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Tisco: Not just India, but South Asia - Views on News from Equitymaster

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Tisco: Not just India, but South Asia
May 18, 2006

Performance summary
While the topline growth of Tata Steel, one of the cost efficient producers of steel in the world, in FY06 was rather staid on a standalone basis, on a consolidated basis, the rise in sales was 27% YoY. With steel prices cooling off from the historic highs in FY05, it is clearly reflected in the operating margins of the company in 4QFY06. While it is too early to conclude whether the dream run in the case of steel prices is over, we believe that the company's standing in the global steel sector is well established and we suggest investors to assess the company's performance on these lines.

Consolidated financial snapshot
(Rs m) 4QFY05 4QFY06 Change FY05 FY06 Change
Net Sales 46,327 55,514 19.8% 159,986 202,444 26.5%
Expenditure 31,385 41,610 32.6% 97,973 139,061 41.9%
Operating Profit (EBDITA) 14,942 13,903 -7.0% 62,013 63,383 2.2%
EBITDA margin (%) 32.3% 25.0%   38.8% 31.3%  
Other income 345 642 86.3% 1,824 2,466 35.2%
Interest 145 287 98.3% 1,981 1,555 -21.5%
Depreciation 1,639 2,199 34.1% 6,455 8,604 33.3%
Profit before tax 13,503 12,060 -10.7% 55,401 55,691 0.5%
Extraordinary items (393) 190 -148.4% (977) (541) -44.6%
Share of profits of associates 84 139 66.7% 580 322 -44.5%
Minority interest 92 1 -98.8% 260 186 -28.2%
Tax 3,897 4,256 9.2% 18,712 17,939 -4.1%
Profit after Tax/(Loss) 9,205 8,132 -11.7% 36,033 37,346 3.6%
Net profit margin (%) 19.9% 14.6%   22.5% 18.4%  
No. of Shares (m) 553.5 553.5   553.5 553.5  
Diluted earnings per share         67.5  
Price to earnings ratio (x)         7.7  

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 4 m tonnes (MT) with another 1 MT coming into play within FY06. Tata Steel also 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.

What has driven performance in FY06?
Steel demand higher by 4% in FY06: Since steel is a global sector (prices are governed by the demand-supply equation in the global markets), it is pertinent to shed some light on the global trend in the recent past. Even as the crude steel production grew by over 5.5% worldwide in the calendar year 2005, demand grew at a slower rate of 4.1% YoY during the same period. The demand growth is slightly above the growth that was witnessed over the past decade. However, what is important to note is the fact that hot-rolled steel prices were lower by more than 23% YoY, while cold-rolled steel prices was lower by 14%. Even as prices were falling, key raw material costs (including iron ore, coal and zinc) went up sharply in 2005. This has had a negative impact on not only Tisco's FY06 performance but also other global steel majors. As far as China is concerned, while production in the country grew by 24.6% YoY, demand was higher by 16.7%, indicating excess supply. Perhaps, this is one of the major reasons for the fall in steel prices globally.

As far as Tisco is concerned, steel production in FY06 was higher by 11% YoY. Of this, the production of HRS was higher at 19% during the year and consequently, its share of total volume sales was higher by 28% (25% in FY05). As far as the market share in the automobile segment in FY06 is concerned, the company made significant stride in the CRS (37% share in FY06 as compared to 35% a year before). On a standalone basis, as compared to our topline growth estimate of around 9% YoY, actual growth was around 4%, which could be attributed to lower prices in the last quarter.

EBDITA margins down: On a consolidated basis, operating margins were down sharply. As we had mentioned earlier, it is a combination of steel prices softening and raw material costs hardening. To put things in perspective, iron ore prices in the calendar year 2005 was higher by 71% YoY while coking coal prices shot up by 119% in the same period. While steel prices have increased in 1QFY07 as compared to 4QFY06, the recent tumbling of commodity prices globally is likely to have a negative bearing on the company's performance in the next one year. To that extent, we have a cautious view on operating margins.

Consolidated cost break-up
(% of net sales) FY05 FY06
Purchase of finished, semi-finished & others 9.0% 4.3%
Raw materials 11.8% 15.6%
Staff costs 8.9% 8.9%
Power 4.9% 5.4%
Freight 6.5% 6.6%
Other expenditure 19.2% 20.6%

Net profit also falls: On a consolidated basis, growth at the profit before tax level was static owing to higher depreciation charges, even as net interest charges fell significantly. The reduction in interest charges could be attributed to lower cost of funds raised from international markets (6.6% in FY06 as compared to 7.5% in FY05). The company is in the capacity expansion phase (to be completed by FY08 and FY09 in phases) and higher depreciation charges have to be view in this light.

Performance over the last few quarters…
Standalone 1QFY05 2QFY05 3QFY05 4QFY05 1QFY06 2QFY06 3QFY06 4QFY06
Net sales growth (YoY) 40.2% 43.1% 41.8% 20.8% 9.5% 3.4% -1.4% 6.8%
Net profit growth (YoY) 179.1% 130.6% 99.1% 44.5% 24.0% 12.5% -15.4% -13.8%
Operating margins 44.3% 43.6% 42.1% 37.3% 45.8% 42.7% 37.8% 31.5%

What to expect?
At Rs 520, the stock is trading at a price to earnings multiple of 7.7 times its consolidated FY06 earning and at a price to book value multiple of 2.9 times estimated FY06 book value. While the company expects steel demand in India to grow at over 8% in the calendar year 2006, Chinese demand is projected to grow at 13% YoY. We continue to have a cautious view on steel prices in the next two years, given the supply-side concerns. Having said that, the company's acquisitions in Singapore and Thailand are likely to help it diversify revenue base and strengthen the global reach over the next five years. Also, the expansion plans are robust and restructuring of international operations will strengthen the balance sheet in the medium-term. While we believe that Tisco's standing as one of the low-cost producer in the world will benefit even in a downturn, the fact that steel prices are volatile increases the risk profile of the stock significantly.

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