Tough choices: Europe weighs heavy on Tata Steel

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Published: June 1, 2015 12:05:49 AM

The steel maker braces for another tough year even as it looks to sell its long products business in Europe

It’s now close to a decade since Tata Steel bought the Anglo-Dutch steelmaker Corus but the winner’s curse doesn’t seem to have lifted. The $12 billion that Tata Steel finally spent on the acquisition has delivered nothing; facilities had to be sold or mothballed and there’s no sign of a sustainable turnaround.

Karl Koehler, managing director, Tata Steel Europe (TSE), said recently FY16 would be another tough year for European steel with demand likely to remain subdued. “We’re expecting the overcapacity in China to continue and that will lead to margin pressure on European producers,” Koehler said pointing out that the weaker euro is hurting realisations for UK sales in the Eurozone. Nevertheless, the company will continue to focus on high value steels and maintain the pace of new product launches.

While TSE’s profitability has improved over the last six quarters, this has been driven mostly by flat products; long products continue to do badly and the company is looking to sell the business, possibly to Klesch Group. TSE took an impairment charge of R4,951 crore on account of long products in the UK resulting in a loss in Q4 FY15. “With utilisations low and fixed costs high, we estimate that long product business has been Ebitda loss-making to break-even,” a JP Morgan report said.

Worse, industrial action threatens to affect operations in the UK where the employee unions have opted for a ballot over the proposed closure of the current pension scheme; such a ballot is sought to decide on a strike, lock-out or action short of a strike. The company wants to replace the existing British Steel pension scheme with a ‘money purchase’ one in which employees, the government and the employer will make definite contributions. However, the unions rejected it saying it would further burden the 17,000 employees.

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“The ballot outcome will be important to decide on the future investments. The UK business has been in a challenging phase and a liability on the group which has made significant investments to support the business over the last nine years,” Koushik Chatterjee, group executive director, finance and corporate, Tata Steel, observed.

Even otherwise, Tata Steel has a tough year ahead with cheap imports flooding the Indian market in the wake of a global glut. The firm acknowledges the excess capacity steel in the world markets will continue to pressure prices. India was a net importer of steel in FY15 with a significant surge in imports not only from China and Russia, but also FTA countries like Japan and Korea.

The resumption of captive mining is reason for cheer but higher mining taxes will hurt. The MMDR Amendment Act has brought in new levies, namely District Mineral Foundation and the National Mineral Exploration Trust. “Taxes on mining have increased to approximately 79%, one of the highest across mining countries,” Chatterjee said.

TV Narendran, managing director, Tata Steel India and South East Asia believes a quick revival in demand is unlikely; rural demand is weak while that from the infrastructure and construction segments is yet to take off significantly. “We remain concerned about the liquidity situation affecting key customer segments like construction, infrastructure, SMEs,” he says.

Narendran is hoping initiatives like smart cities, industrial corridor, metro projects and Make in India will translate into a concrete upturn soon. He’s also expecting some respite in terms of steel prices due to the depreciation of the rupee.

Commercial production at the company’s greenfield Kalinganagar project is expected to commence in the second half of FY15; this will enable the company to diversify its client base, make deeper inroads into sectors like oil and gas and thereby grow the higher margin domestic business. However, analysts caution that steel realisations in Q1 FY16 could further fall by Rs 1,000-Rs 1,500/tonne.

With iron ore operations have resumed operations at all mines in India, including Khondbond, raw material costs are likely to normalise. The decline in Ebitda/tonne for Indian operations – to approximately Rs 6972/tonne in FY15—was caused by a steep fall in realisations and on account of purchased iron ore, which pushed up raw material costs by Rs 1,700 crore. Inventories to the tune of 1.5 MT will, however, continue to eat into margins.

Tata Steel’s massive consolidated net debt of close to Rs 70,000 crore will continue to weigh on its finances.

Chatterjee, however, said $7 billion of international debt had been refinanced, almost 15 months ahead of its start of repayment, helping de-risk the balance sheet. “The gross debt of the group was maintained despite incurring a capex of Rs 13,492 crore in FY 2015,” he added.

Nevertheless, it will remain on the books. Moreover, the investment of $ 4 billion, for the first phase (3mtpa) of the Kalinganagar project or a cost of about $1300/tonne, analysts say, could be un-remunerative. “The plant will generate lower return on equity than the cost,” HSBC wrote in a report adding it would limit the firm’s ability to de-leverage its balance sheet over the next few years in a substantial manner. In 2014-15, the firm reported a net loss of Rs 3,956 crore, against a net profit of Rs 3,664crore in 2013-14 while revenues fell 6.1% y-o-y to Rs 1.39 lakh crore.

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