Authors:
Abhishek Behal & Vatsal Jain , NMIMS
Mumbai
Shares of Indian Steel Major,
Tata Steel have corrected by almost 40% in the past six months closing at Rs
210 on Thursday afternoon. What has been the reason behind this meltdown in the
value of a company that is amongst the highest producers of steel in India?
Tata Steel, formally TISCO seemed
to be on a constant growth path since its inception in the year 1907 with no
major hiccups during the journey. However things started getting sour for the
company since their 2007 Acquisition of the European Steel maker Corus for a
massive 12.04 Billion Dollars, an overvalued acquisition involving a bidding
war with Companhia Siderúrgica Nacional
of Brazil.The finalization and integration of the acquired organization was
followed by the Sub Prime Crisis that hit most economies with nations
witnessing deep recession. If this wasn't bad enough, the European Union found
itself in the midst of a major crisis starting from the year 2009, when once
well performing nations like Greece were found to have violated the
requirements of the 1992 Maastricht Treaty and required billions of dollars of
aid so that they could continue to service their sovereign debt requirements.
At the time of finalization of
the deal, with most major countries experiencing a period of boom, Europe’s
annual real steel consumption stood at180 million tones which as a result of
the economic crisis fell to just above 140 million tonnes in 2012. The falling
demand as common sense would state was experienced with a sharp fall in prices
of steel all over Europe. The Company’s European business has since seen a
downward trend.
The falling demand in EU for
steel can be attributed to Automobiles and Infrastructure sector that accounts
for nearly 50% of metal’s consumption. Since the Eurozone crisis, the EU has
been affected by extreme contractions in Infrastructure spending due to
austerity measures. This fall has been further compounded by a sharp fall in
the automotive sector, one of the biggest contributors to the European economy,
which saw car sales drop by 9.7% Y-o-Y as compared to 2011 - 12. The graph
below shows the steel demand trajectory in Europe from 2007 to 2013 (E). Steel
demand between 2007 and 2013 has dropped by almost 30 %.
Steel demand in Europe
The Company’s European operations
are operating at capacity levels of 70% which reflects an ineffective
utilization of available assets due to contracting demand in Europe as compared
to its Indian counterpart where Tata Steel is planning to increase its current
production by 3 million tones before the end of Q3 2013 and the capacity
utilization levels have been fairly healthy.
What has made life more difficult
for Tata Steel is the humongous amount of debt on their books and the
consequent interest liability that comes with it. A large part of this debt was
taken up to complete the Corus acquisition in the year 2007. The net debt on
company stands over Rs 60,000 Crores, on which the company is paying an annual
interest of about 7 %. The financial effect of this debt on the company can be
gauged by the fact that in FY 13, out of a total EBITDA of Rs 5400 Crore, a sum
of Rs 4,000 Crore alone went into the Interest payment for this debt, meaning
effectively 75% of the EBITDA is being used to service the Interest payments
only. The continuously falling rupee means that the company’s debt standing
close to $ 10 bn which is partly foreign and partly local, is going to see a
rise, while its Rupee earnings are going to face stiff pressure to match up to
the massive interest payments required.
In May this year, Tata Steel
announced a $ 1.6 billion goodwill write off as a ramification of loss in value
of its European and South East Asian assets owning to depressed macroeconomic
conditions which have led to lower steel demand all over the world. This was
factored into their 2012 – 13 Annual Report in which the company has reported a
loss of Rs 7,362 Crores down from a profit of Rs 4,748 Crores during 2011- 12.
Analyst reactions to this decision were mostly mixed with few arguing that such
a step was not completely unexpected and will in no way affect their cash flows
in the future and maintained their Buy rating on the stock. Whereas some
analysts went to the extent of suggesting that the company should consider
selling its European assets as well, however any such rumors were rejected by
the firm.
This write off made by the
Company will be adjusted against the Goodwill that was created by the
acquisition of Corus. If we examine the realistic impact what comes up is that
since the write off is a non-cash event it will have no real impact on the
company’s operational or financial flexibility.
PAT (Impairment Factor)
As we can see had TATA STEEL not
factored in the Impairment charge towards a Goodwill write off the PAT for FY
2013 would in fact have been a positive Rs 2434 crores (Assuming Effective Tax
Rate on Group Income of 42%).
The reaction in the short-term in
our opinion has been overly pessimistic with disregard of the fact that
writing-off the goodwill has given the organization a chance to lighten its
balance sheet and reduce the tax liability that the organization would have had
on its reportable profits. The Company’s balance sheet still holds Rs 9000
Crore of goodwill on account of Corus which can see further deduction if the
profits in the Domestic Market continue to rise which accounted for nearly 90%
of the Profit after Tax of the consolidated figure.
Barring the debt levels of the
Consolidated Group, a company which values Corporate Governance has its
fundamentals intact with strong upside in revenues from its Indian Operations.
Future expectations of revival of the European steel market in 2014 with
expected growth of 3.3% (Source: World Steel Association) will help the
organization increase its earning potential as it continues to bring down its
fixed costs and adds new products to its portfolio that are in sync with the
European market.
Latest news doing the rounds are
that Tata Steel is in the running to acquire British firm Stemcor’s Indian Iron
Ore assets which is being currently valued at $ 800 Million which is seen as a
beneficial opportunity with the Steel Industry currently at the bottom of its
business cycle. Though it is advised that the company tread with caution and
avoid packing on more debt on its Balance Sheet and reduce margins at a time
when they are attempting to reduce unnecessary costs and planned expansions
towards capacity enhancement.
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