Tata Steel shines on pension resolution, profitability

Tata Steel's profitability per tonne of steel sold increased by 20% in March qtr for domestic ops

It is rare that a large-cap scrip jumps by eight per cent or more in a day. The Tata Steel stock did so on Wednesday when it closed at Rs 493.40. In the past five years, there have been only four such instances.

The latest gain could be attributed to strong operational performance for the March quarter and progress on settlement of the British Steel Pension Scheme (BSPS) in its UK-based operations. Also suggesting it could rise further in the coming months.

For the March quarter, profitability per tonne of steel sold increased by about 20 per cent in the domestic (India) operations. The European operations’ earnings before interest, tax, depreciation and amortisation (Ebitda) per tonne more than doubled to $103. A triple-digit for the latter has not been seen for many years.

Corus, now Tata Steel Europe, earned an Ebitda per tonne of $262 in the March 2008 quarter, crashing to $83 in the December 2008 quarter. Thereafter, it struggled on profitability, often slipping into the red. Thus, the latest quarterly performance was bound to excite the Street.

Also, progress is now visible on the restructuring programme of the European business. After exiting its long products segment by selling the Scunthorpe unit a year before, this February saw the company having decided to sell the UK subsidiary’s speciality steel business. And, the biggest issue on the restructuring effort has been the British pension scheme. The company not only had to continue funding it annually; there was always the risk of a further increase in liabilities. Painful when profits have been under pressure.

The resolution is also key for the company’s negotiations to join hands with other steel entities for its European operations, as none were keen to take on the liabilities and risks associated with the pension scheme. Analysts say the issue was among the largest stumbling blocks in the company’s negotiations with Germany's ThyssenKrupp.

Thus, as the company mentioned on Tuesday evening (along with its quarterly results) that the first step in the restructuring of the BSPS was complete, the markets rejoiced. Tata Steel UK has completed a consultation process with employees and closure of the old scheme meant that all its active members became deferred pensioners. With the move, the UK pension liabilities will get limited to employee contribution only (unlike earlier, when it was pre-defined). Thus, reducing the future liabilities. The new scheme will have improved funding, as it would have lower future annual increases for pensioners and deferred members, say analysts.

However, all this comes at a cost. The new settlement will entail Tata Steel making a payment of £550 million and also give 33 per cent equity stake in Tata Steel UK to the members of the pension scheme (required under the rules), contingent on conditions being met. In this regard, however, the company had already made a provision of Rs 3,627 crore in the March quarter.

Analysts, though, are not perturbed by these expenses. Those at Credit Suisse had said the settlement makes Tata Steel pay upfront what it would have anyway paid to keep the scheme funded on an annual basis (the FY18 payout was set to be £65 million). And, the risk that the deficit could balloon, raising contributions at a later stage, is now gone for good, a big positive.

Further, analysts say, the existing shareholders should not be concerned, as the settlement is akin to a debt-to-equity conversion. With debt of $3.5 billion, no equity value can be ascribed to the UK operations until Ebitda gets closer to $150/tonne (at seven times the ratio of enterprise value to Ebitda), the Credit Suisse analysts say. Currently, the UK operations seem to be generating $20-30 a tonne of Ebitda.

Apart from curtailing the financial liability, resolution of the pension scheme will also lead to improvement in profitability. Analysts say restructuring of BSPS alone can provide $12-13 a tonne of cost savings, while employee cost savings can provide an additional $6-7/tonne, given the reduction in average employees seen in FY17 itself (taking total benefits to $20 a tonne). Abhishek Poddar and Samrat Verma of Kotak Institutional Equities say settlement of the UK pension issue will lead to strategic restructuring of the European operations, including a potential deal with ThyssenKrupp.