A turnaround in the fortunes of Tata Steel Europe (formerly Corus) is on the cards; will it be sustainable?
Tata Steel recently announced its results for the quarter ended September 30, 2010. Hidden in the maze of numbers was the performance of its subsidiary, Tata Steel Europe (earlier known as Corus). It posted an operating profit of Rs 886 crore against a loss of Rs 1,802 crore in the same quarter of the previous financial year.
With the European operations accounting for 70 per cent of Tata Steel Group’s production, the spotlight is on the turnaround of Tata Steel Europe, which entailed some unpalatable decisions. This wasn’t just another turnaround story. Not so long ago, Tata Steel had drawn flak from analysts and investors alike for the drag on its profits caused by Tata Steel Europe. Tata Steel had acquired Corus in 2007 for £6 billion. The world at that time was riding a commodity boom and everything looked hunky dory. But towards the middle of 2008, once the subprime crisis broke and Lehman Brothers collapsed, the Western world went into a tailspin. Much of Tata Steel Europe’s operations were in Europe. A large part of the steel it made got sold to automobile makers and construction firms — sectors mauled by the financial meltdown. It was soon mired in losses. Tata Steel had bought a lemon, detractors wasted no time in saying.
In a few more quarters it will be clear whether or not the turnaround is just a flash in the pan. Tata Steel Europe has gained from the recovery in the steel market, the thaw in iron ore prices and some deft restructuring. Tata Steel Europe Managing Director & Chief Executive Officer Karl-Ulrich Kohler has attributed the turnaround to the cost and restructuring measures implemented in response to the financial crisis. As if to announce the turnaround, the company was only this September renamed Tata Steel Europe.
Cutting costs
In the second half of 2008-09, as the market deteriorated, Tata Steel Europe undertook two major cost-saving initiatives: Weathering the Storm and Fit for Future. While Fit for Future was more strategic in nature and was aimed at improving long-term cost-competitiveness, Weathering the Storm comprised several short-term actions designed to cut costs and keep the supply and demand in balance. It was Fit for Future that entailed some hard decisions, even at the cost of incurring the wrath of the workers’ unions. Headcount reduction, asset management and restructuring, including closure of some unprofitable businesses, were at the core of this programme.
In December 2008, when Weathering the Storm was launched, the savings target for 2009 was set at £550 million. The actual amount achieved was around £730 million. “In 2009-10, the total savings targeted under the programme were £778 million, whereas we had achieved actual savings of £866 million. We exceeded our targets,” Tata Steel Group Chief Financial Officer Koushik Chatterjee says.
Fit for Future aimed to achieve benefits of £250 million per annum. The programme was launched in January 2009 and hence the benefits rolled out in 2009-10, though from March 2008 to March 2010, 6,500 personnel were offloaded. The total savings achieved in 2009-10, which was the first year, were £107 million. Adding the numbers, the combined savings stand at a staggering £1 billion.
Is that good enough? “Developments in the marketplace and steps taken by us in the aftermath of the crisis ensure that we will be better equipped to face the adverse market conditions in the future. It is important to note the reasons that led to a fall in Tata Steel Europe’s profitability last year,” Chatterjee says. It was a combination of factors: A significant decline in European volumes, mismatch between the cost of raw materials and steel prices in the wake of the unprecedented global crisis and continuation of production at the loss-making Teesside Cast Products.
Motilal Oswal analyst Sanjay Jain says that the company is still vulnerable to commodity prices. Tata Steel Europe has taken a host of measures to buffer against a commodity price crash. “The rebranding to Tata Steel Europe commenced from end-September. This gives us an opportunity for a refreshed market positioning that fully leverages the strength of the global Tata Steel brand,” Chatterjee says. The group has rolled out what it calls a One Company Approach Model, where the marketing, sales and distribution teams have been aligned with major industries/sectors. “Steel production is now organised around three hubs with manufacturing optimised throughout Europe,” Chatterjee adds. There are other initiatives as well like the Customer First Programme and supply chain initiatives. Capital deployment to the tune of £185 million was made for enhancing hot metal production at Port Talbot.
Of course, Tata Steel Europe has also managed to push back repayment of debt. “The refinancing of £3.53 billion term loan and revolving credit facilities has been completed. The new loan was drawn on October 7, 2010 and the entire amount outstanding under the acquisition debt facilities was repaid. The main benefit of this refinancing is that the repayment has been pushed for three to four years giving additional flexibility to borrow for working capital purposes and to incur capex. Refinanced loan also does not carry covenants, helping Tata Steel Europe to concentrate on carrying out its business effectively,” Chatterjee says.
Ore assured
Tata Steel Europe was hamstrung by the unavailability of iron ore. In contrast, Tata Steel, the Indian company, has its own captive iron ore mines. So when iron ore prices skyrocketed on the back of strong demand from China, the company was still breathing easy. For Tata Steel Europe, captive raw material will start flowing in from 2012. It will have access to iron ore from the Canadian project, New Millennium Capital Corp, and coal from the Mozambique project (Riversdale Mining). While iron ore will go to Europe, coal will make its way to India and Europe. Captive raw material sources have become crucial to beat the volatility in prices. Earlier this year steel producers were compelled to move to quarterly contracts for iron ore and coking coal, the two key inputs — a dramatic shift from the 40-year-old annual benchmarking system.
Resource majors can afford to make such a dramatic change in pricing policies given the oligopolistic nature of the industry. Of the $200 billion iron ore industry, BHP Billiton, Rio Tinto and Brazil’s Vale control two-thirds. Coking coal, again, is controlled by BHP, Rio, Anglo American and Xstrata. While Tata Steel’s India operations have 100 per cent iron ore security and 50 per cent for coking coal, Tata Steel Europe has no captive sources. Well, almost. Port Talbot is sitting on a coking coal reserve for which exploration studies are on.
After months of negotiations, Tata Steel Europe has also tentatively agreed to sell the beleaguered Teesside plant to Thailand’s Sahaviriya Steel Industries for a price of £320 million. However, according to both firms, the deal is far from complete. This is the first of several steps required to reach a definitive sale agreement in the coming months. Teesside was partially mothballed in February this year, after a consortium of four buyers pulled out of a 10-year purchase contract with Tata Steel Europe, leading to a loss of nearly 1,500 jobs. The contract had helped the company sell nearly 80 per cent of the plant’s total output, which explains the need for mothballing when the deal was snapped. Between April and December 2009, Teesside lost around £150 million due to the terminated contract. Tata Steel Europe has said it would continue to pursue legal action against the consortium.
The next few quarters will test Tata Steel Europe’s mettle.
