Tata Steel: After a weak Q2, what lies ahead

Indian steel companies have had a bumpy ride over the past year. A weak demand globally, primarily due to the overhang of Brexit and trade tensions between the US and China, and persisting challenges in the domestic market impacted the performance of all steel companies. The story of Tata Steel is no different.

The stock has fallen about 30 per cent over the past year, and a weak operational performance in the latest September quarter suggests that the pain could last for a few more quarters. That said, an expected pick-up in domestic steel demand in the second half of the fiscal year, possible bottoming out of steel prices and raw material cost benefit in the coming quarters should improve the prospects of steel companies gradually.

For Tata Steel in particular, the merger of Bhushan Steel (acquired under IBC through its wholly owned subsidiary Bamnipal Steel), is expected to bring in synergies on the cost front. Also, the increased focus on domestic business to improve profitability will aid earnings in the long run. Tata Steel is in the process of simplifying its structure, the benefits of which are expected to be seen from the next fiscal.

While the long-term prospects of the company are sound, given near-term uncertainties on the global front, slow demand recovery and high debt levels , a significant improvement in earnings may happen only from the next fiscal. Hence, investors can hold the stock for now and wait for sustained signs of recovery.

Weak demand

Tata Steel’s consolidated sales volumes in Q2FY20 stood at 6.53 million tonnes (mt), up by 3 per cent sequentially and down by 4 per cent y-o-y.

The demand for steel in India, a major market for Tata Steel, has been tepid. Activities in the infrastructure and construction sector, which contributes significantly to steel demand, continues to be modest. The automotive sector, from which the realisations are higher for the steel industry, has decelerated sharply.

Tata Steel increased its exports to offset the loss of demand in the domestic market. The share of exports increased to 15 per cent in the second quarter of FY20 as against 8 per cent in the previous quarter and 11 per cent during the same quarter last year. This, however, has not aided revenues much as the realisation (sale value) in the export market is less than that in the domestic market.

The blended realisation of the group fell to ₹52,954 per tonne in the recent September quarter from ₹60,142 per tonne a year ago.

While the group’s revenue fell 15 per cent y-o-y to ₹34,579 crore in the second quarter of FY20, the net profit at ₹3,302 crore is optically better (due to tax adjustments), recording a growth of 6 per cent compared with the profit in the year-ago period. If not for such tax adjustments, the company would have recorded a loss during the quarter.

Profitability under pressure

As per various reports, the costs of iron ore and coking coal, the key raw materials of steel, have softened in the second quarter of FY20. Tata Steel has pointed out that gains from lower cost will benefit it only in the coming quarters. With low volumes, weak realisations and reduced cost benefits, the operating profit and margins were under pressure in Q2 FY20.

The operating profit of the group fell more than 50 per cent y-o-y to ₹4,018 crore. This led to the weakening of EBITDA per tonne (operating profit per tonne), which stood at ₹6,155 in Q2FY20 against ₹12,173 a year ago. As a result, the operating profit margins also fell from 21 per cent to 12 per cent during the said period.

That said, the operational performance of Tata Steel’s Indian operations (standalone) has been decent with EBITDA per tonne and EBITDA margins of ₹11,200 and 21 per cent, respectively, in the September quarter. The European operations have been the worst impacted with an EBITDA per tonne of ₹720 in Q2FY20 against ₹4,862 a tonne recorded a year ago.

The demand for steel is expected to improve in the second half of the fiscal. The management believes the prices have bottomed out for now and would be stable going forward. Also, cost benefits on the raw material front are expected to flow in the coming quarters and could aid the margins.

Trimming capex

The consolidated debt went up from about one ₹1-lakh crore as on March 31, 2019 to ₹1.11-lakh crore as on September 30, 2019, primarily on account of acquisition of Usha Matin’s steel business in April 2019 and the recognition of leases as per the new accounting standard for leases — Ind AS116.

The net debt to EBITDA of the company stood at about 4.6 times as of September 2019. This has prompted the company to cut down its capex for the year from ₹11,000 crore to ₹8,300 crore.