Tata Steel: Scunthorpe asset sale not enough

Disposal will help cut losses; Street looking forward to the sale of another unit in the UK

The sale of a Scunthorpe-based division to Greybull Capital is both positive and negative for Tata Steel.

The good part is the sale will cut losses at Tata Steel Europe (TSE). Because the long-products division was running at sub-optimal capacity (three million tonnes per annum or mtpa versus full capacity of 4.5 mtpa) due to low demand and realisations, leading to losses. The total capacity of TSE is 17.4 mtpa.

For the December quarter, TSE had seen Ebitda (earnings before interest, taxes, depreciation, and amortisation) losses widen to £68 million ($97 million) from £25 million ($35.5 million) in the September quarter. Analysts at HSBC estimate the unit sale to help TSE cut down losses by $100-150 million at the Ebitda level. With no signs of an early turnaround in Europe, selling the asset was a better option to reduce losses.

The negative part is that Tata Steel will continue to carry debt and pension liabilities from the unit. There will be no addition to pension contributions from current levels. Employees will remain under the £14-billion British Steel Pension Scheme, for which TSE is the sponsor.

After the Scunthorpe deal, focus will shift to the flat products division at Port Talbot, another loss-maker in the UK. After the sale of all UK-based assets, TSE will operate only the Ijmuiden (Netherlands) unit. This, according to analysts at Deutsche Bank, will lead to a sharp improvement in TSE's profits, making a strong case for re-rating. Analysts at Morgan Stanley estimate a recovery in European operations' Ebitda to £117 million and £293 million in FY17 and FY18, respectively. TSE is expected to report an Ebitda loss of £92 million in FY16 compared to an Ebitda profit of £290 million in FY15 (includes profit of £460 million in the Netherlands and loss of £170 million in the UK (Scunthorpe and Port Talbot).

Many have upgraded their target prices after the sale. While Morgan Stanley has a target of Rs 327, UBS and HSBC have targets of Rs 330 and Rs 290, respectively. However, others including Ambit (target price Rs 175) and Edelweiss (Rs 301) remain bearish on the stock which is trading at Rs 325. Edelweiss believes Tata Steel will realise up to Rs 20,000 crore at best from the sale of UK assets, resulting in value accretion of Rs 153 per share, which is already priced in.