are earning much higher Ebidta per ton, Tata Steel, with its capabilities, can improve the profitability of acquired capacity significantly, they opine.

For instance, Usha Martin's Ebitda per tonne for FY18 comes to Rs5,500, say analysts at Kotak Institutional Equities. The figure is much less than that of peers such as Jindal Steel and Power's FY18 Ebitda/tonne of Rs10,600 with similar facilities. Tata Steel India had reported Ebitda/tonne at Rs12,987 during FY18.

What is more the acquisition will have a limited impact on leverage. Net debt to Ebitda could rise slightly to 3.6 times, feel analysts. However, they are watchful on final decision on Bhushan Power’s acquisition to determine Tata Steel's leverage position. The latter is competing with other bidders such as JSW Steel for the same.

 

Meanwhile, analysts at Jefferies say the deal, albeit small, would give a lift to Tata's India volumes by 6 per cent, and lift long products' volumes by 24 per cent. This will also expand the product mix.  Analysts maintain their positive stance on Tata Steel, considering the expansion in the more profitable Indian operations. The company has already restructured its European operations and formed a joint venture with ThyssenKrupp to drive profitability of its European operations. Analysts at Prabhudas Lilladher say steel price outlook should allay concerns on aggressive domestic inorganic expansions. With profitability being the top priority, strong fundamentals of domestic market and ample growth options would drive steady return and payback on the acquired asset.