Lower realisations may outweigh cost improvements

Tata Steel’s Q1 FY23 results beat consensus estimates with a 4 per cent revenue beat and EBITDA margin coming in 300 basis points higher that estimates. But the current results captured only a portion of the different commodity costs at play. The full impact of lower steel prices is expected to play out later in the fiscal year leading to slower revenue growth.

Tata Steel stock price declined by 1.2 per cent on Tuesday although results were better than expectations as investors were focused on the outlook. The company reported 19 per cent y-o-y growth in revenues to ₹63,430 crore driven by higher realisations and an EBITDA margin of 23 per cent (29.8 per cent in Q1 FY22) as higher input costs continue. For now, the consolidated revenue growth witnessed its first decline post Covid, at 9 per cent q-o-q. Sequential volume decline of 11 per cent in Europe and 22 per cent in Indian operations were witnessed. At the top line, this was partially offset by higher steel prices which grew by 10 per cent sequentially in both the regions.

Segment performance

Tata Steel’s standalone operations reported average realisation of ₹82,300 per tonne in Q1 even as the spot prices for hot rolled coil domestically may have declined to around ₹60,000 per tonne at the end of the quarter. The domestic spot price decline, triggered by imposition of export duty, was felt only mid-way through the quarter. Even as Tata Steel manages better realisations through its product mix, the full impact of lower steel prices should be reflected Q2 onwards. The management reiterated that customer stocking may run out domestically, leading to improved volume growth in the next 1-2 quarters and offsetting lower prices to an extent.

European operations continued to gain on higher realisations now at ₹121,000 per tonne which is a growth of 10 per cent q-o-q and 45 per cent y-o-y. The high input prices, carbon credit costs in manufacturing, and the Russia-Ukraine disruption in supplies are holding up the steel prices in Europe.

The high input costs continue to impact margins, but Tata Steel witnessed a marginal improvement sequentially. The consolidated gross margin improved to 63 per cent in Q1 from 60 per cent in previous quarter but was well below the 69 per cent reported in Q1 FY22. The sequential improvement was because of European operations which improved gross margins on the back of higher realisations. The domestic operations continue to operate in tight margin conditions with gross margins having slumped from 79 per cent in Q1 FY22 to around 60.2 per cent in the last two quarters. The coking coal import prices are expected to decline from their peaks, along with lower gas costs in central Europe in the remainder of the year. This is expected to gradually flow through the P&L in the next few quarters as raw material contracts are renewed. This is expected to mark Q1 FY23 as the bottom of rising energy costs which have already tripled from last year. The EBITDA margins have stayed flat sequentially but at the lower range of 22 per cent in Q1 FY23 compared to 30 per cent in Q1 FY22.

Outlook

Average steel price for Tata Steel should reflect lower spot prices domestically. In Europe, lower energy costs following normalisation in energy supplies as market adapts to the ongoing conflict, should normalise the high realisations. The volumes uptake should improve following the weak current quarter as steel prices normalise and customer stocking runs out. As China reopens gradually post regional Covid lockdown, it is expected to improve global demand. At the same time, higher input prices (lack of access to Australian coking coal) will restrict supply in China and which should keep the prices firm.

Thus with many moving parts influencing FY23 expectations, overall lower realisation should most likely outweigh cost improvements and volume growth from Q2 FY23 onwards. The lower operating leverage from declining realisations should impact both domestic and consolidated results as well. Tata Steel is trading at 5.3X one year forward earnings which is a 46 per cent discount to last five-year average.

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