Wednesday, January 19, 2011

Tata Steel FPO

Adarsh Gopalakrishnan

BL Research Bureau

Tata Steel's public offer, which is in the Rs 594-610 price band, is an attractive one, considering that investors need pay only Rs 7.3-7.5 (price-earnings multiple) for a rupee of earnings on shares subscribed to by them.

The valuation is also cheaper than domestic or comparable international steel companies.

The value of Tata Steel as an enterprise, on a per tonne basis, is lower than what it would cost to replace its assets at current prices and also lower than its peers'.

The expansion in India will increase the proportion of domestic output for Tata Steel relative to that overseas — an advantage since the former is far more profitable. The Jamshedpur plant will account for 35 per cent of the consolidated capacity on adding 2.9 million tonnes of brownfield capacity by the end of next year.

The second factor working in its favour is the prospect of European operations stabilising with the loss-making Teeside facility shed and an ambitious raw-material integration programme under way. Both should result in significantly improved profitability on a consolidated basis. This offer targets proceeds of between Rs 3,390 crore and Rs 3,480 crore for the ongoing brownfield expansion plans in Jamshedpur and part of it will be used to repay non-convertible debt falling due in May.

DOMESTIC ARM

Indian steel consumption grew by 7.4 per cent for the 11 months ended November 2010, fuelled by healthy demand from the automobile and construction segments. Steel consumption tracks that of GDP growth and the latter is expected to grow at 8-10 per cent over the next five years.

The company's domestic operations have made Rs 30-40 of cash on every Rs 100 of sales before providing for depreciation, interest and taxes over the last three years.

Tata Steel's Indian operations saw sales for the first half of the current fiscal growing at 21 per cent to Rs 13,509 crore while net profits expanded by 115 per cent to Rs 3,644 crore. The strong performance was due to the previous fiscal's low base and higher realisations which the company capitalised on. Being a largely integrated player with large captive mining operations and reliant only to the extent of 50 per cent for coking coal, the company pockets proceeds from price hikes which less integrated players pass on to miners.

EUROPEAN OPERATIONS

In contrast, Tata Steel's consolidated numbers for the first half of the year grew by 13.7 per cent to over Rs 55,000 crore while profits bounced back into the black to over Rs 3,800 crore. However, the bounce-back in steel consumption was fuelled by stimulus measures for automobile sales, among other segments. The first eleven months of 2010 saw European steel production rise by 26 per cent on alow base provided by 2009 which saw 30 per cent decline in steel production.

With the effects of stimulus wearing off, the recovery is expected to be of the slow and grinding variety and in pockets such as the UK would be further exacerbated by severe austerity measures undertaken by the British government. The recovery has also faced several road-blocks in the form of sovereign debt crises in several constituents. Limited utilisation of European steel production capacity, which remains at 70-80 per cent, has kept realisations on a tight leash in Europe.

Tata Steel Europe (erstwhile Corus) has responded by shedding or idling assets such as the Teeside Casting Plant (whose output found few takers) and optimising capacity at its other production facilities. Tata Steel Europe's operational measures have included tying up raw material sources of iron ore and coal in Canada and Mozambique, among other places. The company is hoping to improve margins at its European operations by reducing the extent of reliance on external raw material sources.

THE BIG PICTURE

The company plans to counter a stagnant or slow-growth European market by aggressively adding capacity at the relatively faster growing and more profitable operations domestically. The fully integrated domestic capacity of 10 million tonnes would account for a third of the consolidated output and boost EBIDTA margins. In the longer run, the company plans to add, in two phases, 6 mtpa of steel capacity in Orissa by 2013-14. This, along with a relatively well-integrated European capacity, will result in a more balanced and profitable Tata Steel.

CHALLENGES

The company's current net debt equity levels stand at 1.76 which should move to 1.46 on the post-issue capital. The company currently holds Rs 55,000 crore of consolidated debt, and the issue should serve to deleverage the balance sheet to a limited extent. However, greenfield expansion plans will require borrowing, which could peg up this level again.

The consolidated operations are largely dependent on external sources for raw materials. External shocks such as the floods in Queensland, Australia, could have an impact on the European operations. Over the last few months, steel makers have also been under pressure due to slipping demand and rising raw material costs which steel producers have been unable to completely pass through. Steel producers globally recently undertook a series of price hikes, but the fragile European setting and inflation-prone Asian economies have been sensitive to price hikes in steel, putting pressure on the margins of steel producers.

Source : Businessline

Our Recommendation :

Long term investors should buy in the secondary market where they can get below the issue price post listing. Since there will be more floating stock in the short term 6-9 months the stock is likely to under perform. Stay away re-enter around 550 levels

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