The memorandum of understanding (MoU) between Tata Steel and Thyssenkrupp AG to create a 50:50 JV in Europe paves the way for the former to reduce exposure to a structurally weaker business and allocate additional capital to more profitable operations back in India, say analysts. In its latest report, Fitch Ratings has observed that reduction in direct exposure to Europe — which faces weak regional demand, high conversion costs and lack of captive raw material sources — while increasing significance of its more profitable Indian operations will not only reduce earnings volatility, but also improve the Tata Steel’s overall business profile. On September 20, Tata Steel and Germany’s Thyssenkrupp had signed an agreement to merge their European steel operations that would create Europe’s second-largest steel firm after ArcelorMittal. The combined entity would have a turnover of about 15 billion euro per annum (Rs 1.15 lakh crore). The companies said the 50:50 joint venture did not involve any cash and both groups would contribute debt and liabilities and remain long-term investors. The debt transferred to the JV by Tata Steel, which is 2.5 billion euro will be non-recourse.
Following that, Tata Steel’s consolidated debt will reduce to Rs 55,000 crore from Rs 74,500 crore as on March 2017, observe analysts at Kotak Institutional Equities. The combined EBITDA (earnings before interest, tax, depreciation and amortisation) for both the entities is close to 1.5 billion euro ($1.7 billion) without assuming synergies — the EBITDA can increase to $2.1 billion (or more) on inclusion of cost synergy gains. In fact, KIE notes that assuming these synergies are realised, the JV is estimated to be earnings accretive by about 9-10% at the lower end of the synergy benefits of 400 million euro.
The companies have said cost synergies to the tune of 400-600 million euro per annum could be realised by the JV through integration of commercial functions, R&D and other supporting activities. Also, elimination of cash burn in Europe will take off the cash flow load from Indian operations and improve capital allocation to more profitable Indian operations.
Tata Steel has said it intends to double its capacity in India from 13 million tonne in the next five years to enhance its market position. Apart from organic growth at its Kalinganagar and Jamshedpur sites, the company may acquire distressed assets in India. A number of domestic steelmakers such as Essar Steel, Bhushan Steel and Electrosteel Steels are in bankruptcy proceedings.
According to the ratings firm, Tata Steel’s leverage will decline further to 4x by FY19, driven by robust Ebitda in India and reduced capex. “Tata Steel’s capex averaged around Rs 12,000 crore each year over FY14-17 as it set up its Kalinganagar plant, and we assume roughly half of that level will be spent annually over the next three years resulting in positive FCF (free cash flows). However, higher-than-expected spending to pursue capacity growth is a key risk to our estimates,” it said.