Tata Steel & SAIL - A Structural Advantage

The two premier steel manufacturing firms in the country, Tata Steel and SAIL, are well poised for growth and are ably shouldering the country’s economic aspirations. So, which of these stocks should you pick? DSIJ helps you decide.

Steel is a global commodity and forms the backbone of any industrialised society, with a large part of the consumption coming from the manufacturing, construction, infrastructure and automotive sectors. The consumption of steel is linked to the growth of the economy. When the economy grows, the consumption of steel also rises as it includes the overall development of the country. In the past six years (05-06 to 011-012), the demand for steel has increased at a CAGR of 11 per cent to 69.18 mtpa, while production has grown by nine per cent to 70 million tonnes per annum (mtpa).

Going forward, we believe that the demand will continue to see a similar kind of growth on the back of higher growth from the infrastructure sector, which is currently underpenetrated. On the infrastructure spending front, in the FY13 budget, the government has doubled the tax free bonds for financing infrastructure projects to `60000 crore. Also, to ease the access of credit to infrastructure projects, India Infrastructure Finance Company (IIFCL) has put in place a structure for credit enhancement and take-out finance. Moreover, the 12th Five Year Plan is expected to allocate USD 1 trillion of investment in infrastructure over the next five years. The governmental thrust on large infrastructure expenditure and the timely implementation of infrastructure projects such ashighways, ports, power projects, etc., coupled with higher spending in the rural and urban housing development, consumer durables and auto sectors will all drive growth for steel companies in the coming years.

The industry is dominated by the top five steel players which are Tata Steel India (6.86 mtpa), SAIL (13.8 mtpa), JSW Steel (11 mtpa), RINL (6.3 mtpa) and Essar Steel (increased its capacity from 4.6 mtpa to 10 mtpa in January 2012). Tata Steel is also in the process of completing its expansion project at Jamshedpur, which will take its capacity to 10 mtpa. Together, these five players constitute 60 per cent of the country’s total steel production. These companies can be divided on the basis of primary or integrated steel producers and secondary producers.

Basic Comparison

Among the top integrated players, Tata Steel and SAIL are one of the largest steel manufacturers in the country. Both the companies have chalked out huge expansion plans to meet the increasing demand in the coming years. Tata Steel became the top Indian steel player in 2007 post the acquisition of Corus for `12000 crore, and has created a mark for itself on the global front. Today, the company is the sixth largest steel producer in the world. On the other hand, SAIL is the largest steel producer in India, with a capacity of 13.8 mtpa as of FY11. Tata Steel’s total production capacity is 24 mtpa, out of which Europe constitutes 18.4 mtpa, India constitutes 6.8 mtpa and the remaining comes from other parts of the world. Its European division brought in 65 per cent of the company’s total revenue in FY11, whereas the Indian division brought in 26 per cent.

Source: JPC

Tata Steel and SAIL accounted for 32 per cent of India’s crude steel production in FY2012, and have an advantage over other steel companies in terms of the market share that they enjoy, access to mines, etc. These two companies will always have an edge over other steel players in the country on account of their size.

It must be noted here that while the fortunes of steel companies tend to depend on the general economic conditions, they are particularly more sensitive to the performance of the automotive, construction, durable equipments and other industrial products’ industries, which have a larger role to play in the performance of steel companies in India.

Operational Assessment

Tata Steel has put in a lot of effort into updating technology and improving its operational efficiency over the years. These efforts include the use of new technology to produce low ash clean coal, beneficiation of low grade iron ore and new coal agglomeration technology aimed at increasing the use of low cost non-coking coal for coke production. Over the past two years, its EBITDA/tonne has improved from `6419 in 2008-09 to `6806 in FY2011.

On the other hand, SAIL’s operating performance over the past two years has been quite disappointing. The company’s EBITDA/tonne has declined from a high of `7309 in 2008-09 to `5630 in 2010-11.

This sharp improvement in the profitability of Tata Steel was mainly on account of the improvement in its product mix, cost reduction and increased benefits arising from the integrated iron ore mines. The company has reduced its sales of semi-finished steel products, and has increased the sales volume of value-added steel for the automotive segment, which generates higher margins as compared to any other steel product. Apart from improving its product mix, the company has trimmed costs over the years by way of various expansions and modernisation of its plants. This is evident from the improvement of raw material consumption on a per tonne basis of steel production, which has declined over the last three years from 3.06 tonne/tonne crude steel (tcs) in 2007-08 to 2.94 t/tcs in 2009-10.

Although SAIL has captive iron ore mines, it has lagged behind in terms of updating its technology to improve the raw material consumption and cost. A major part of the operations of the company are conducted through energy-inefficient processes, which include the open hearth and ingot routes of production.

