Saturday, August 3, 2013

THE TATA STEEL STORY -“A global Ambition gone wrong”

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.

0 comments:

Post a Comment

.........................................................................