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Tisco: ‘Steels’ the show, for now - Views on News from Equitymaster
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Tisco: ‘Steels’ the show, for now
Jul 29, 2005

Performance summary
Tisco had announced its June quarter results a couple of days back. The company’s performance has been rather insulated from the recent correction witnessed in steel prices. Nonetheless, while the topline growth has been rather tepid, the growth in operating margins has surprised us. It is this continuous improvement in operating margins that was reflected in the bottomline growth. The company continues to remain one of the most efficient steel producers in the world. Controlled financial expenses and lower tax burden also aided matters.

(Rs m) 1QFY05 1QFY06 Change
Net Sales 31,647 34,645 9.5%
Expenditure 17,627 18,763 6.4%
Operating Profit (EBDITA) 14,020 15,882 13.3%
EBITDA margin (%) 44.3% 45.8%  
Other income 275 303 10.5%
Interest 490 342 -30.2%
Depreciation 1,576 1,706 8.3%
Profit before tax 12,229 14,138 15.6%
Extraordinary items (243) (296) 21.7%
Tax 4,531 4,601 1.5%
Profit after Tax/(Loss) 7,455 9,241 24.0%
Net profit margin (%) 23.6% 26.7%  
No. of Shares (m) 369 554  
Diluted earnings per share* 80.8 66.8  
Price to earnings ratio (x)   5.6  
(* annualised)      

About the company
Tata Iron and Steel Company (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 with another 1 m tonnes coming into play within FY06. The company also intends to add another 2.4 m tonnes of capacity, which is likely to be completed by FY09 and another 6 m tonnes in phases by FY11. Tisco has been focusing on increasing contribution from value-added and branded products and derives over one-third of its total revenues from these. Exports form about 14% of its revenues (FY05).

What has driven performance in 1QFY06?
Muted topline:  Though muted and below our expectation, the topline growth was nonetheless decent considering that the company had a planned shutdown of its finishing mills for almost a month that led to lower production of saleable steel. It was because of this reason that despite the crude steel production being higher by 5% YoY during the quarter, saleable steel production was lower by about 5% YoY. This in turn led to lower steel sales (down 3% YoY). However, despite this, the topline growth was at a respectable 9.5% YoY. As per the segmental break-up provided by the company, while steel sales (80% of total revenues) were higher by 5% YoY, thanks to the 8% higher realisations during the quarter, it was the growth in its other segments viz. 23% YoY growth in ferro-alloys and minerals and 33% growth in others, that contributed to the near 10% topline growth during the quarter.

It must be noted that steel prices, globally, have been on the descent and the same has been reflected almost immediately in domestic steel prices, which have fallen by 20% to 25% in the last 3-4 months. The reason for this sharp correction in steel prices has been the steel inventory build-up in 1HCY05 that led to lower offtake of steel globally. Moreover, anticipation of a further fall in steel prices led to deferment of steel offtake, which further pressurised steel prices turning into a vicious circle. However, considering that a considerable portion of Tisco’s sales comes through value added sales, which are less impacted by swinging steel prices and with almost 65% to 70% of its overall sales done through long-term contracts, the volatility in steel prices has not affected the company’s performance significantly.

Cost break-up
(% of net sales) 1QFY05 1QFY06
Purchase of finished, semi-finished & others 9.1% 6.1%
Raw materials 12.9% 14.0%
Staff costs 10.0% 8.8%
Power 5.6% 5.7%
Freight 6.3% 6.4%
Other expenditure 19.0% 19.5%

Record high operating margins:  Operating margins during the quarter were at record highs of almost 46%. This not only betters its 1QFY05 performance when operating margins were at over 44% but are also much higher compared to the previous quarter (37% in 4QFY05). The key reason for this improvement has been a sharp fall in purchase of finished and semi-finished steel, seemingly owing to the fact that the company had had a temporary shutdown of its finishing fills. Further, there was some improvement witnessed in staff costs also (see table above). However, raw material costs rose from 13% of net sales to 14% in 1QFY06 as Tisco imports about 30% to 35% of its coal requirements and coal prices internationally have been on an upswing. However, as per the management, there has been some reduction in imported coal as the company managed to meet a larger share of its requirement from indigenous sources. Further aiding the margins have been the company’s continued focus on sale of value added products, which fetch better margins.

It flows to the bottomline:  While higher sales and improved operating margins have been the key growth drivers for the bottomline, a 30% reduction in interest expenses, as the company continues to rationalise its debt, and a lower tax incidence at about 33% as compared to 37% in 1QFY05, aided the 24% bottomline growth during the quarter.

What to expect?
At Rs 373, the stock is trading at a price to earnings multiple of 4.9 times our estimated FY06 earnings and 1.9 times price to book value, which we believe is expensive. While the company managed only a muted topline performance during the quarter, we are confident that the company would achieve its stated targets for the current fiscal. We expect that the loss of volume sales would be made up in the remaining quarters of the fiscal as the company ramps up its production by almost 25%. Further, while the spot prices of steel have corrected significantly, there are signs of the same bottoming out as the industry’s inventory pile-up starts to liquidate. Further, it must be noted that as per the management, Tisco has faced no deferment in offtake and the problem has been primarily at the company’s end as it had lower production to sell.

The company’s 1QFY06 performance has not been a disappointing. However, from an investors’ point of view, it must be noted that every business has a fair value. As per our valuation band (P/BV), Tisco is richly valued on FY06 basis, despite factoring in higher earnings for FY06. While it is difficult to time the steel cycle downturn, we reckon that steel prices would spiral to lower levels in FY07 again as greater capacity (read supply) comes on stream.

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