Europe business disappoints, but concerns not over yet for Tata Steel

Though a sequential pick-up in volumes is expected in March quarter, demand is still weak and profitability is likely to remain under pressure on lower realisations

Tata Steel's consolidated losses shot up sharply to Rs 763 crore for the December 2012 quarter as a result of lower realisations and volumes, especially in the European operations, which accounts for 50% of the company’s sales volumes. Since the losses are higher than the expectations, the scope of downgrades of the stock has increased.

As per Bloomberg consensus estimates, Tata Steel was seen reporting a net profit of about Rs 2,500 crore. But, given the net loss of Rs 529 crore in the first nine months of FY13, the possibility of meeting these estimates is low. Hence, downgrades are quite likely.

Post the results, analysts are of the view that the company could possibly report a loss for the current financial year. "We are expecting loss this year as against the estimated profit of Rs 600 crore earlier. Earnings revision will certainly have pressure on the share prices in the near term," says Eric Martins who tracks the company at Systematix Shares & Stocks.

The stock which closed down 2.2% at Rs 376.15, could slip further as the results came post market hours on Wednesday. At these levels, it is trading about 5.5 times EV/EBIDTA of its FY14 estimates, which is among the few comforting factors and should provide some cushion and limit the downside.

Disappointing Q3
The company’s performance was largely impacted by its European operation, mainly due to lower demand in the region. While volumes for Tata Steel Europe fell by 10% year-on-year (and by 12% sequentially) to 3.02 million tonne (MT) in the December quarter, realisations were also impacted due to lower steel prices. This impacted Tata Steel’s consolidated sales which fell both, year-on-year as well as sequentially (see table). The impact would have been even higher had Tata Steel India (domestic operations) not compensated. Led by the recent commissioning of expanded capacity equivalent to 3Mt, its domestic volumes were up 17% year-on-year to 1.89 MT.

At the operating level though, pressure on realisation as well as higher costs led to Tata Steel Europe reporting an operating loss of $78 million. Although its EBIDTA (earnings before interest, depreciation, tax and amortisation) per tonne, which came to negative $26 for December 2012 quarter, was better than negative $44, the same is higher than negative $2 in the September quarter. This indicates that after the initial improvement, things have again turned worse.

 

This is also a reason that consolidated EBIDTA margins have fallen sequentially by 20 basis points in the recently concluded quarter.

Outlook
The performance of Tata Steel Europe continues to be a key worry as analysts believe that even going forward due to lower demand and higher cost, it will prove to be drag on the consolidated performance. Domestic business, though, reported good growth in volumes, but that too has suffered on account of lower realisations due to lower steel prices in India.

 

Tata Steel India’s realisation per tonne came at $903 in December quarter compared to $962 in September quarter. This is also reflected in standalone revenue growth, which grew by just 2.3% sequentially despite strong volumes. Again, cost pressures meant that the standalone profits in December quarter declined 22.5% compared to September quarter.

 

Going ahead, relative to the performance of December quarter, the March 2013 quarter is expected to be better as a result of expectations of higher volumes, both in Europe and India, for two reasons. First, seasonally, the December quarter is a weak one for Europe while there would also be benefits of 4th blast furnace in Europe, which was fully refurbished and commission in the current month. This should lead to higher volumes as well as cost savings.

Secondly,with the expanded capacity in the relatively higher margin Indian operations, standalone volumes and margins should also get support. However, most of these positives are already factored in.