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Tata Steel: Debtís a damp squib - Views on News from Equitymaster

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Tata Steel: Debtís a damp squib
Jan 31, 2008

Performance summary
  • Standalone topline grows by 11% YoY, helped mainly by higher realizations.

  • Expenses grow at a lower rate than topline, resulting into an EBITDA margin expansion of 220 basis points (2.2%).

  • Bottomline growth drops to 0.5% YoY during the quarter as interest expenses jump nearly seven fold and other income falls 32% YoY.

  • Bottomline for the first nine month grows 12% YoY on the back of an 11% growth in topline.

(Rs m) 3QFY07 3QFY08 Change 9mFY07 9mFY08 Change
Steel sales (000' tonnes) 1,234 1,244 0.7% 3,533 3,503 -0.9%
Net sales 44,695 49,739 11.3% 125,712 139,566 11.0%
Expenditure 26,858 28,773 7.1% 75,015 81,354 8.5%
Operating profit (EBDITA) 17,836 20,966 17.5% 50,697 58,212 14.8%
EBDITA margin (%) 39.9% 42.2% 40.3% 41.7%
Other income 987 670 -32.1% 3,539 3,075 -13.1%
Interest (net) 520 3,627 597.0% 1,291 6,448 399.5%
Depreciation 1,991 2,092 5.1% 5,899 6,255 6.0%
Profit before tax 16,313 15,918 -2.4% 47,046 48,584 3.3%
Extraordinary income/(expense) (493) (171) -65.3% (1,120) 3,654
Tax 5,183 5,061 -2.4% 14,740 17,423 18.2%
Profit after tax/(loss) 10,638 10,686 0.5% 31,187 34,815 11.6%
Net profit margin (%) 23.8% 21.5% 24.8% 24.9%
No. of shares (m) 580.7 609.2 580.7 609.2
Diluted earnings per share (Rs)* 69.4
Price to earnings ratio (x)* 10.6
( * on trailing twelve months earnings)

What has driven performance in 3QFY08?
  • Tata Steel sold 1.24 m tonnes of steel during 3QFY08, just 1% higher than the 1.23 m tonnes it sold in the same quarter last year. Despite this, topline in value terms has grown by 12% YoY, a fact that could be attributed to improved realisations. Despite demand continuing to rise, just 1% growth in volumes for Tata Steel has come as a surprise. This however, could be attributed to capacity constraints. As per CMIE, between April and Nov 2007, growth in production stood at 7.1% YoY while consumption outpaced the production growth. On the pricing front, steel companies had hiked prices in October but they were rolled back in the subsequent two months. Nevertheless, the company still managed a 11% YoY growth aided mostly by improved realisations.

  • The companyís operating profits have improved by nearly 18% YoY, better than the 11% growth in topline during the quarter and attributable to a lower than proportionate growth in costs. It should be remembered that the company sources most of its key raw material requirement like iron ore through its own mines and hence, is insulated from the price volatilities of these commodities. Thus, when iron ore dependent steel producers are facing input cost pressures and are under pressure to maintain margins, Tata Steel has continued to expand its margins by 220 basis points (1.7%). Coke prices though, seemed to have climbed, resulting in a 13% YoY jump in raw material expenses.

    Cost break-upÖ
    (Rs m) 3QFY07 3QFY08 Change
    Raw materials 8,635 9,778 13.2%
    % sales 19.3% 19.7%
    Staff cost 3,611 3,646 1.0%
    % sales 8.1% 7.3%
    Freight and handling 2,856 2,877 0.7%
    % sales 6.4% 5.8%
    Purchase of power 2,261 2,395 5.9%
    % sales 5.1% 4.8%
    Other expenses 9,496 10,077 6.1%
    % sales 21.2% 20.3%

  • PBT during 3QFY08 has fallen by 2% YoY, due mainly to the huge seven fold jump in interest expenses. Other income has also negatively impacted margins, as it has fallen by 32% YoY. Higher interest expense is a consequence of huge debt taken by the company to fund the Corus acquisition. Further, had it not been for a 65% reduction in extraordinary expense, the bottomline which has witnessed a marginal rise of 1% YoY during the quarter, might have actually turned negative. This reduction in extraordinary expense is attributable to the exchange rate related profits that have accrued to the company on its foreign currency borrowings.

What to expect?
At the current price of Rs 735, the stock is trading at a multiple of 1.7 times its FY10 book value. This is slightly less than the 2x multiple that we assign to a company like Tata Steel. Given the strong pricing power still being enjoyed by domestic steel companies, we will indeed reassess our projections and changes if any, would be incorporated into the research report.

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