The steel demand in India is slowing down. Flat products demand is affected by a deceleration in the consumer durable and the auto sectors. On the other hand, long products demand growth is showing some strength on the back of a pick up in construction activity.
Looking at this growth opportunity in the long product segment from the Golden Quadrilateral and rural road project, Tata Steel is contemplating to set up a 1 m tonne green-field unit for manufacturing long products. (The existing products under the long product category produced by the company comprise wire rods, special quality bars and continuous cast billets.) This would increase the company’s existing capacity of 3.5 m tonnes hot rolled products to 4.5 m tonnes. The project is estimated to cost about Rs 15 bn to the company.
Tisco is expected to incur capital expenditure (capex) of Rs 3 bn to Rs 4 bn every year for maintenance of its plants and improving the technology. The company has already completed the fourth phase of modernization at Jamshedpur. Also, its Rs 16 bn cold rolled mill was commissioned last year. As a result, it does not have any major capex plan left.
However, the company’s total debt in FY02 is expected to be over Rs 50 bn with debt equity ratio of about 1.5:1. Although this leverage by Tisco would keep its interest cost high, the company is striving to bring down the average interest cost by replacing high cost debt. Setting up the green field project would further increase the leverage of the company. Nevertheless, the rise in demand for long products could justify the setting up of a green-field project.
Although, construction projects would boost the volume growth, realization depends on the recovery in steel prices. Steel majors are expecting a revival in the steel demand in the second half of the year driven by good monsoon. The year-end growth in the sector is projected to be around 3-5% (a decline of 0.4% in first quarter steel production). Not only this, steel prices are also expected to improve by October end.
However, this positive monsoon impact is unlikely to wipe out the excess capacity of 4 m tonnes in flat product segment of the steel market. Steel consumption in India is just 8 m tonnes while the capacity is 12 m tonnes. Even if the demand scenario in the county is to improve in the second half of the year, there will still remain an excess capacity of atleast 2 m tonnes. The demand supply mismatch is likely to keep steel prices under pressure. Grim scenario in the world markets coupled with anti dumping duties imposed by the US, Canada and European Union would further contribute in lowering the prices. India’s steel exports have already witnessed a negative growth rate of 4.5% in FY01, after growing at an impressive rate of 54% in the previous year.
At the current market price of Rs 86, Tisco is trading at a P/E multiple of 6x its FY02 projected earnings. If the company decides to set up this project, its cash flows in the next 2-3 years are likely to be under strain. As the project would take atleast 2 years to complete, its positive impact on cash flows would be felt only then, assuming long product demand continues to be strong.
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