Stock Fundamentals

What makes Tata Steel a solid bet over the long term

Satya Sontanam | Updated on August 30, 2020

Smooth integration of acquisitions, and likely demand and price recovery place it on steady footing

The Indian steel industry, among other key sectors, has been significantly impacted by the Covid-induced slowdown and disruption in business activities.

But the worst may be behind for the sector, both in terms of demand and prices. For long-term investors with a high risk appetite and willing to bet on the demand revival over the next two to three years, the recent correction in stock prices offers a good opportunity.

Tata Steel, one of the largest producers of steel in India, looks well-positioned to benefit from the next run-up in the steel industry cycle. Focus on Indian operations, captive iron ore mines, rationalisation of capex plans, sufficient installed capacity and recent Bhushan Steel and Usha Martin acquisitions are likely to hold the company’s earnings in good stead over the long run.

The stock has recouped most of its losses since the steep correction in March. At the current market price, the stock trades at 20-40 per cent discount to peak levels witnessed during good steel cycles. This presents investors with a good opportunity to accumulate the stock gradually.

The outlook and prospects for the company hinges on how fast the demand revives, and a sustainable favourable pricing environment.

Industry outlook

Evolving from the stress in 2015-16, the steel industry performed well in 2018 just to witness another year of unfavourable market conditions in 2019. Just when the market conditions started to improve from the end of 2019 with the signing of phase one trade deal between the US and the China, the Covid-19 outbreak brought global economic activities to a near standstill with nationwide lockdowns and social-distancing norms.

As per the forecasts by the World Steel Association, the steel demand in 2020 will contract by 6.4 per cent y-o-y (against an increase of 3.4 per cent in 2019), dropping to 1,654 million tonnes (mt). It is much worse for India as the domestic steel demand is expected to fall by 18 per cent y-o-y in 2020.

But according to the WSA, it is possible that the impact on steel demand in relation to the expected contraction in GDP may be less severe than that seen during the 2008 global financial crisis.

While the demand from developed countries is not expected to improve any time soon, as per WSA, the developing economies, excluding China, are expected to see a substantial recovery of 9.2 per cent y-o-y in 2021 (against a fall of 11.6 per cent in 2020). In India, the demand recovery is expected to be much higher at 15 per cent in 2021.

Government initiatives such as ‘Make in India’ are expected to boost steel demand growth. In addition, the government’s focus on accelerating the rural economy and plans for building smart cities, affordable housing, dedicated freight and high-speed rail corridors are expected to create significant demand for steel in the long run. With per-capita steel consumption in India at much lower levels and the National Steel Policy’s objective of producing 300 mt by 2030, the metal’s demand is set to rise.

Tata Steel, with its domestic steel producing capacity at about 25 mt, is well-placed to benefit over the long run. The ramp-up of operations at Bhushan Steel, acquired in 2018, and the integration of the acquired steel business of Usha Martin are helping Tata Steel deliver improvements in operating performance, aiding profitability.

If the current crisis leads to consolidation in the capital-intrinsic industry, Tata Steel — an integrated steel player which is less dependent on the external market for its key raw material (iron ore) — is likely to benefit.

Focus on profitable business

Tata Steel’s attempts to reshape the company by focussing exclusively on the Indian operations by divesting non-core overseas businesses — that are in deep stress — has not fructified.

The definitive agreement entered by Tata Steel with thyssenkrupp to hive off most of the European operations and the company’s plans to sell stake in South-East Asian operations to Chinese HBIS have not seen the light of the day. However, in case of Europe, the company seems to have been taking actions to not extend any monetary support from Indian operations. The South-East Asian operations are already considered as ‘assets held for sale’.

During the lockdown period, the Indian business operated at around 50 per cent of its capacities in April 2020. Gradually, the capacity utilisations are ramping up and is likely to be almost 100 per cent in August 2020. The loss of business in the domestic market has been, to an extent, offset for now by increasing the share of export sales.

To withstand the current crisis, the company has been focussing on cash flow management to generate a free cash flow quarter and maintain the net debt at the March 2020 level (₹ 1,04,779 crore). Also, the company plans to lower its capital expenditure (capex).

This move is expected to stabilise the business in the volatile market. Further, given the gradual demand revival, the existing capacity seems sufficient in the short run. Escalation in trade tensions, headwinds to the economic revival and worsening of the pandemic are key risks.

Published on August 30, 2020

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