Tata Steel’s Q1 supports India push but investors enquire at what cost

Posted on by KNBT

Graphic: Mint

Graphic: Mint

Tata Steel Ltd’s June-quarter results reinforce its obsession with adding capacity in the domestic market. They also illustrate why investors are concerned about how the company goes about this and the interim impact on its financials.

Take debt, which is the bigger worry. Tata Steel’s gross debt as of 30 June has risen by 26.6% to ₹1.17 trillion compared to its 31 March levels. The chief contributor is the debt addition due to the Bhushan Steel Ltd acquisition.

Of course, Tata Steel has cash and equivalents of ₹13,086 crore, but this too has come down from ₹22,932 crore as of 31 March.

And as the business hums along and Bhushan Steel’s contribution steps up, the cash balance will move up. But then, Tata Steel has its sights on Bhushan Power and Steel Ltd—where it may now have to pay more than it expected earlier.

On the one hand, that will add further debt to the company’s books and it will have two assets that may have good potential in the long term but will require considerable work to be done in the short to medium term.

While that could be the main concern that’s pulled Tata Steel’s shares down in 2018 so far, its logic of investing in India has held up. In the three months ended 30 June, the company’s consolidated volume sales increased by 12.3% from a year ago, per tonne realizations rose by 8.7% and its Ebitda (earnings before interest, tax, depreciation and amortization) increased by 32.8% to ₹6,559 crore.

But the real story is the contribution to this Ebitda. The India stand-alone steel business contributed 78% of this Ebitda, although in the country, realizations rose by a relatively slower 5.3%. The rest of the group, including its European and South-East Asian ventures, and some smaller domestic subsidiaries too, contributed to the remaining 22%.

Notably, India accounts for only 45% of the group’s sales by volume as of now. What this means is, as Tata Steel adds to domestic volumes, once these operations stabilize, its profitability should leap.

That, of course, assumes that all stays well with the domestic steel industry. The indications are good. Steel demand grew by about 9% in the April-June quarter and the Tata Steel management said that the current quarter—usually a seasonally weak one—is seeing good demand.

The acquisitions bring another problem. While the Ebitda growth was healthy, depreciation and interest costs have risen too, and the full impact will be visible in the current quarter, since Bhushan Steel’s acquisition was effective 18 May.

Also, while India and Europe both saw their Ebitda improve, adverse non-cash foreign exchange movements of companies that do the financing of the company’s South-East Asian operations affected Ebitda. Others (which include these entities) reported a loss of ₹400 crore compared to a profit of ₹743 crore a year ago.

This meant that Tata Steel’s consolidated Ebitda has come in a bit lower than what the Street had pencilled in. Since the miss is chiefly due to non-operational reasons that are not likely to sustain, investors may not mind it as much. Its profit before tax and one-time items increased by 46.2% over a year ago but declined by 11.7% sequentially.

The company’s steel business continues to be doing well and the conditions in both India and Europe are looking good, especially as steel prices are showing a firm trend. The main concern that investors will have is the point when Tata Steel will say no to more acquisitions and consolidate what it has already acquired.

The effects of taking on more debt will be felt till then, offset by the cash flows from the acquired assets, more so in the longer run when their performance improves.

The company’s debt position will also ease a bit once the joint venture with Thyssenkrupp AG becomes effective.

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