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Tisco: What to do? - Views on News from Equitymaster
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Tisco: What to do?
Oct 11, 2006

Steel industry is a key sector in the Indian economy, as it meets the requirements of various industries such as engineering, electrical and electronics, infrastructure, automobile and automobile components and packaging. India is the 8th largest steel producer in the world with an installed capacity of 36.1 million tonnes (MT) in FY06. During the year domestic steel production and consumption has increased by 5.1% and 7.1% respectively over the previous year. Steel consumption in India is expected to grow by 7 to 8 % by 2011-12 and production will grow to 66 MT. Globally, steel demand is estimated to have grown by 2.7% to 998 MT. Despite the fact that India is a small player in the global steel sector, we have one of the most efficient producers of steel in the world, Tata Steel. Company Overview
Tata Steel (Tisco), Asia's first and India's largest and oldest private sector integrated steel company, is one of the lowest cost steel producers in the world. The company services major industries such as construction, infrastructure, automobiles and consumer durables. Tisco's ability to improve product mix and its cost leadership has enabled it to maintain profits despite operating in a highly cyclical and capital-intensive industry. The company has been constantly focusing on enriching its product mix, to move up the value chain in each product category in order to cater to the high-end market. The company’s focus is on 2 key segments – Automotive and Construction. It was rated as the best steel company in the world by the World Steel Dynamics (WSD), the world’s leading steel information service provider (WSD rates various steel companies in the world on various parameters including operating cost, capacity, profitability, level of integration etc.).

De-risked product mix…
The company’s revenue grew at a slower rate of 4% YoY to Rs 151 bn in FY06. However, the topline growth since FY04 stands at 20% CAGR, which was largely driven by FY05 financials. In FY05, turnover grew by 35% on account of strong steel demand and historically high realisations. While the topline growth has been subjected to global price movements, Tisco has made significant strides to de-risk revenues. The supplies of hot rolled, cold rolled and galvanized products to the automotive industry increased by 21% during FY05 and sales of branded products increased by 13%.

The company’s product mix consists of hot rolled, cold rolled, galvanized cold rolled, long and semi-finished steel products. Though hot rolled, cold rolled and galvanized products softened in FY06 in line with the international trend, branded products revenues witnessed a growth of 14% YoY. With the opening of 115 brand exclusive outlets in FY06, branded sales are expected to increase by 30%.

Lowest cost producer…
The purchase of semi finished and finished steel products reduced by 50% to Rs 6.6 bn. This was because the company used converted pig iron instead of buying them from the market. With the commissioning of a blast furnace, requirement of pig iron and sponge iron has come down during FY06. The blast furnace also has the distinction of producing lowest cost hot metal in the world. Though freight, power and employee-related costs increased as a percentage of sales in FY06, Tisco was able to curtail its manufacturing expenses significantly (280 basis points), which resulted in EBDITA per tonne increasing by 1%. This is indeed commendable considering the significant increase in raw material and fuel costs on a YoY basis. Tisco remains one of cost efficient producers of steel in the world.

Value creator…
Favorable steel prices over the last four years have enabled Tisco to retire debts aggressively, which is reflected in its debt to equity ratio. The debt to equity ratio in FY06 stood at 0.3 times (0.9 in FY04). Interest coverage ratio has improved from 22.8 in FY04 to 45.2 in Fy06, on account of improved cash flow from operations, efficiency and redemption of non- convertible debentures. In FY03, the company turned EVA positive.

Conclusion
Despite weaker steel prices off late, Tisco has maintained EBITDA margins at a healthy 40% levels in FY06 (42% in FY05). The company’s usage of imported coal has come down to 32% in FY06, which we expect to decline further in the long-term. The company plans to expand its capacity to 30 MT by 2015. Currently, the company is planning to acquire Corus Steel (Anglo-Dutch company) in line with its plans to expand globally. While we believe that this is a good move, the medium-term impact of such a large-scale acquisition remains a cause of concern.

At Rs 519.70, the stock is trading at a price to earnings multiple of 8.05 times FY06 earnings and a price to book value multiple of 3.01 times. While it is indeed difficult to predict the peaks and troughs of steel prices, we have a cautious view on steel prices over the medium-term. Therefore, the risk-return matrix is skewed towards risks.

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