Can UK steel fire up JSW furnace?

Concerns on weak Europe environment, liabilities of Tata UK ops, and JSW's debt

Markets were unnerved on buzz that JSW Steel was among those short-listed to acquire Tata Steel's loss-making UK operations. The JSW Steel share price fell almost three per cent on Tuesday, even as the indices inched up.

There is a reason for the negative market reaction.

First, JSW Steel, which has 14.3 million tonnes of annual steel-making capacity, is among the preferred picks of analysts in the steel sector. That is because the company has been doing well in the domestic arena as compared to most of its peers, despite a challenging business environment.

Second, European macroeconomic fundamentals and business environment remain weak and have been primarily responsible for Tata Steel's decision to sell the operations, which have been making losses for some time now. Tata Steel's UK operations have been under pressure due to Chinese imports, soaring costs, and weak demand.

The Street is also concerned about the liabilities that the UK assets will bring to the acquirer. Employee-related liabilities, including pensions, have been one of the issues. However, in order to avoid job losses, the UK government has offered support to the acquirer. This may include financial assistance and the UK government taking a 25 per cent stake in the acquired business. Details on all these are not yet known.

Last, there is no clarity on the funding for the acquisition and how it may reflect on JSW's already-indebted balance sheet, if the company acquires the UK assets. As on December 31, 2015, JSW Steel's net consolidated debt-equity ratio stood at 1.83, up from 1.72 as on September 30, 2015.

(Debt/equity ratio is a debt ratio used to measure a company's financial leverage, calculated by dividing a company’s total liabilities by its stockholders’ equity. For example, if a company has a total shareholder value of $180,000 and has $620,000 in liabilities. Its debt/equity ratio is then 3.4444 ($620,000/$180,000), or 344.44 per cent, indicating the company has been heavily taking on debt and thus has high risk. )

Meanwhile, on the acquisition front, JSW's history is varied. It has turned around entities acquired in India. These include the Maharashtra (Dolvi)-based unit of Ispat, as well as those of Maxsteel and Welspun.

However, its US acquisition has not been fruitful: The steel plate and pipe mill operations of its subsidiary, JSW Steel (USA) Inc, have suffered losses during the last few years. In fact, during the quarter ended December 2015, JSW Steel made a provision of Rs 5,596 crore for the fall in value of investments. The company said this was in view of the lower long-term commodity prices forecasts and continuing losses at the US operations. As a result, JSW Steel reported a net loss of Rs 923 crore (on consolidated basis) despite an operating profit of Rs 892 crore led by domestic operations, for the December quarter.

Anyway, if the company can acquire UK assets at attractive valuations and without significant liabilities, the acquisition can bring positives. Rahul Dholam at Angel Broking says that with adequate capacities and the commodity cycle at a low, JSW may be able to reap benefits of an acquisition done at the bottom of valuations. But, a lot depends on the bidding, which may be competitive as there are seven bidders for the UK-based 5.5-million-tonne annual capacities of Tata Steel.

The JSW Steel stock closed 0.2 per cent higher on Wednesday at Rs 1,291 and is yet to recover from Tuesday's losses.