Global headwinds haven’t subsided, but with strong profitability at home and expected fall in costs in European business, analysts expect gains in medium term.
A bleak outlook for its European operations due to global headwinds has been partly responsible for the 33 per cent decline in Tata Steel’s stock since the start of July 2011. Though Indian operations remain strong, with raw material integration holding the key, European operations lack this and continue to feel the heat. The profitability of Tata Steel Europe (TSE), its wholly owned subsidiary which accounts for about 70 per cent of revenue, is expected to further dip in the December quarter on lower realisations and higher costs.
The bad news ends there. The start of coal supply from its Mozambique project after March 2012 would provide some cushion to TSE’s needs. The company also continues its efforts to keep costs under control. Bikash Bhalotia at PINC Research sees the developments as positive, though with marginal benefits in the initial stage. He says the second and third phase of the Benga project in Mozambique would bring major benefits (meeting a fourth of requirement).
| BOUNCEBACK LIKELY IN FY13 Margins seen rising on lower costs | |||
| In Rs crore | FY2011 | FY2012E | FY2013E |
| Revenues | 117,150 | 122,601 | 129,334 |
| % chg y-o-y | 15.1 | 4.7 | 5.5 |
| Ebidta | 14,392 | 14,278 | 17,179 |
| EBIDTA (%) | 12.3 | 11.6 | 13.3 |
| Net profit | 8,983 | 5,518 | 6,529 |
| % chg y-o-y | LTP | -38.6 | 18.3 |
| EPS (Rs ) | 99.0 | 53.9 | 65.3 |
| PE (x) | 4.2 | 7.6 | 6.3 |
| E: Estimates; LTP- Loss to Profit Source: CapitaLine Plus, Bloomberg, Analyst reports | |||
Thus, even as near-term prospects look subdued, analysts say Tata Steel should do well in the medium term. Most of them, thus, are positive on the stock, which has gained 10 per cent in the past six days to Rs 410, with a 12-month consensus target of Rs 513.
Mozambique cushion
Last weekend, the company announced the first phase of the Benga project (jointly owned by Tata Steel and Rio Tinto) would start production from March 2012. At an annual rate of 5.3 million tonnes (mt), hard coking coal production would be close to 1.7 mt, of which 0.7 mt (40 per cent) would be available to Tata Steel. This will be directed to TSE’s plants in Scunthorpe, Port Talbot and Ijmuiden. TSE, with 16 mtpa capacity, requires 10-12 mtpa of coking coal, say analysts. Since TSE does not have access to captive coal and iron ore, the start of captive supplies (at lower costs) is positive.
Part of these will also go to Tata’s Jamshedpur plant in India. Tata Steel already has 100 per cent backward integration for iron ore but only 60 per cent for coking coal in domestic operations. The bigger gains will come from start of the second phase, when Benga’s capacity is to be doubled, reaching 20 mt in the third phase (25 per cent of TSE’s needs).
TSE still under pressure
TSE had seen a subdued September quarter. Falling demand in Europe led to a 1.4 per cent year-on-year decline in volumes to 3.48 mt. This, coupled with declining realisations and high coal costs, resulted in the Ebitda (earnings before interest, taxes, depreciation and amortisation) per tonne falling close to $30, compared to $48 in the June quarter. Though international prices of coking coal have declined by $40-50 to $235 a tonne, TSE has a long-term supply agreement at higher costs, which will keep costs elevated in the near term.
The demand for steel is likely to remain under pressure, with analysts expecting volumes to decline further during the second half. The December quarter is historically weak in terms of volumes because of the festive season in Europe.
Analysts at Bank of America-Merrill Lynch expect volumes to decline eight per cent sequentially in the December quarter. They say input costs for TSE are yet to peak and could remain sticky due to the lag effect.
Analysts at Standard Chartered Securities say the past six months have seen steel prices decline from $767 to $637 a tonne. Given the European economic scenario, they do not see any improvement in demand in the medium term. However, some benefit from falling ore and coal prices would start from the March quarter. The fresh coking coal contracts have been signed at $235 a tonne from that quarter, compared to $330 a tonne in the June quarter, reckon analysts.
TSE is also doing its bit to push profitability. It recently cut 115 jobs and shut a steel mill in Wales. The company said the facility would remain mothballed until the UK economy and steel demand justified re-operation and supplies would be made from its hot strip mill at Port Talbot, whose costs were lower.
India business on firm wicket
Its Indian operations remain strong. With raw material integration, Tata Steel is India’s most efficient player. It reported an Ebitda per tonne of $370, compared to JSW’s $130-140 and SAIL’s $92 in the September quarter.
Though the demand in India is also under pressure, the rupee depreciation is helping steel prices remain firm. Hence, profitability of Indian operations is likely to be healthy. Its 2.9 mt expansion at Jamshedpur is also progressing well, with commissioning expected from January 2012, adding a third to domestic capacity.
The project is expected to add volumes of 1.9-2.0 mt in 2012-13. Analysts at Espirito Santo Securities expect operating profits from Indian operations to increase by 23 per cent year-on-year to $3 billion in FY13. They add that robust cash flows from domestic operations will improve Tata Steel’s consolidated balance sheet over FY12-13.
