Metal mettle

POUND WISE

Demand growth, expansion and higher share of value added products should help Tata Steel perform better.

They say one should look at the bigger picture, which in case of Tata Steel looks bright. The steel behemoth posted lower than expected numbers for Q4 FY06, with standalone net profit declining by 13.8 per cent y-o-y and operating margins reducing from 37.34 per cent to 31.5 per cent.

This fall is primarily attributed to a 22 per cent rise in raw material costs, 15 per cent fall in realisations, depreciation and employee separation cost shown as per the accounting norms.

Net profit for FY06 was static at Rs 3506 crore. But, going forward, analysts expect the robust demand, capacity expansion and value addition to add more muscle for Tata Steel.

Commenting on the latest numbers, Tata Steel VP-finance, Kaushik Chatterjee, puts the fourth quarter numbers in perspective, "Realisations have been hit more in ferro alloys than in steel. Also, costs incurred on new projects and capacity expansions and high excise duty also contributed to the lower margins."

Indeed, the fall in operating profits in Q4 from ferro alloys has been more pronounced at 18.56 per cent y-o-y to Rs 134.09 crore than the 12.87 per cent fall in steel business profits to Rs 994.85 crore.

The company's saleable steel capacity increased by 17 per cent to 4.9 million tones, affecting profitability. "The main culprits for decline in profit numbers were raw material costs, especially zinc and coking coal," Vishal Chandak, analyst at Emkay Share & Stock Brokers.

Strong demand
But, the demand for steel looks stronger in the coming months. Steel prices are back from the lows in January and February and are firming up further with rising demand, dilution of inventory and increased import costs.

In the current fiscal till now, average international steel prices are up 11 per cent, from $ 416 per tonne for hot rolled coils in FY06. They are expected to be stable in the coming quarter.

Earlier prices had dropped substantially due to piling up of huge inventories. For instance, in FY06, there was a fall of 11 per cent over FY05.

Chatterjee says, "The demand will be robust both in the domestic and international markets. The demand growth will be maximum in China, followed by rest of Asia, where India will lead. Even Europe and America are coming out of inventory problems."

On the domestic front, he adds that with a number of infrastructure projects coming up and the auto sector witnessing consistent growth due to changing lifestyles, demand for steel is expected to be strong.

The construction and realty demand pick up in urban as well as semi urban areas, will be a major growth driver for the sector. The buoyant markets would drive up margins in the coming months.

Cost control
While, the peaking prices of inputs pressurised margins, Chatterjee says that the company has been trying to control costs through process innovations like reduction of slag volume in blast furnaces, modernisation of casters to improve productivity and reduction of imported coking coal.

For instance, the share of imported coal fell from 45 per cent in FY05 to 36 per cent in FY06. However, since the raw material supply is not growing at the same pace as the demand, a fall in input prices is unlikely.

However, some analysts are hopeful about a softening in input prices in course of time.

Chandak says, "Raw material prices are expected to fall once demand-supply imbalance is taken care of, through production of more raw materials. Thus, even as entering into long-term contracts for supply of raw materials can be a way to lower costs for Tata Steel, in the present situation, going for long-term contracts could be more harmful."

Brand value
The company has been into branding for some time now and its value added branded products include Steelium, Tata Tiscon, Tata Shaktee, Tata Bearings and Tata Structura earn a premium over unbranded products.

Moreover, the company has got into a retail outlet brand - steeljunction - which is promoted as a one-stop destination for its entire range of products.

Expansions that earn
Apart from that, the company is also ready to reap the rewards of its acquisitions. Last fiscal, while the company's stand-alone sales grew 4.42 per cent, its consolidated revenues were up 26.54 per cent.

Similarly, its stand-alone net profit grew at 0.93 per cent while consolidated profits jumped by 4.2 per cent.

Chatterjee says, "We have reaped substantial benefits through synergies with Nat Steel and plan to repeat the same with Millennium Steel." Millennium Steel is a leading player in South East Asia with 25 per cent market share in long steel products.

"Geographical proximity also helps us derive synergies. We can utilise the acquired capacities without incremental investments," adds Chatterjee.

Not just that, Chatterjee feels that overseas acquisitions have helped Tata Steel in facing the impact of raw material price hike on its domestic operations.

Tata Steel is also into organic expansion and is planning greenfield projects in Orissa, Chattisgadh and Jharkhand, a port at Dhamra with L&T and a joint venture with Bluescope Steel to foray into better building solutions.

Valuation and outlook
The company's valuations compare well with local and global peers. According to an estimate by Anand Rathi Securities, Tata Steel trades at 6.8x on FY07E earnings, while Nippon Steel trades at 11.7x, Pocso: 7.5x, Mittal Steel: 6.2x and Sail: 4.5x.

Going forward, Chandak expects steel prices to rise by around $ 35-40 per tonne, on the back of a 19 per cent hike in iron ore prices globally. Companies like Tata Steel who have captive mines (that insulate it from the industry cost cycle) should witness margins expansions. 
 

FINANCIALS
Rs crore	Q4 FY06	Q4 FY05	Chg (%)	FY06	FY05	Chg (%)
Net sales	4128.97	3864.65	6.84	15139.39	14498.95	4.42
Operating profit	1300.80	1442.93	-9.85	5931.51	6045.36	-1.88
OPM %	31.50	37.34	"�	39.18	41.70	"�
Net profit	783.11	908.58	-13.81	3506.38	3474.16	0.93
EPS (Rs)	14.15	16.42	"�	63.35	62.77	"�

Moreover, one of the most positive factors for the steel industry in India is the continuing robustness of local demand.

With most of the user industries like auto, capital goods and infrastructure, announcing capacity expansion and hefty order backlogs, one can expect more shine on steel companies in the coming quarters, particularly Tata Steel.