The Hindu Business Line : Tata Steel: Buy

Prices to stabilise at higher levels
Acquisitions to improve valuations
Higher volumes, a buffer against any price decline
Available at a PEM of 5.5times

MR B. MUTHURAMAN, MD.

Recovery in steel prices, improvement in operational parameters, favourable macro-economic outlook, likely pay-offs from international operations and attractive valuations make the Tata Steel stock a good investment candidate.

Investors with a long-term perspective can take measured exposure to the Tata Steel stock. At the current price of about Rs 460, it trades at a multiple of 5.5 times its likely 2006-07 earnings on a consolidated basis. We do not expect the stock to deliver manifold gains of the kind seen over the past couple of years. However, it could offer moderate returns that will be appropriate for a large-cap stock with considerable growth potential.

Prices to stay firm

Steel prices, after declining steadily in the second half of 2005, are showing signs of recovery. This is not just a technical bounce-back, but is well supported by fundamentals. The rising cost of raw materials (iron ore and zinc, in particular) is likely to ensure that prices of finished steel stay firm over the medium term.

Blast furnace at the company's Jamshedpur facility... Value-added products and retailing to pay off in the long run.

The threat of China continuing to remain a net exporter of finished steel now appears less. Its Government is taking steps to curtail production as domestic steel-makers are battling hard to protect their margins. One-third of the steel capacities in China have high-cost structures, making it difficult for them to compete with their low-cost global peers.

The Chinese National Steel Policy, with a focussed approach to consolidation, is also likely to ensure stability in prices in the medium/long-term.

Strong domestic market

The upswing in the construction sector and the rising level of infrastructure activity point towards increased buoyancy in the demand for steel products.

Even if there is a slowdown in global demand, players such as Tata Steel are better placed, as higher domestic demand is likely to ensure steady flow of revenues. The newly-added one-million-tonne per annum capacity at Jamshedpur is expected to bolster volume growth. Volumes in the steel division rose 12 per cent Year-on-Year in 2005-06 and were instrumental in the company recording a 4.5 per cent growth in revenues despite a marginal decline in average realisations.

Inorganic growth

Tata Steel's initiatives to move along the inorganic growth path over the past few quarters have brightened the long-term prospects for the steel major. After completing the acquisition of NatSteel of Singapore last year, Tata Steel is integrating the operations of Millennium Steel of Thailand in which it acquired a 67 per cent stake last December.

Both NatSteel and Millennium Steel operate at low margins; the operating margin for the former for 2005-06 was 6 per cent and for the latter it stood at about 9 per cent.

Tata Steel is now undertaking a 1.8-million tonnes per annum (mtpa) expansion at Jamshedpur, which is expected to be completed in another 18 months. On completion, billet requirements of its subsidiaries will be sourced through the same.

Scouting for aquisitions

This is likely to bring down the operating costs of its subsidiaries and, thereby, improve margins. Tata Steel has been scouting for acquisitions in South Africa. Any successful move by the company is likely to further strengthen its position and improve valuations.

That apart, Tata Steel has outlined aggressive plans to start greenfield projects in Orissa, Jharkhand, and Chhattisgarh besides Iran and Bangladesh.

However, issues such as allotment of mines, gas pricing and political developments are acting as roadblocks. With its long-held advantage of being a low-cost producer and its shift to owning operations in several countries with different advantages, Tata Steel is poised for growth compared to other domestic players.

Improvement in key operational parameters, along with a reducing dependence on imported coal, is likely to offer cost savings to the company.

The benefits of fresh coking coal contracts entered into by the company at lower rates (5-10 per cent lower from 2005-06 level) are likely to flow in the second half of 2006-07 when the inventory gets exhausted.

Value-added products

The company's increasing focus on value-added products and its efforts in steel retailing are strong positives. The higher share of value-added products is likely to maintain average realisation at a fairly high level as has happened in the past.

In the recent cool-off in steel prices, the post-decline average realisations for flat products was 20 per cent better for Tata Steel vis-a-vis its global peers.

It is this strength that places Tata Steel in a better position to weather any cyclical downturn than other domestic players.

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