Tata Steel: Riding the cycle

Soaring steel prices have helped the company post handsome operating margins.

With steel prices soaring, it's not surprising that the Rs 131,535.8 crore Tata Steel managed better realisations in the March 2008 quarter, especially since the steel maker sells large amounts of high value products catering for the automotive and construction sectors.

What's more the management believes that even if the Indian economy slows down somewhat, demand will outstrip supply so that prices remain firm. A fourth of Tata Steel's contracts are annual in nature and it has managed to negotiate better terms when these were renewed in April 2008.

Even though Tata Steel's (stand-alone) production rose just marginally in the March 2008 quarter, the higher average sale price of Rs 44,850 per tonne "" up nearly 14 per cent y-o-y "" helped push up revenues to Rs 5,737 crore, an increase of 15 per cent.

Besides, a host of measures taken to reduce energy consumption and improve efficiencies helped the company post better operating margins, which were up by 360 basis points at 42 per cent. Most important, the raw material bill stayed virtually flat as a percentage of sales which is creditable.

However, the company's subsidiary Corus didn't have as great a fourth quarter; possibly because it is not an integrated operation like its parent: it does not have captive resources of key inputs such as iron ore.

However, Corus has managed to pass on most of the the increase in raw material costs through price hikes and continues to do so. It has announced a hike in prices of between 20 - 30 per cent for flat rolled products (hot-rolled coils, galvanised coil, steel pipes ) and that should help improve margins going forward: indeed Corus' operating margin for FY08 was better at 9 per cent than in the previous year.

The management believes that the demand will remain strong in Europe in the near term. Corus is well on track to realise the $450 million of savings every year from the integration of the operations with Tata Steel and the savings could even be higher.

Steel companies are grappling with rising raw material costs especially because prices of imported spot met coke have surged. As a strategy,Tata Steel plans to acquire mining assets whether it is limestone, iron ore or coal; it has already started acquiring some assets. To fund these acquisitions, Tata Steel is looking to restructure parts of the company and perhaps rope in investors by selling them a stake, so as to unlock value.

The idea, the management says, is to be self-sufficient in raw materials to the extent of about 45-50 per cent of its requirement. The Tata Steel stock has lost nearly 20 per cent over the last month though it was up 2 per cent at Rs 757 on Thursday and now trades at a price ""earnings multiple of just under 7 times consolidated FY 09 earnings and should outperform the broader market.

SAIL, which too saw better realisations in the March quarter, trades at Rs 155 and commands a multiple 5.5 times estimated FY 09 earnings.