India business drives Tata Steel's March quarter show

Earnings upgrade likely in FY15 if the firm manages to sustain elevated margins in the domestic business

Tata Steel's shift from expensive defensives to beaten-down industrials appears to be justified, going by the company's March quarter numbers. The steel maker has beaten the Street's profit estimates, driven by higher realisations and cost efficiencies. Its revenues have grown 22.8 per cent, year-on-year, to Rs 42,017 crore - ahead of the Rs 40,400 crore the market was expecting. The higher-than-expected margins and realisations have left most analysts surprised.

Weak demand has made it difficult for Indian steel makers to increase prices. However, Tata Steel's Ebitda ( earnings before interest, taxes, depreciation, and amortisation) per tonne in the domestic market stands at Rs 17,000 a tonne, which is significantly ahead of Rs 14,183 the company had reported in the December quarter. The decline of nearly Rs 3,000 has left many analysts questioning the sustainability of such numbers in the coming quarters. Analysts say the three per cent increase in realisations sequentially does not explain the sharp jump in Ebitda per tonne. Given the unexpected increase in the company's realisations, earnings upgrades are likely, if the earnings appear to be sustainable. For its European operations, the firm's reported Ebitda of $36 a tonne, which is lower than the $44 a tonne it had clocked in the December quarter.

Tata Steel's domestic business has done exceptionally well during the quarter thanks to higher volumes, improved efficiencies and higher realisations. During the quarter, its domestic steel volumes grew 16 per cent sequentially and six per cent annually to 2.4 million tonnes. While street demand has largely remained flat in India, the firm claims its "better products and vast distribution network helped" it sell one million tonnes more over the previous year. The European business has disappointed in comparison.

The company's Ebitda of Rs 5,011 crore, of which the domestic business accounts for Rs 4,109 crore, implies the European business has not delivered upon the Street's expectations. The firm's operating margin in the domestic segment in the March quarter expanded by 470 basis points sequentially to 33.7 per cent. The weaker-than-expected performance in Europe has dragged down the company's consolidated operating margins during the quarter to 10.9 per cent.

Analysts say such a sharp uptick in margins might not be sustainable. The stock currently trades at 9x forward earnings and 7-8x its enterprise value/Ebitda, which is not cheap. However, if the company sustains its March quarter performance, then it could see earnings upgrades.