Tata Steel Limited recently outlined a programme to reduce costs and improve product mix at its European operations, which are held by the company's wholly-owned subsidiary, Tata Steel UK Holdings Limited (TSUKH).
The planned cost rationalisation is credit positive for both companies as it will support a turnaround in TSUKH's less profitable operations that have impacted Tata Steel's consolidated credit quality, said Moody's Investors Services in a report.
The European operations accounted for 35 per cent of Tata Steel's total shipments in the first half of FY20, but generated only around 2.4 per cent of its reported consolidated EBITDA.
The programme chalked out by the company features two key initiatives for its European operations--reducing costs and improving realisations.
Synergies from centralised sourcing of key raw materials and capital equipment for the European and Indian businesses, and a reduction in workforce of up to 3,000 (or 15 per cent of its total strength in Europe) will reduce costs.
At the same time, an better product mix with increasing contribution of high-value steel products will support better realisations. The company also plans to deploy technology – including the application of big data and advanced analytics – to streamline and automate processes, reduce lead time for orders, improve production planning, and streamline its marketing and sales network. If these concerted efforts deliver significant cost savings, they will help improve profitability.
In particular, the company aims to improve the profitability of its European operations, measured by the EBITDA margin, to 10 per cent through the cycle on a reported basis, from one per cent in the first half of fiscal 2020.
Additionally, the transformation plans to help the European operations generate positive free cash flows in fiscal 2021.
Although the programme is credit positive and a continuation of the company's efforts to turn around the European operations, a timely and meaningful improvement in performance is key, the Moody’s report said.
Sustained weakness in demand from Europe's steel-consuming sectors, global economic slowdown and increasing trade barriers cast downside risks to the pace of credit profile improvement.
Tata Steel's Indian operations are the cornerstone of its strong profitability, as these operations are integrated into the production of key raw materials in steel making, which combats the country's slowing steel demand and declining end-product prices.
Sluggish economic growth and weak offtake from the automobile, manufacturing, property and construction industries have diminished steel demand in India and caused a decline in end-product prices in the first half. Even so, Tata Steel reported a 26 per cent EBITDA margin in the first half of fiscal 2020 in its standalone Indian operations.
"Given the large gap in the profitability of its European operations and that of its India business, we do not anticipate any significant change in their respective contribution to the company's consolidated EBITDA over the next two years, at least," said the report.
"However, a turn around in the performance of the substantially less profitable European business will improve TSUKH's credit profile and reduce the divergence in the two business' credit strengths," it added.