Stock Review: TATA STEEL

TATA Steel's September 2010 quarter consolidated results were better than expected, fuelled mainly by better sales and profitability of its domestic operations. Its European business, however, has started feeling the heat of high raw material prices, which may continue to dent the next quarter's performance as well.

   Tata Steel's Indian operations are expected to do well both in terms of sales realisation and margins as steel prices are supposed to increase due to supply constraints and its fully integrated operations. Reduction in debt burden is another positive factor.

   The company had repaid over 1,700 crore of debt in FY10. This would help the company lower its interest costs. In the September quarter, the company paid 13% lower interest compared to the year-ago level.

   The company's 3-million tonnes per annum (mtpa) brownfield project is progressing on schedule and the company expects it to be fully commissioned in November 2011. These capacity expansions can have direct impact on the sales numbers, as there is strong demand for steel in domestic sector.

   On the global front, Tata Steel Europe's EBITDA declined 35% on a quarter on quarter basis in spite of 4% increased sales volume. The company is facing higher raw material costs due to non-integrative nature of its European business. The management has taken several integration initiatives to decrease its dependence on raw material.

   Tata Steel Europe plans to source coking coal from the Benga project in Mozambique. The company also seeks to secure raw material supply for its European operations by taking stake in New Millennium's direct shipping ore (DSO) project. However, the company may continue to face pressure on its operating margin in coming quarters since both the projects are not likely to be productive before the end of FY11. But revenues are expected to be strong, helped by higher steel prices in Europe due to better-than-expected demand from the automobile sector.

   The decision to sell Teesside Cast Product for $500 million — close to 2,300 crore — should help the company sharply reduce its liquidity concern. It also plans to raise 7,000 crore through equity, GDRs, FCCBs and debentures. This will increase the leverage level of the company as it has already more than $10 billion of debt on its books. The company, however, has refinanced debt of about € 3.5 billion to replace the term loan it had taken at the time of Corus acquisition. This will significantly reduce pressure on its cash flows.

   The stock of Tata Steel has outperformed market in the past three months. Going ahead, its European steel operations can continue to be under margin pressure due to flat realisations and high raw material costs. The company's domestic operations would remain key to its earnings in coming quarters since it can benefit from any steel price increase without witnessing any increase on the raw material front.