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Radhika Kamath

The upgradation at the Jamshedpur plant will improve the product mix. - Parth Sanyal

THE stock price of Tata Steel has fallen by over 20 per cent during the last six weeks. Investors can take advantage of the slide to either enter the stock or take additional exposure at the current price-level of Rs 353 for potential medium-term returns.

At its current price, the stock trades at a multiple of around eight times its trailing per share earnings for FY-04 and a price-to-book value ratio of about 3.3.

Our recommendation is based on the company's revenue and earnings growth potential, the viability of its expansion plans and macro-economic factors such as the steel demand outlook for the medium term and the continuation of firm steel prices. In the event of steel prices dipping below current levels, Tata Steel is also placed to weather the fallout of the industry's cyclical nature.

The company's performance for FY-05 was impressive. The saleable steel production for the period was 4.11 million tonnes, an all-time high. This is a significant achievement as the company's largest furnace was shutdown from December 3, 2004, for increasing its capacity; is now running successfully after having completed the blowing in on April 6. The cold rolling mill performed remarkably well with production at 1.06 million tonnes — 15 per cent higher than last year's volume.

While the volume growth has not been noteworthy, the company has been able to secure higher price realisation by increasing the sale of value-added products.

As the price realisation for cold rolled and galvanised products is higher than for hot rolled products by 25-35 per cent, on an average, the move up the value chain has led to an expansion in operating profit margins.

The proportion of value-added products in the total production rose 35 per cent, a significant improvement.

Rich product mix

Tata Steel's enhanced focus on branded products is likely to ensure robust growth in its topline and bottomline. The sale of branded products rose to Rs 1,499 crore in the first half of FY 05, from Rs 1,039 crore for the corresponding previous period.

Also, the company's plans of setting up 15 retail stores in the country, which is a path-breaking initiative, could boost sale of its branded products.

Expansion spree

The company has undertaken a series of expansion programmes to attain the planned capacity level of 15 million tonnes by 2010. Its proposed investment in Orissa for setting up a six-million-tonne integrated plant would ensure higher production of value-added products and greater control over cost of production.

The infrastructure bottlenecks are likely to ease, as the company would be setting up a port at Dhamra that would connect its domestic and global operations.

The recently-completed upgradation of the facilities at Jamshedpur would not only produce better quality hot metal, with lower energy consumption, but also help reduce the cost of production.

With this upgradation, Tata Steel will have a finished steel capacity of 7 million tonnes per annum (MTPA); including 2 MTPA capacity of NatSteel Asia, a Singapore-based company, which was acquired recently.

The proposed coke and power project at Haldia would ensure smooth supply of raw materials to feed the additional capacity.

If the ongoing talks to take over the three-million-tonne Hormozgan Steel plant in Iran fructify , it would arm Tata Steel with additional capacity and an opportunity to tap the markets in West Asia.

Synergies from acquisition

With the completion of the acquisition of NatSteel Asia, Tata Steel is best placed to tap emerging opportunities in the Asian market. NatSteel Asia, which has steel assets across seven countries with access to low-cost inputs along with experience in trading, would bolster Tata Steel's plans of achieving geographical growth.

Strong financials

As it is a cash-rich company, Tata Steel is well-placed to fund growth from cash flows from its operations and borrowings.

The company has also been able to reduce the debt burden substantially, giving it leeway to enhance its financial leverage.

The operating profit per tonne of steel has doubled to Rs 15,853 for the first nine months of FY-05 while the global average for the period was as low as Rs 4,950.

With its continued thrust on improving operational efficiency and cutting costs, we believe it would continue to attain superior business performance.

Higher steel prices and a sizeable share of value-added products in its portfolio are likely to improve its OPMs.

Other factors

With higher demand for steel from auto and construction sector, Tata Steel is likely to remain the preferred supplier for most players in the domestic market.

The ownership of low-cost iron ore and coking coal, favourable location for procuring, ongoing cost-cutting efforts, robust demand in domestic market along with the potential for strong demand overseas, access to high growth markets and a continuous enrichment of product mix would augur well for the company's growth.

Increasing competition, fall in steel prices, slowdown in the growth rate of consumption and an expansion of equity base to fund its expansion programme remain principal risks to our recommendation.

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