The Hindu Business Line : Tata Steel: Buy

TATA Steel's initiatives to move along the inorganic path for growth over the past few months have brightened the long-term prospects for the steel major. The biggest concern now is the steel prices, which have cooled off by about 25-30 per cent from their historic highs of last year. The prices are still higher than the long-term average and are expected to stabilise at close to these levels. With its long-held advantage of being a low-cost producer and its shift to owning operations spread in several geographies with different advantages, the company is poised for growth compared to other domestic players.

Investors may buy the stock with at least a three-year perspective. The stock trades at a price-to-earnings multiple of about 5.5 times its likely FY 06 earnings. Any weakness linked to the broad market can be used to accumulate the stock. The earnings growth in the near term is, however, likely to remain flat on the back of recent price-cuts announced by the company.

Currently, the global steel market is facing a glut-contributed largely by rising Chinese steel output. This scenario is, however, unlikely to continue for long. A number of Chinese steelmakers are planning plant shut downs over the next year or so, owing to shortage of raw materials. This, along with consolidation, which is likely to take shape over the next few years, could lead to price stability at higher levels over the long-term.

On the domestic front, a favourable demand-supply equation in the long term is likely to de-risk Tata Steel's revenues from exports. This means, even if there is a slowdown in global demand, the strong domestic demand on the back of sustained growth in infrastructure is likely to absorb the incremental output.

Tata Steel's market share, especially in the galvanised steel segment, has improved steadily over the past few years. Its ongoing efforts in steel retailing are a positive in this direction.

Tata Steel, of late, has been shifting its focus. It plans to make the primary metal in countries which are rich in raw materials, and undertake processing in locations which are growing markets. Its recent acquisitions, including that of NatSteel of Singapore in 2004, gel well with this strategy. Last week, it signed an agreement to acquire a 40 per cent stake in Millennium Steel of Thailand, for $73 million. The acquisition, apart from offering a strategic fit with its expansion plans, is likely to enhance its market position in South-East Asia.

The joint venture entered into with BlueScope Steel of Australia last month is another Tata Steel step aimed at strengthening its downstream operations. The joint venture proposes to offer a wide range of branded steel products for building and construction applications.

Tata Steel, which is sitting on a huge pile of cash, is comfortably placed to fund its growth through the inorganic route over the next year or two.

Thereafter, it may have to look for other means to fund its expansion plans. A relatively low level of gearing offers enough room for it to borrow.

The performance of its ferro-alloys division in the last two quarters has been disappointing. This is likely to continue in the medium term on the back of slack demand for stainless steel.

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