Tata Steel: Profits dented

Soaring costs and lower sales drive down operating profit margins.

As anticipated the second half of 2008-09 is turning out to be far worse than the first half. The net profits of Tata Steel crashed 56 per cent in the December 2008 quarter to Rs 466 crore as the steel major grappled with relatively weak demand and soaring costs.

This is probably the first time in three years that India’s largest steel maker has reported a fall in net profits.

The operating profit margin was down 1200 basis points to 30 per cent as the company’s revenues slid 3.5 per cent to Rs 4,802 crore and raw material costs soared by about 360 basis points, mainly due to the higher cost of coking coal.

The operating margin for the six months to September 2008 was 49 per cent. Lower production volumes on account of some shutdowns at the plant drove down revenues.

Meanwhile, JSW Steel posted a loss of Rs 130 crore in the December quarter on flat revenues of Rs 2790 crore—the company had scaled back production by about 20 per cent in the December 2008 quarter.

Analysts expect steel and ferro chrome prices to fall further, given that demand from sectors such as automobiles and construction remains weak, and believe that the outlook remains challenging. Steel prices, which have come off by about 15-20 per cent in the December quarter are tipped to fall further by 5 per cent in the March 2009 quarter.

While Tata Steel has entered into longer term contracts that expire in April, profits are nonetheless expected to be hit in the March 2009 quarter too.

The company has a leveraged balance sheet with an adjusted net debt to equity of between 1.3--1.6 times for the current year and the consolidated debt at the group level is in the region of $11 billion.

The big worry is the UK subsidary, Corus, which had announced a 30 per cent cutback in production; that could translate into a lower output by about 3-4 million tonnes, say industry watchers.

Besides, realisations would be lower by at least $200 per tonne than in the first half of 2008-10, say analysts, leading to a contraction in the profits or even losses.

Thus, the consolidated operating profit for the second half of 2008-09 is expected to be far lower than the $3.3 billion posted in the first half on revenues of $18.91 billion.

A recovery in steel prices is now expected only towards the end of 2009. An HSBC research report released recently noted that steel production is expected to contract by 7 per cent globally in 2009 as economic weakness spreads across regions.

The report notes that prices could fall further though 2009 could be the low point of the cycle with production cuts already close to the trough levels seen in the mid-1970s and early-1980s.