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Tisco: Beating the cycle

Jun 19, 2003

One of the biggest concerns for any commodity industry is the cyclicality factor. The cycle can turn fortunes for the industry and its players. During a cyclical upturn, efficient industry players are able to reap bumper profits. However, when the cycle reverses gears, efficient players manage to outperform peers. Steel is one of such sectors, which behaves in a cyclical pattern and one company in this industry, which has been able to stand strong even in a downturn, is Tata Iron and Steel (Tisco).

Note: Operating profits include other income
Source: Tisco

The above chart reflects the point. As can be seen in the chart above, Tisco has outperformed cycle downturns on a number of occasions by improving operating profits or atleast maintaining them, e.g. FY96, FY99 and FY01. Even in FY02 when steel prices were on the lower side, the company was able to maintain its operating profit margins at 18.9%.

The above results are a result of the conscious efforts taken by the company to improve operating efficiency. To begin with, the company has the distinction of being one of the lowest cost steel producers in the world. This is an effect of improved raw material consumption and employee efficiencies over the years. This is advantageous for the company, as it is able to protect its margins even in a downturn. Apart from this, in order to further enhance its margins, Tisco is constantly improving its product mix by targeting growth in the value added and branded segments. These products tend to garner better realisations for the company apart from creating a loyal user base for its products. Just to put things in perspective, as a percentage of total production, cold-rolled (CR) products’ share has increased from 10% in FY01 to 28% in FY03, which the company plans to further enhance to about 33%-34% in FY04. Also, sale of branded products has increased at a CAGR of 24% in the last two years.

Sales contract mix…
FY02 (%)Nature of ContractFY03 (%)FY04 (%)*Industry Competition
6Annual1115< 2
10Half-yearly103< 2
12Quarterly710< 5
61Monthly646745 - 50
11Spot8530 - 35
Source: Tisco

Apart from the above, the policy of entering into term-sale contracts augurs well for the company. As can be seen in the table above, the company has managed to reduce its spot sales from 11% in FY02 to 8% in FY03 and is targeting 5% in FY04. This is a big positive for the company, as it is insulated from the daily price fluctuations witnessed in steel prices. This is in sharp contrast to industry practice wherein over 30% of the steel sales are in the spot markets. This high dependence on spot markets leads to earnings volatility. Thus, higher the sales through term contracts (preferably medium and long term), lower the susceptibility to market price fluctuations.

At Rs 157, Tisco is trading at P/E multiple of 5.7x its FY03 earnings. With the company’s continuous focus on increasing the share of value added/branded products’ contribution to total revenues, it should be able to ensure relatively stable margins going forward. Contract sales would further aid at maintaining margins to some extent. Moreover, Tisco is expanding its steel capacity from the current 4 million tonnes to 5 million tonnes. This would help it to capitalize on the demand, which would emanate from construction, auto and consumer durables segments as the Indian economy further. However, amongst all the positives that the company enjoys, the steel cycle should never get out of the investors sight.

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