Tata Steel: Markets in wait-and-watch mode

The stock, after touching a high of Rs 468 in opening deals, slipped nearly 3% to Rs 442 levels towards the close of trade. In contrast, the benchmark indices - the S&P BSE Sensex and the CNX Nift

Tata Steel did not see a runaway rally at the bourses on Thursday, a day after the company announced that it is in talks with the Klesch Group, a Swiss Investment bank with interests in commodities, to undertake "detailed due diligence and negotiations" for the possible sale of its long steel business and associated distribution activities in Europe. This business of Tata Steel was generating nearly 20% of its volume at 3.2 million tonnes.

The stock, after touching a high of Rs 468 in opening deals, slipped nearly 3% to Rs 442 levels towards the close of trade. In contrast, the benchmark indices – the S&P BSE Sensex and the CNX Nifty lost nearly 1.5% each.

Analysts believe that this could probably by a rerating event for the stock. Analysts at CLSA, in a note post the development, said that they expect the market to now assign a decent probability to this asset sale and might also factor in potential sale of other Corus assets as well.

Essentially, analysts are upbeat that Tata Steel’s management has finally signalled their willingness to sell of Corus’ assets as they were a drag on the company’s financials. CLSA says that if the sale is culminated at an enterprise value per tonne (EV/tonne) of $200, then FY16-17 EPS will rise by 16-19 per cent, while valuation could improve by Rs 28 per share.

The assets in MoU involves 4.5 million tonnes of integrated steel mill at Scunthrope, besides downstream and distribution facilities across Europe. Scunthrope produced 3.2 million tonnes of liquid steel during FY14. A total of 6,500 employees operate these units.

The decision of sale of long products unit is important as these were the least profitable units in the region. According to a Motilal Oswal report the long product business generated average quarterly EBIT (earnings before interest and tax) of GBP 17 million against GBP 122 million of the strip products.

JP Morgan also says that the flat products units account for most of operating profit of Tata Steel’s European operations. JP Morgan says that the Longs division is likely operating at EBIDTA breakeven at best.

The sale of long product would thus mean that profitability of Tata Steel would improve substantially as huge revenue and cost portion which were not contributing to the bottomline would be off its books. JP Morgan believes that after the transaction, profitability of Tata Steel Europe would improve significantly.

Subdued reaction

So why has the market not taken positively to such obvious benefits? There seems to be two main reasons.

First. Tata Steel has signed a non-binding MoU, which means there is no certainty regarding final sale of the assets. All it means is that the Klesch Group will be carrying out the diligence of the assets and it is not a done deal yet, as Tata Steel themselves said that MoU will only allow Klesch to carry out due-diligence and negotiations.

Second. Klesch group largely runs like a finance company which was founded by Gary Klesch, a former senior US Treasury official. The group describes itself as operating in global industrial commodities business. Analysts at JP Morgan expect the group to acquire the assets at very compelling valuations.

On a replacement value basis, the assets are valued at $3.5 billion to $5 billion on operating versus nameplate capacity basis. JP Morgan feels that transaction could range between 0.2 times to 0.5 times of replacement value. However, one would have to wait to see at what valuations the deal will be finally struck and if that is acceptable to the Tata’s.

In any case, since there is no figure ascribed to the transaction, analysts are not sure to committing a number to the deal. This uncertainty will play on the stock till a final figure is announced. One thing, however, is certain that the deal will be at a fraction of the cost at which they were acquired. The final impact on debt reduction of the group will decide future course of the stock.