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Tisco: Wait and watch - Views on News from Equitymaster
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Tisco: Wait and watch
Jul 21, 2006

Performance summary
Tata Steel (Tisco) has announced mixed results for the first quarter of FY07. On a consolidated basis, topline and bottomline have grown by 18% YoY and 3% YoY respectively. Pressure on realisations was clearly witnessed during the quarter, considering that volumes grew at a robust rate of 28% YoY. While operating margins were affected by lower prices, net profits would have declined but for higher other income.

Consolidated snapshot...
(Rs m) 1QFY06 1QFY07 Change
Net Sales 48,853 57,641 18.0%
Expenditure 32,011 40,228 25.7%
Operating Profit (EBDITA) 16,842 17,414 3.4%
EBITDA margin (%) 34.5% 30.2%  
Other income 312 791 153.9%
Interest 429 554 29.1%
Depreciation 1,902 2,382 25.2%
Profit before tax 14,822 15,270 3.0%
Extraordinary items (304) (188) -38.2%
Share of profits of associates 167 209 25.4%
Minority interest 85 157 83.3%
Tax 4,747 4,943 4.1%
Profit after tax 9,853 10,192 3.4%
Net profit margin (%) 20.2% 17.7%  
No. of Shares (m) 552.3 553.0  
Diluted earnings per share (Rs)*   63.5  
Price to earnings ratio (x)   7.6  
(*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.

What has driven performance in 1QFY07?
Strong volumes drive growth: With demand for automobiles continuing to remain robust in 1QFY07, Tisco has benefited (it has a 37% market share in the Indian auto segment). This is partly reflected in the company's topline in the same period. On a standalone basis, while steel production was higher by 17% YoY, volume sales were higher by 27% YoY. However, the standalone topline growth of 10% YoY highlights the fact that prices were lower on a YoY basis. To put things in perspective, based on our calculation, average realisation in 1QFY07 was US$ 677 per MT, which was lower by 15% YoY. Growth in topline at the consolidated level (including NatSteel and Millennium Steel) was higher largely led by better capacity utilisation. In our view, as we have maintained in the past, we do not foresee any major issue on the volumes front in the long-term. However, prices continue to remain a cause of concern, considering the significant capacity additions in the global markets over the last six years. Also, even after the Mittal takeover of Arcelor, the sector remains highly fragmented.

Margins - How far can it go down?: Following the softening of steel prices in the global markets over the last few quarters, Tisco now makes lower EBDITA per metric tonne (MT) of steel sold on a YoY basis. After plummeting sharply in the first quarter of the calendar year 2006, there was a recovery in steel prices in the last quarter (April to June), which is aptly reflected both at the PBIT and EBDITA level. Though EBDITA per MT and PBIT per MT of steel sold is lower by 23% and 20% respectively in 1QFY07, as compared to 4QFY06, there has been a significant jump. Steel majors, including Tisco, continue to face input cost pressure in light of supply-related issues (of coke and coal). Consequently, steel companies are on the prowl to acquire strategic stake in coal mining companies (Tisco acquired 5% stake in an Australian mining company recently). Though visibility with respect to steel prices remains low, we remain cautious about margins from a medium-term perspective.

Consolidated cost break-up
(% of net sales) 1QFY06 1QFY07
Purchase of finished, semi-finished & others 26.1% 23.0%
Raw materials 10.9% 12.9%
Staff costs 7.7% 7.0%
Power 4.7% 5.5%
Freight 5.4% 5.9%
Other expenditure 16.9% 16.7%
Stock adjustments -6.3% -1.2%

Net profit-Nothing exciting: While steel prices were remunerative on a QoQ basis, Tisco's net profit grew at just over 2% YoY in 1QFY07, excluding extraordinary adjustments (provision for employee separation costs). Despite interest and depreciation charges increasing at a faster pace (in light of the foreign currency issue and capacity expansion respectively), net profit got a boost from other income. The company has parked surplus cash from equity/debt issues, which has added to the bottomline in 1QFY07. As we go forward, given the expansion plans, other income should decline, thus impacting bottomline performance.

Performance over the last few quarters…
Standalone 2QFY05 3QFY05 4QFY05 1QFY06 2QFY06 3QFY06 4QFY06 1QFY07
Net sales growth (YoY) 43.1% 41.8% 20.8% 9.5% 3.4% -1.4% 19.8% 10.1%
Net profit growth (YoY) 130.6% 99.1% 44.5% 24.0% 12.5% -15.4% -11.7% 3.2%
Operating margins 43.6% 42.1% 37.3% 45.8% 42.7% 37.8% 25.0% 40.4%

What to expect?
At Rs 482, the stock is trading at a price to earnings multiple of 7.6 times its trailing twelve month earnings 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. This is much slower than the 17% rise in demand in China in 2005, even as new capacities are coming into stream. 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 its 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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