Stock Review: TATA STEEL

Tata Steel plans to issue securities with debt and equity features to raise funds without straining its balance sheet further. While the company intends to treat the funds under a separate class of capital, analysts feel it would not change the existing nature of its capital structure much.

The company has a higher proportion of debt in the employed capital when compared with other steel makers due to past acquisitions, which were funded by the loan money. Every 100 paise of the company's equity capital support 230 paise of debt, way higher than its peers who have nearly equal amount of debt and equity.

Tata Steel has been raising capital to reduce the proportion of its debt. In January 2011, it grossed . 3,480 crore by issuing equities. The use of perpetual hybrid security reflects that the promoters are probably not comfortable diluting their equity stake from the current 28%. A hybrid security has equity and debt characteristics. Tata Steel's security has no redemption date and can be repaid within 10 years at the discretion of the company. For investors, fixed income instruments such as bonds do appear more attractive at a time when stock markets are volatile. But the benefits of investing in a hybrid instrument are debatable.

For instance, though the coupon rate on Tata Steel's hybrid instrument is 11.8%, interest payment depends solely on the company's performance. Investment experts feel that given the inherent risk of uncertain interest payments, it would make more sense for investors who are bullish on the company to invest in its stock and gain tax-free dividends.

The access to low-cost funds is a major benefit of the hybrid instrument for Tata Steel. The cost of equity is 16-24% for emerging markets and debt cost is two percentage points more than the coupon rate of the hybrid security.

The company intends to include the instrument as a separate class of capital under schedule 6 of Indian GAAP. This will not increase the interest burden of the company since the interest as and when paid will be recorded as a change in equity on its balance sheet.
Analysts do not see much impact on the company's financials either, since the . 1,500 crore raised is a fraction of its outstanding debt of over 53,100 crore in FY10.