FPO Review: TATA STEEL

TATA Steel, the seventh-largest player in the global steel industry, is attempting to take advantage of strong domestic demand from user industries by expanding its capacities here. In India, the total steel output grew 7.4% year-on-year during the first 11 months of the calendar year 2010, amongst the fastest in BRIC countries, according to the global industry body. This pace of growth is expected to continue over the next few years. To part finance the expansion plan, Tata Steel is coming out with its FPO aggregating nearly . 3,385 crore (at the lower price band).

In the local markets, the company's production cost is among the lowest in the industry, thanks to its captive iron ore mines. In addition, it gets nearly half of its coal requirements from its facilities. The Indian operations contributed 24.5% to its consolidated net sales in the first half of the current financial year.

However, in the case of Tata Steel Europe, which accounted for 64.4% of its consolidated sales in the first half of the current fiscal, there is considerable uncertainty over the medium term. That's because its European facilities have practically no captive resources of key inputs, and the company purchases them from third party suppliers. Also, key raw material costs have shown an upward trend over the past few quarters, which could lead to a rise in its production costs. Besides, there is considerable uncertainty related to steel demand in Western Europe, considering the slack demand in several user industries such as auto and housing.

   As part of its raw materials strategy for European operations, Tata Steel has taken a stake in New Millennium Capital Corporation, Canada, and it is expected to start production of iron ore in 2012. In addition, Tata Steel has an interest in a coal venture being developed in Mozambique, which is controlled by Australia based Riversdale Mining. But, even when fully operational over the medium term, these facilities will only meet about 20-25% of Tata Steel Europe's raw material requirements, analysts said. It could then become difficult for Tata Steel Europe to replicate the performance recorded in the first half of the current financial year.

   Tata Steel's FPO would be at a P/E of 7.5 times (at the lower end of price band) by annualising first half earnings and adjusted for the expansion in its equity. The Tata Steel stock ended Monday's trade at . 622.9, 4.9% higher than the FPO's lower price band. Other large domestic players such as SAIL trade at a P/E of 11.9 times on a trailing four-quarter basis, while JSW Steel trades at 10.7 times (excluding the recent Ispat Industries acquisition).