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Tata Steel: Riding the wave! - Views on News from Equitymaster

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Tata Steel: Riding the wave!
Oct 26, 2007

Performance summary
  • Standalone topline grows by 14% YoY, helped mainly by higher realizations.

  • Expenses grow at a lower rate than topline, resulting into an EBITDA margin expansion of 170 basis points (1.7%).

  • Bottomline growth drops to 8% YoY during the quarter as interest expenses jump more than four fold and other income falls 47% YoY.

  • Bottomline for the half year grows 17% YoY on the back of an 11% growth in topline.

(Rs m) 2QFY07 2QFY08 Change 1HFY07 1HFY08 Change
Steel sales (000' tonnes) 1,184 1,218 2.9% 2,299 2,259 -1.7%
Net sales 42,023 47,851 13.9% 81,017 89,827 10.9%
Expenditure 24,975 27,597 10.5% 48,156 52,581 9.2%
Operating profit (EBDITA) 17,048 20,254 18.8% 32,861 37,246 13.3%
EBDITA margin (%) 40.6% 42.3%   40.6% 41.5%  
Other income 1,772 943 -46.8% 2,552 2,404 -5.8%
Interest (net) 478 2,022 323.2% 771 2,821 266.1%
Depreciation 1,957 2,050 4.7% 3,909 4,163 6.5%
Profit before tax 16,386 17,126 4.5% 30,734 32,667 6.3%
Extraordinary income/(expense) (443) 340   (627) 3,825  
Tax 4,928 5,558 12.8% 9,558 12,362 29.3%
Profit after tax/(loss) 11,015 11,908 8.1% 20,549 24,129 17.4%
Net profit margin (%) 26.2% 24.9%   25.4% 26.9%  
No. of shares (m) 580.7 609.2   580.7 609.2  
Diluted earnings per share (Rs)*         75.2  
Price to earnings ratio (x)*         13.2  
( * on trailing twelve months earnings)

What is the company’s business?
Tata Steel is India’s largest private sector steel company, and 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. Recently, the company took a major step towards becoming a leading producer of steel globally by acquiring Corus Group Plc, Europe’s second largest steel producer. With this acquisition, the total consolidated capacity of the company has touched 25.6MTPA, making it the sixth largest player globally.

What has driven performance in 2QFY08?
Relishing the realisations: Tata Steel sold 1.22 m tonnes of steel during 2QFY08, nearly 3% higher than the 1.18 m tonnes it sold in the same quarter last year. Despite this, topline in value terms has grown by 14% YoY, a fact that could be attributed to improved realisations. With demand remaining buoyant and prices of key inputs like iron ore continuing to soar, steel makers have been able to effect price hikes and Tata Steel was no exception. We believe that prices should remain firm in the medium term as markets apart from the US and China continue to face a shortfall in the wake of long-gestation periods for new steel capacities. The domestic demand scenario too is unlikely to slowdown anytime soon, thus providing further cushioning to prices.

Margins improve: The company’s operating profits have improved by nearly 19% YoY, much better than the 14% growth in topline during the quarter and attributable to a lower than proportionate growth in costs. It should be remembered that the company sources most of its key raw material requirement like iron ore and coal through its own mines and hence, is insulated from the price volatilities of these commodities. Thus, when iron ore dependent steel producers are facing input cost pressures and are under pressure to maintain margins, Tata Steel has been able to expand its margins by 170 basis points (1.7%). Other expenses though have risen by 20% YoY but have been more than offset by muted increases in all the other cost heads.

cost break up
(Rs m) 1QFY07 1QFY08 Change
Raw materials 8,246 8,911 8.1%
% sales 19.6% 18.6%  
Staff cost 3,627 3,769 3.9%
% sales 8.6% 7.9%  
Freight and handling 2,747 2,800 1.9%
% sales 6.5% 5.9%  
Purchase of power 2,256 2,387 5.8%
% sales 5.4% 5.0%  
Other expenses 8,089 9,730 20.3%
% sales 19.3% 20.3%  

PBT growth at 5% has come in at a much lower rate than the 19% growth in EBITDA, due mainly to the huge four fold jump in interest expenses. Other income has also negatively impacted margins, as it has fallen by 47% YoY. Higher interest expense is a consequence of huge debt taken by the company to fund the Corus acquisition. Extraordinary income during the quarter has come in at Rs 340 m and this has helped the company post a bottomline growth of 8% YoY. This gain is attributable to the exchange rate related profits that have accrued to the company on its foreign currency borrowings. Absent such gains, the bottomline growth stands at a mere 1% YoY.

Over the last few quarters
The topline, after remaining subdued during the first quarter of FY08, has once again grown strongly and this coupled with the high operating margins bodes well for the company as it will enable it to repay before schedule the high debt that it has taken to fund its Corus purchase.

  2QFY07 3QFY07 4QFY07 1QFY08 2QFY08
Net sales (YoY growth %) 17.5% 18.9% 21.5% 7.2% 13.9%
OPM 30.8% 31.7% 38.2% 40.5% 42.3%
NPM 18.9% 17.7% 22.2% 29.1% 24.9%

What to expect?
At the current price of Rs 995, the stock is trading at a multiple of 2.3 times its FY10 book value. This is more than the 2x multiple that we assign to a company like Tata Steel. It has fixed November 5 as the record date for its simultaneous but unlinked right issues and while this is likely to lower the effective purchase price, we still feel that the risk return ratio at the current juncture is in favour of the former.

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