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Tata steel: Cost of acquisition
May 17, 2007

Performance summary
Tata Steel, the 6th largest steel producer in the world, announced results for 4QFY07 and full year FY07 yesterday. On a consolidated basis, topline and bottomline have grown by 40% YoY and 19% YoY respectively during the quarter. For the full year, the same have stood at 24% and 12% respectively on a YoY basis. Here, while operating margins have fallen marginally, it is the more than 2.5 fold jump in interest expenses, which has led to the bottomline growing at a slower pace than the topline.

The Board of Directors has recommended a dividend of 130% for the financial year 2006-07 and a special dividend of 25% on the occasion of the Centenary year of the Company. We would also like to add that the consolidated results for the quarter do not include the financials of its latest acquisition, Corus Group Plc as Tata Steel did not have “control” having regard to the provisions of the UK takeover code and the scheme.

Financial performance snapshot
  Consolidated Standalone
(Rs m) 4QFY06 4QFY07 Change FY06 FY07 Change 4QFY06 4QFY07 Change
Net sales 53,256 74,697 40.3% 203,221 252,133 24.1% 41,005 49,804 21.5%
Expenditure 39,349 55,019 39.8% 139,777 177,632 27.1% 27,974 30,769 10.0%
Operating profit (EBITDA) 13,907 19,679 41.5% 63,444 74,502 17.4% 13,031 19,035 46.1%
EBITDA margin 26.1% 26.3%   31.2% 29.5%   31.8% 38.2%  
Other income 493 897 81.8% 2,467 4,381 77.5% 644 798 23.9%
Interest 305 1,870 512.9% 1,616 4,112 154.4% 195 448 130.0%
Depreciation 2,151 2,817 30.9% 8,604 10,110 17.5% 1,933 2,294 18.7%
Profit before tax/(loss) 11,944 15,889 33.0% 55,692 64,661 16.1% 11,547 17,091 48.0%
Tax 4,256 5,890 38.4% 17,939 21,474 19.7% 4,060 5,655 39.3%
Extraordinary items (339) 404 -219.0% 542 1,530 182.3% (344) 401 -216.7%
Profit after tax/(loss) 8,028 9,595 19.5% 37,211 41,656 11.9% 7,831 11,035 40.9%
Minority interest (1) (208)   (186) (675)   - -  
Share of profits of associates 106 256   322 792        
Net profit 8,132 9,644 18.6% 37,346 41,772 11.9% 7,831 11,035 40.9%
Net margin 15.3% 12.9%   18.4% 16.6%   19.1% 22.2% 16.0%
No of shares (m)       553 580        
Diluted EPS (Rs)*         72.0        
P/E (times)         8.2        
*trailing twelve month earnings

What is the company's business?
Tata Steel (Tisco) is India’s largest private sector steel company. The company has the distinction of being one of the lowest cost steel producers in the world at about US$ 200 per tonne for hot rolled coil. The company has a total steel capacity of 5 m tonnes (MT), and intends to add another 2.4 MT of capacity, which is likely to be completed by FY09 and another 6 MT in phases by FY11. The company has been focusing on increasing contribution from value-added and branded products and derives over one-third of its total revenues from these. Recently, the company took a major step towards becoming a leading producer of steel globally by acquiring Corus Group Plc, Europe’s second largest steel producer. With this acquisition, the total consolidated capacity of the company has touched 25.6MTPA, making Tata Steel the sixth largest player globally.

What has driven performance in 4FY07?
Firm prices and increased volumes: On a standalone basis, 22% YoY growth in topline in 4QFY07 was mainly driven by growth in saleable steel volumes and firm prices (almost 12% YoY growth in realisations). During the year, saleable steel production was higher by 9%, while sales were higher by 8%. Further, the company has said that FY07 was a record-breaking year for both flat and long products. While flat products sales were higher by 28% YoY, long products recorded 27% YoY growth in sales.

On a consolidated basis too, the company has reported good set of numbers. The 24% YoY growth in topline was mainly achieved on account of higher sales volumes. Though NatSteel on account of lower trading volumes, reported 2% decline in revenues, the impact was offset by robust 22% YoY growth reported by Tata Steel Thailand (previously known as Millennium).

Cost break up (% of sales) 4QFY06 4QFY07
Raw materials consumed 22.3% 18.6%
Purchase of finsished and semi finished products 3.1% 2.2%
Staff cost 9.0% 8.6%
Purchase of power 5.6% 4.8%
Freight and handling 6.9% 6.0%
Other expenditure 21.4% 21.5%
Total cost 68.2% 61.8%

Improved efficiency: On a standalone basis, in 4QFY07, the company has not only been able to reduce costs as a percentage of sales but has maintained costs on a cost per tonne basis on account of improved efficiency. This coupled with firm prices has led to 640 basis points expansion in operating margins. As against this, net margins have expanded by only 310 basis points owing to higher outgo of finance charges.

On a consolidated basis, the company reported muted margins primarily on account of rising costs of operation and higher finance charges (interest), which is being incurred in Tata Steel Asia Singapore, which has raised the funds for the Corus acquisition, and as per Indian GAAP, it has to be considered as an expense item in consolidation. Further, some cost pressure was also exerted by increased freight costs in recent times, increased cost of key raw material used in production of galvanised products –‘zinc’ and consultancy charges and fees with respect to expansion plans. The company has also incurred additional expenses on employee separation compensation (included as extraordinary item).

Over the last few quarters: Over the last few quarters, the company’s performance has been volatile, in line with volatile steel prices. Margins dipped in the middle of FY06 on account of more than 30% correction in steel prices in the international markets. However, in recent past (at the start of FY07) margins have expanded on account of volume growth and buoyancy in end user industries like automobiles. As visibility with respect to steel prices remains low, we remain cautious about margins from a medium-term perspective. In the last quarter of financial year FY07, margins have not only improved sequentially but also on a YoY basis, primarily on account of increased volumes and firm prices.

Particulars 4QFY06 1QFY07 2QFY07 3QFY07 4QFY07
EBITDA margin 25.0% 30.2% 30.8% 31.7% 38.2%
Net margin 14.4% 17.6% 18.9% 17.7% 22.2%

What to expect?
At the current price of Rs 592, the stock is trading at a price to earnings multiple of 8.2 times its trailing twelve month earnings. With the acquisition of Millennium (renamed as Tata Steel Thailand) and NatSteel the company has forayed into South East Asian markets and now Corus acquisition will help company further spread its wings globally. The acquisition has also created a powerful combination of low cost upstream production in India with the high-end downstream processing facilities in end-user markets. The combined entity will enjoy synergies in procurement, distribution and logistics. In the medium to short term, while the synergies may be less visible, the long-term prospects look good indeed.

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