Some respite for Tata Steel

Though improving steel prices and restructuring of European operations will enhance profitability, a meaningful pick-up in demand is crucial for the stock to get re-rated

Tata Steel, after plunging to a closing low of Rs 361.25 on November 20, following a dismal September quarter performance, has gained almost eight per cent, to Rs 390. These gains are partly due to the steel price rises by the company in Britain and Europe, the restructuring initiatives at the UK operations, as well as optimism on the improvement in steel prices in India, too.

These factors are positive and can lead to improved profitability and a further upside of eight to 10 per cent for the stock, given the consensus price target of Rs 421 (from Bloomberg). However, for any significant gains, improvement in European steel demand, leading to a volume increase, is crucial. This might not happen anytime soon.

Improving prices
Tata Steel Europe (TSE), which accounts for almost 75 per cent of Tata Steel’s consolidated revenue, recently raised the prices of flat and long products by around £30 a tonne in the UK, followed by a price increase of £40 a tonne in the rest of Europe. This was after the UK’s other domestic suppliers such as Mechel Services raising prices and others in Europe such as ArcelorMittal also increasing these by £40 a tonne.
 

RECOVERY HOPES IN FY14
In Rs crore	FY12	FY13E	FY14E
Net sales	132,900	125,504	137,505
% change y-o-y	12.0	-6.0	10.0
Ebitda	12,417	13,765	17,601
Ebitda (%)	9.3	11.0	12.8
Net profit	5,390	2,370	4,742
% change y-o-y	-39.9	-56.0	100.1
EPS (Rs)	20.9	24.4	48.8
PE (x)	18.6	16.0	8.0
E: Estimates             Consolidated financials                Source: Phillipcapital India research

These price rises should help improve Tata Steel’s profitability, given that TSE had seen realisations decline by $80 a tonne sequentially, to $1,124 a tonne during the September quarter, thereby impacting profitability. Notably, the six to eight per cent steel price rises, say analysts at Morgan Stanley, should be sustainable. They say similar price rises were announced in the US over recent weeks and given the increase in Chinese domestic hot-rolled coil (HRC) and export prices, the domestic-import price differential in European markets has narrowed significantly, allowing local mills to raise prices. The price increase announcements also signal bottoming out of steel prices and, hence, bringing re-stocking demand back, all of which is positive news for steel makers.

Operating gains
While realisations are seen improving, raw material prices are also relatively lower than six months earlier. Per tonne iron-ore prices, down from $130 to $90 in the past three to four months, are stabilising around $110. Coal prices have corrected significantly, with spot prices at $130-140, while contract prices are likely to stabilise at $160 a tonne, feels Giriraj Daga at Nirmal Bang (much lower than the $200-plus seen two to three quarters earlier). If coal prices inch up, increasing supplies from the Benga project in Mozambique can provide a respite in 2013. However, the supply of iron ore from its DSO project in Canada is likely to start only by end-2013, with the benefits accruing only in FY14, feel Daga.

That apart, restructuring of its European operations, which include closure of 12 processing and distribution sites, and enhanced focus on services at six distribution sites, leading to manpower reduction (900 jobs), should result in some cost savings.

In India, Tata Steel commissioned its three million tonne (mt) blast furnace in Jamshedpur, which reached 90 per cent capacity utilisation in September. The company sees volume benefits in the second half and maintains incremental production of one mt in FY13. Cost savings will also come from the coke oven plant commissioning in this month, to be fully ramped up by March 2013. This will eliminate the need to purchase coke from external sources and lead to cost savings from the March quarter, feel Enam analysts.

Broadly, while there has been some respite for Tata Steel, the key concern remains volumes in the European markets. Though demand might get a push from re-stocking during the December-March period, how this pans out thereafter is crucial. Analysts at JP Morgan (overweight on the stock) also observe that demand recovery in Britain is a critical variable. Positively, they add that from next year, iron ore and coking coal supply from Tata Steel’s foreign mining assets should increase its competitiveness.