Near-term margin pressure may prevail for Tata Steel

Profitability may remain subdued in December quarter, even as some benefit accrues on account of softness in raw material prices

Weak demand and soft prices across geographies impacted Tata Steel’s consolidated performance for the September quarter (Q2). Though some softness was anticipated, weaker-than-expected performance of its subsidiaries and the company’s operating profit falling to multi-quarter lows meant that Q2 numbers fell short of Street estimates.
 
Adjusted for one-offs, Tata Steel’s earnings before interest, tax, depreciation, and amortisation at Rs 4,018 crore came lower than Bloomberg consensus estimates of Rs 4,309 crore, and so did its pre-tax and net profits. Worse, the near-term outlook also remains subdued.
 
The average domestic price of flat steel, which is used in automobiles and consumer durables, continued its downward trajectory and fell about 10 per cent sequentially to Rs 37,192 per tonne in Q2, while the average price of long steel product (used in construction) declined 13 per cent sequentially to Rs 30,864 per tonne.
 
The devil, obviously, is the weak demand environment, especially in the auto industry. Though Q2 is historically a weak quarter impacted by the monsoon, softness in global prices and weak domestic demand meant that steel prices fell the most in six years.
 
Even though slowdown in the auto sector was countered by higher sales in the construction and engineering segments, as well as exports, leading to a 4 per cent sequential rise in deliveries, sales volume in the more profitable India business was nevertheless down 4.5 per cent year-on-year. The change in product mix and pressure on realisations was bound to impact profitability. Thus, standalone operations saw per-tonne profitability at Rs 11,200, much lower than Rs 14,218 in the previous quarter and Rs 18,444 last year.
 
The company’s subsidiaries such as Tata Steel BSL, which saw raw material supplies hit on account of the monsoon, further dented overall profitability.

Consequently, the per-tonne profitability of Tata Steel BSL at Rs 5,062 fell from Rs 9,092 in the June quarter (first quarter, or Q1) and Rs 10,291 in the year-ago period.
 
European operations (Tata Steel Europe) continue to remain the pain point. Production in Q2FY20 was also lower on account of weak market conditions, planned summer shutdowns, and unplanned outages. Tata Steel Europe, though, maintained deliveries and per-tonne profitability at Rs 720 was better than Rs 276 in Q1, aided by declining raw material costs. However, it was much lower than Rs 4,862 in the year-ago quarter, indicating that any recovery is far away.
 
Tata Steel continues its renewed focus on cost-competitiveness for turning around European operations wherein it completed the sale of some businesses during Q2.
 
While cost-cutting moves are positive, analysts believe any major lift will only be provided by the domestic operations, where Tata Steel is concentrating on. Even though benefits may accrue from lower raw material prices, the pressure on pricing is likely to take a toll on profitability during the current quarter as well.
 
With pressure on profitability, Tata Steel has trimmed capital expenditure plans, which should improve cash flows. But, its original plan of $1 billion debt reduction in FY20 may not be fully achieved.
 
The stock closed flat at Rs 403.15 on the BSE. The muted reaction is also because the stock has fallen significantly from nearly Rs 600 a year back, indicating that a big part of the pain is priced in.
 
For now, analysts such as those at Motilal Oswal Financial Services have a ‘neutral’ rating for the stock after the results.