Analysis: Shrinking European business good for Tata Steel's profitability

The company will focus on the Indian market where profitability is higher

A day after Tata Steel announced an impairment or non-cash write down of $1.6 billion, the company's stock was down 0.8 per cent in early trades to Rs 303. The write-off was largely due to the company's struggling European operations, where demand has slowed substantially over the last couple of years.

The stock has not reacted very negatively as the condition of the European operations was known. It's due to this pressure that the company's shares have under-performed the Sensex by 25% year-to-date.

The company continues to be among the lowest cost producers of steel globally and is expected to post robust numbers in FY14. The company has a 10 million tonne plant in India and has the lowest cost of production. Even though other steel makers in India have been hit by various raw material (coal and iron ore) and regulatory issues (mining ban), Tata Steel has remained unaffected as it has access to its own raw material supplies.

Analysts believe that shrinking European operations are good for Tata Steel as costs will come down. Instead, the company will focus on the Indian market, where it is increasing capacity. Demand is picking up in India and will drive the company’s profitability.

Morgan Stanley continues to be bullish on the stock due to structural changes taking place at the company and sharply growing Indian operations (where Tata's competitive advantages have widened as almost all its peers have been negatively impacted from regulatory developments). Analysts believe that shrinking European operations should improve profitability and return ratios over medium term.