Tata Iron and Steel: Hold

Recommendation: Hold

Krishnan Thiagarajan

AFTER a strong first quarter, Tata Iron and Steel Co (Tata Steel) has continued its good run in the second quarter of 2000-01.

Although the sales growth remained sluggish at 9.5 per cent (actual sales of Rs 1,870.34 crore) in the second quarter vis-a-vis 21 per cent in the first quarter, the post-tax earnings growth proved to be far more healthy over the same period.

In the second quarter, Tata Steel's post-tax earnings (without considering extraordinary items) grew 186 per cent to Rs 257.8 crore over the corresponding previous period compared to 161 per cent growth in the first quarter. However, unlike the first quarter, when the sales growth was fuelled by higher sales volumes and realisations, it appears that in the second quarter, the improvement in the operating profit margins of Tata Steel was driven largely by cost-cutting and improved product mix.

In the second quarter, while the production inched up by 4.16 per cent to 0.87 million tonnes, sales remained more or less stagnant at 0.83 million tonnes. This is in sharp contrast to the 11.54 per cent growth in production volumes and 13 per cent growth in sales volumes in the first quarter.

As the international prices of steel also remained sluggish throughout the second quarter, the sharp appreciation in the operating margins can be traced mainly to cost-reduction exercises and, probably, to a better product mix.

The operating profit margins improved by 6.84 percentage points to 22.93 per cent, contributed by a tight control over expenditure. For the second quarter, Tata Steel's total expenditure went up by only 0.61 per cent vis-a-vis growth in sales of 9.53 per cent. This improvement is largely on account of superior energy and refractory consumption and a reduction in the employee cost by around 2.7 per cent this quarter.

On account of a higher `other income' component and reduction in the interest burden by 18.37 per cent, the gross profit margin of Tata Steel improved by 8.45 percentage points to 20.38 per cent in the second quarter. After accounting for a rise in depreciation by 8.08 per cent and adjustment of extraordinary items in the form of provision for employee separation compensation and provision of power costs of previous years (a one time charge of Rs 94.37 crore) and provision for taxation, the post-tax earnings stands at Rs 115.03 crore.

After adjusting for extraordinary items, the post-tax earnings growth was still up by around 76 per cent. For the half-year ended September 30, 2000, the turnover went up by 14.8 per cent to Rs 3,598.61 crore and post-tax earnings grew 176 per cent to Rs 406.69 crore (without extraordinary items).

Though the post-tax earnings of Tata Steel improved in the second quarter compared to the first quarter, the global industry fundamentals are exhibiting mixed signals. According to a recent survey by the International Iron and Steel Institute, global steel production is set to register a 5.8 per cent growth to reach 752 million tonnes in 2000-01, compared to the previous year.

Led by the strong growth from the European Union, China and Asia, the global steel consumption is expected to touch 830 million tonnes by 2005. This essentially means that the demand for steel is likely to be fairly strong. However, the international prices of steel have slowed down sharply over the past four to five months and this is likely to impact realisations to a large extent.

The developments at the global level are likely to impact the financial performance of the domestic steel producers such as Tata Steel in two ways. First, the downtrend in steel prices is expected to force domestic steel producers to resort to price cuts in the near future. Although producers such as Tata Steel, on account of being one of the lowest cost-producer of steel in the world, may be better-placed relative to its peers, the operating profit margins are slated to come under pressure, if the domestic prices weaken.

Second, as a sequel to the ban imposed by the US Ministry of Commerce on the export of hot-rolled coils to the US by 11 countries, including India, it has also lodged a complaint with the World Trade Organisation. Although the charges of dumping are likely to be contested by the Indian steel producers, led by SAIL and Tata Steel, the outcome of this event may have a crucial bearing on the export prospects of the entire Indian steel industry.

For Tata Steel, the need to improve product mix is likely to assume significance in the coming quarters. With the commencement of the commercial production of the cold-rolling mill at Jamshedpur by August 2000, Tata Steel will be banking on CR to improve its product mix and also bolster its current sales realisation. According to company sources, Tata Steel is targeting a product mix of CR coils (34 per cent), HR Coils (27 per cent), longs (29 per cent) and semis (8 per cent) in the medium term.

As Tata Steel is also slated to manufacture automobile-grade CR sheets, the key challenge for it lies in changing the mindset of the passenger car manufacturers who are now importing auto-grade CR sheets to source it from domestic players. Given the uncertainties on the price front and the challenges on the operational front, shareholders can hold the Tata Steel stock and fresh investments can be contemplated after a clear picture emerges on the price/operational front.