Steely move

While the deal looks beneficial for Uttam Galva as well as ArcelorMittal, the former’s stock has captured most of the positives making valuations expensive

The recent deal between ArcelorMittal Netherlands, a wholly-owned subsidiary ArcelorMittal, Uttam Galva and its promoters when consummated will lead to ArcelorMittal becoming a co-promoter of Uttam Galva. ArcelorMittal has agreed to buy 5.6 per cent in Uttam Galva from the existing promoters and an additional 29.4 per cent through the open offer to take its total stake to 35 per cent stake.

Even if the open offer is not fully successful, the Indian promoters will provide shares from their existing holdings so as to enable both parties to have an equal holding in the company. While the deal is considered positive for both the companies, analysts believe that a 160 per cent run up in the share price of Uttam Galva in the last three months (24 per cent post the announcement) captures most of the positives.

The company
Uttam Galva Steels, a leading domestic producer of value-added steel, procures raw material like hot rolled coils (HRC) from primary steel producers and processes it to make value-added products such as cold rolled steel, galvanised products and colour-coated coils and sheets. These products are used in the auto industry, consumer durables and engineering products among others, and yield higher prices compared to the traditional steel products or crude steel. 
 

MARGIN PRESSURES
in Rs crore	FY08	FY09	Q1 FY10E	% Chg y-o-y
Sales	3,156	4,372.0	1,073.0	35.3
EBIDTA	301	365.0	103.0	6.9
EBIDTA (%)	9.5	8.3	9.6	-255 bps
Interest	114	166.0	34.0	-20.8
Net profit	124	100.0	35.0	30.0
EPS (Rs)	8.8	7.3	2.6	46.7

     

Synergies
Uttam Galva Steels currently has a capacity to produce one million tonnes of value-added steel for which it depends on other players for its raw material requirements, mainly sourced from overseas, including from players like ArcelorMittal. According to estimates, over 50 per cent of Uttam Galva’s raw requirements are sourced from ArcelorMittal, which is the world’s largest steel making company. With this deal, Uttam Galva will stand to gain as it is not a fully integrated player. “Our company will benefit due to the access to secured and timely supply of raw material and higher technologies required for value-added products,” says Ankit Miglani, director, Uttam Galva Steels.

The last few years have been critical for non-integrated steel players, given that the management of prices, raw material supplies and inventory has been difficult. Additionally, since large steel companies are getting inclined to manufacture and sell their own value-added products, it has resulted in increased competition for players like Uttam Galva. Thus, its association with ArcelorMittal should help in combating the emerging competition.   

Analysts believe this deal will also help ArcelorMittal in many ways. “For ArcelorMittal, it is a low cost acquisition which will provide ready access to existing clients in the value-added space in international and domestic markets,” says Deven Choksey, managing director, KR Choksey Shares and Securities.

Uttam Galva generates about 60 per cent of its revenues from the export market by supplying its products to customers in more than 143 countries, including the US and European markets, where it is already an established player with its products approved by major international companies.

While commenting on the domestic market strategy, Choksey adds, “As the demand for value-added steel is growing in India and expected to grow even higher in the years to come, the deal with Uttam Galva will provide ArcelorMittal a platform in India.”

Here, analysts also believe, given that ArcelorMittal is finding difficult to establish its presence in the Indian markets due to the slow progress regarding the acquisition of mines and land, this deal could help in exploring the opportunities and in establishing a manufacturing base early in the Indian market.

Beyond the deal
Although the deal is considered to be favourable for both the companies, the market is also reading beyond the fine print. Questions like what purpose will this one million tonne capacity (Uttam Galva’s current capacity) and a small equity investment serve for a company like ArcelorMittal, which is very large in scale. “Obviously, ArcelorMittal is not looking for one million tonne of capacity. For them it is a low cost acquisition and now they can increase the capacity gradually to higher levels,” says Choksey.

Such hopes if they materialise, could have a bearing on the company’s financials as well as justify current stock valuations, which look expensive. “For the long term it is too early to say. But, if tomorrow ArcelorMittal says that they we will acquire the entire stake in the company and take the current capacity to four million tonne then the things will definitely change" says investment advisor, SP Tulsian of sptulsian.com.

Conclusion
While it is too early to say what plans the company and its promoters have store, investors may be well off in keeping away from the stock. At Rs 133, the company’s market capitalisation works out to Rs 1,652 crore which along with the Rs 1,410 crore debt translates into an enterprise value of Rs 3,062.9 crore. The latter is almost 8.5 times the company’s reported EBIDTA for 2008-09. Even on the basis of PE multiple, the stock is currently trading at 15 times the estimated 2008-09 earnings.

Further, even if the next year’s EPS is assumed to grow at 25 per cent on the back of higher capacity utilisation and better realisations, the PE still does not seem to be attractive at 12.5 times. “I think, at this price one should get out of the stock because there are better alternatives available in the market,” says Choksey. Overall, there could be many synergies and advantages for both companies. However, most of the positives are already factored in the prices. The triggers in the long-run could be further clarity on the future strategy and plans of both the companies.