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S. Muralidhar

Tata Steel plant at Jamshedpur. High steel prices and cost-cutting boost profits.

SHAREHOLDERS of Tata Steel can hold on to the stock at the current Rs 328 level. At this price, the stock is trading at a price-earnings multiple of less than seven times. It is expected to follow the broad market trend and is unlikely to break away until the new government's policies and steel industry prospects become clear.

The company's growth story of last year and the proposed bonus issue seem to have been factored into the stock's price. Investors with a long-term perspective may consider adding the stock to their portfolio.

Spectacular performance: For Tata Steel 2003-04 was an extraordinary year and even within the steel industry the company was uniquely positioned to pull off the good performance that it did due to its access to raw materials, its ability to constantly benchmark itself against the lowest cost steel manufacturers globally, and its reach, which enables it penetrate new markets abroad.

These are the main reasons, in addition to buoyant steel prices last year, which boosted the company's post-tax profits 70 per cent, despite a mere 1.37 per cent increase in sales volumes.

Factors that aided the company's attempts at reducing costs include the reduction of raw material consumption per tonne of saleable steel from 3.2 tonnes in 2002-03 to 2.8 tonnes in 2003-04. This came down progressively from 3.7 tonnes in 2000-01. Labour productivity also improved from 245 tonnes of crude steel per man-year to about 260 for 2003-04. Tata Steel's operating profit margin went up from about 26.4 per cent the previous year to about 34.8 per cent in 2003-04. An enviable profitability number for a company operating in the core manufacturing sector and deeply impacted by the vagaries of the commodities business cycle.

A number of factors contributed to this, including a better product mix, increased sales of branded products and, of course, the higher prevailing prices of steel. Branded steel products as a proportion of total sales in 2003-04 are about 27 per cent, more than double that of the previous year.

Challenges during 2004-05: The least of the challenges Tata Steel will face during 2004-05 will be the partial loss of its competitive advantage from the ownership of mines that have been the source of its assured supply of such key raw materials as coal and iron ore. At a time such as the last quarter of 2003-04, when input prices were at a high, this was a key factor in determining its edge over other steel-makers in India.

The bigger tests that Tata Steel will have to faceto sustain the current rate of growth is the rise in cost of other inputs such as limestone, sponge iron, pig iron, coal, freight (potentially, even in fuel costs), ferro alloys and higher energy costs.

Further, volatility in prices of steel is expected to be high during the coming year, particularly as there is the likelihood of a fluctuation in the demand situation, with the projected slowdown in China's consumption.

But the point to note is that China's decision to slow down its overheating economy is expected to lead to a reduction in import of long products, as the infrastructure and construction sectors will be the first to feel the impact of the new policy. However, the demand for flat products, fed largely by the booming automotive and consumer durables sectors in China will continue to be met by imports from countries like India.

Another challenge that Tata Steel could face this fiscal is the handling of a phased shutdown of its plants, which may be necessary due to the company's plans to step up capacity. Managing these shutdowns without allowing them to disrupt supplies to the market will be a key to meeting Tata Steel's plans to achieve a near three per cent increase in steel sales during 2004-05.

Competitive measures: Tata Steel has been taking steps to handle some of these challenges.

They include the joint venture in Thailand for procuring assured supplies of limestone at low cost, the increased focus on branded products, and the high value-add products for original equipment manufacturers in the automotive and consumer durables sectors and plans to explore new export markets.

In line with these plans, the company's product mix is also likely to become `richer' with a higher 26 per cent and 31 per cent share for cold-rolled steel and longs respectively, compared to last year's 23 per cent and 26 per cent share.

As a result, the share of hot-rolled steel in the product mix will go down from 36 per cent in 2003-04 to about 30 per cent in 2004-05. The company's strategy to enter into relationships with customers will also enable it to get long-term contracts for steel supplies that will be hedged against price volatility.

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