Tata Steel's domestic business may drag global play; woes may worsen if bearish trend continues
The lack of demand in India, considered to be the cornerstone for the industry worldwide, alongwith China, indicates that Tata Steel could likely take that much longer to climb back.
MUMBAI: For Tata Steel, India's largest private sector steelmaker, its profitable domestic operations helped cushion much of the pain caused by its wholly-owned European subsidiary. But not anymore, as India's oldest steelmaker is confronted by a sharp fall in profits in the June quarter at its Indian operations, which could worsen, if bearish trends prevail in the industry.The Jamshedpur-based steelmaker which consistently gained from captive resources and a marquee product basket, compared to lacklustre performance from its much larger international subsidiary, saw its bottom line fall 39% in the June quarter as jittery customers postponed purchases of automobiles and consumer durables.
What is worrying investors is the company's bet that returns from its forthcoming greenfield project in Odisha would also contribute toward servicing the debt, which by the end of June totalled Rs 54,000 crore.
A 38% rise in expenses and a surge in raw material prices it doesn't own, coupled with the overall sluggish demand, was all it took to drag down the fiscal first quarter profits at the over 100-year-old company, largely credited to be the backbone for the sprawling Tata conglomerate.
But the lack of demand in India, considered to be the cornerstone for the industry worldwide, alongwith China, indicates that Tata Steel could likely take that much longer to climb back. Tata Steel did not respond to queries sent by ET.
But a person familiar with the development said that the company is confident its future projects would start generating returns soon. Tata Steel is building a 6-million-tonne plant in Odisha in two phases and the first phase will be implemented by 2014. It already makes 6.8 million tonnes at Jamshedpur and has a combined capacity of 27 mt globally. It is also expanding Jamshedpur plant to 9.7 mt.
Unfazed by the downtrend, the steelmaker is committed to the expansion, for which Reuters on Tuesday reported the company is expected to mandate a project financing loan of up to 22,000 crore to fund its 6-mt-per-annum-greenfield steel plant at Kalinganagar in Orissa.
"What the company is hoping is that returns from the greenfield project will be high enough and will throw free cashflow to service its debt beyond the project debt. (But) we think that given the sharp downward trend in iron ore and coking coal, the cashflow generation from these projects can be lower than expected and might put some strain on the company to meet its debt obligations," said Rakesh Arora of Macquarie Securities.
"The first quarter volume was 1.6 mt, which is lower compared to our estimate of 1.7 mt," said Anubhav Gupta of Kim Eng Securities, part of Malaysia's Maybank Investment Bank. "Also the steel EBITDA of $346 a tonne (lower by 6%), is due to lower sales and high raw material costs. (Although) Tata Steel will start its new 3-mt-plant in December, with slowing demand, the company's target of 20% rise in FY13 sales volume seems optimistic. Our forecast is 7.3 mt," he wrote in a report.
Shares of Tata Steel are already down by about 9% to 378.90 a share on the BSE in the past month.
The looming debt of over $9 billion is also a major cause for concern. Tata Steel has repaid about $1 billion of debt in the first quarter.
Tata Steel Odisha is being built at a cost of Rs 34,500 crore, with a 65:35 debt-equity. The company plans to raise Rs 26,000 crore through bank loans for the Odisha project, although it isn't clear whether this will be for the second phase.
The company has already seen a downgrade by rating agencies. While Standard & Poor's and Fitch Ratings have lowered the outlook on the company to negative, Moody's Investors Service has cut the credit rating for Tata Steel UK, its wholly-owned subsidiary to junk.
"The ratings action was guided by the view that profitability pressures will remain for Tata Steel given the challenging short-term outlook for the global steel market," said Fitch Ratings associate director Muralidharan R. "In FY12, consolidated EBITDA margins fell to 9.3% driven by the challenging operating environment. Thus, the net financial leverage increased to 4.27x, beyond Fitch's negative rating guideline of 4x. Leverage is likely to remain around the current levels during FY13," he added.
The main reason for the fall in demand is low availability of funds. "There is a general slack demand pattern. Scanty rains and very little liquidity with small and medium enterprises has led to a fall in consumption of steel," said Macquarie's Arora.
Small firms form a bulk of steel buyers who convert them into products used largely in construction, cars and in consumer goods.
But bank credit lending has dwindled as statistics of nationalised banks show. Credit outstanding in the April-June period fell by Rs 57,878 crore. An Axis Bank compilation says that credit for power projects and telecom has grown the slowest. "There is clear indication that there are no new projects in the infrastructure space. Whatever work is being done is in completion of old projects," said a person familiar with trends in the core sector.
The scenario also compelled Tata Steel outgoing chairman Ratan Tata to caution shareholders about a difficult year ahead and of the need for strong measures. Although the company earns more than 50% of its revenue from Tata Steel UK, a recovery in the Indian economy can offset any impact from the European crisis, said Tata said at the AGM recently.