SAIL does not have rolling mills for value-added products. Thus, 20 per cent of its sales volume consists of semi-finished steel, resulting in lower value addition and poorer margins. For Tata Steel, on the other hand, semifinished products constituted only six per cent to the total sales volume in FY11.

Both Tata Steel and SAIL have access to captive iron ore mines, which helps them to reduce the cost of procuring iron ore from the open market. SAIL has the largest captive iron ore operations in India, which takes care of its entire requirement. With plans in place to expand the mining operations, the company will continue to be self-sufficient with regard to iron ore after completion of the ongoing phase of expansion. Tata Steel too has backward linkages to its captive mines and collieries, which it owns and operates across the states of Jharkhand and Odisha. This indicates that both the companies have enough iron ore mines and are placed equally on the iron ore integration front.

However, Tata Steel is one step ahead in terms of backward integration, as the company also has coal mining operations (it procures 60 per cent from the mines) in Jharkhand, Odisha and other places in India. This provides it with cost benefits and an edge over SAIL, which procures 100 per cent of its coal requirement from Coal India. Moreover, Tata Steel has recently entered into a JV with Australia-based firm Riversdale Mining for coking coal, which will initially supply coking coal for its European operations and later for the Indian operations too.

Expansion Plans

Both companies are currently on an expansion spree. SAIL, which was lagging behind in terms of technology upgradation and modernization, is now increasing its crude steel capacity from 13.8 mtpa to 21 mtpa. These new capacities are expected to be operationalised by the end of FY13. However, the expansion plans faced some delay in 2011, and any further delay will lead to cost overruns in the future. Not only SAIL, but Tata Steel is also undergoing major expansion. The company is in the process of increasing its existing plant capacity at Jamshedpur from 6.8 mtpa to 9.7 mtpa, which is expected to start operations by June 2012. Moreover, it has started the construction of a 6 mtpa crude steel capacity in Odisha, which will be executed in two phases of 3 mtpa each. The first phase of this expansion plan is expected to be commissioned by January 2014, and the second phase will start operations by March 2015.

As the companies are in expansion mode, their debt-to-equity levels are likely to be strained. Tata Steel will face severe pressure on its balance sheet, as a huge debt in its books will lead to a higher interest outgo. The impact of this will be seen on the company’s bottomline. Tata Steel’s current consolidated debt-to-equity ratio is at 1.63:1. In contrast, SAIL is in a much better position, and has a cash balance of `15684 crore. This keeps its net debtto-equity ratio at 0.24:1 levels, which is fairly comfortable. The company’s current debt situation is better than that of Tata Steel. For the ongoing project and for its further expansion plans, SAIL will raise funds keeping its debt-to-equity ratio at 1:1.

Financial Evaluation

On the financial front, both companies have shown a weak performance for the first nine months of FY12. Tata Steel’s net sales were up by 16 per cent on a YoY basis at `98397 crore. Its operating profit was down by 22 per cent on a YoY basis to `8890 crore. The decline in operating profit was mainly on account of the European region, which is currently going through a debt crisis. In the December 2012 quarter, weak demand in Europe prompted the company to go in for an inventory write-off worth `741 crore in the European division, and it reported a consolidated net loss of `687 crore.

Tata Steel’s Indian operations remained much better than those in Europe. The net sales of its Indian operations were up by 16.14 per cent on a YoY basis to `24454 crore, and the operating profit was up by two per cent to `8503 crore. However, due to higher input costs, the EBITDA margin of the company was down by 450 basis points to 34.77 per cent on a YoY basis.

The net revenue of SAIL was up by 4.47 per cent to `32649 crore, and the operating profit of the company was down by 20 per cent on a YoY basis to `4230. Its EBITDA margin was down by 400 basis points to 12.13 per cent on a YoY basis.

Further, if we look at the domestic steel consumption numbers for the first nine months, as provided by the Joint Plant Committee (JPC), consumption grew by a mere 4.4 per cent on a YoY basis to 50.86 million tonnes. Higher rupee depreciation and high prices of coking coal at USD 285/tonne impacted the margins of steel companies during the fiscal year.

For the March 2012 quarter though, steel consumption showed some signs of a revival in demand on the back of an upsurge in infrastructure activity. In the backdrop of this, companies raised the steel prices by`1000-1500 per tonne on both flat and long steel products in this period. Further, coking coal prices cooled off to USD 220 /tonne levels, which provided cost benefits during the quarter.

In last one year the scrips of Tata Steel as well as SAIL have declined by 30 per cent and 43 per cent respectively. As for their EV/EBITDA levels, both the companies are available at 5.9x and 6.11x, which is a fairly cheap value. At the current valuation, however, Tata Steel is looking cheaper than SAIL. We believe that with the revival in the global demand for steel, Tata Steel will be in a much better position than SAIL in terms of cost efficiency, backward integration and on the valuations front. Therefore, we recommend that investors buy Tata Steel from a long term perspective.