Tata Steel's earnings outlook muted for 2014-15

Regulatory overhang, weak demand in India and limited gains from Europe might cap earnings growth

Indian steelmakers tend to catch a cold if China or Europe so much as sneeze. The outlook for Indian producers, especially Tata Steel, appears to be clouded. With India turning into a net exporter, a pick-up in demand from Europe and China pulling back from the export markets was supposed to positively impact Tata Steel. However, some of this improvement has been blunted by weak demand in India and China’s slowing growth, which has seen steel and ore inventories rise.

Several brokerages have turned negative on Tata Steel after its coal blocks were de-allocated. While regulatory overhang has been an immediate cause for the downgrades, several other factors could cap the company’s earnings trajectory over the next two years. Steel consumption has grown 0.6 per cent in the current financial year compared to the previous year. Further, capacity addition by Bhushan Steel, Steel Authority of India and Tata Steel itself has put pressure on pricing.

Domestic steel prices have moved closer to export parity levels, claim analysts. Goldman Sachs has cut its consolidated FY15/FY16 post-tax profit by six-seven per cent on lower India volumes. The brokerage has cut its volume estimates for FY15 to nine million tonnes (mt) from the earlier 9.3 mt and for FY16 to 9.8 mt, from the estimated 10.3 mt. However, FY14’s post-tax profits may come ahead of current estimates.

Analysts also believe Tata Steel Europe’s restructuring gains could recede. In the first nine months of FY14, Tata Steel Europe posted an adjusted earnings before interest, taxes, depreciation, and amortisation (Ebitda) of $34 a tonne compared to $10 a tonne in the previous year. Nirmal Bang says this improvement has been driven by higher volumes from Port Talbot and stabilisation of the Holland blast furnace. Any further improvement will depend on actual pick-up in demand across Europe.

The biggest overhang on Tata Steel is its debt, which will peak by FY15, believe analysts. Analysts say de-leveraging will only begin by FY16. Goldman Sachs says while Tata’s FY15 and FY16 earnings should be driven by higher margins in Europe and volume growth in India, leverage is likely to be a concern. The company's net debt / Ebitda for FY15 stands at 4.2x. Also, the fact the company is sensitive to different variables such as interest rates, foreign currency movement, global steel demand and prices.