There may be more to Tata Steel’s bumper profit than meets the eye

Tata Steel shares have done well in the past year is because of prospects of cutting losses in Europe through M&A deals, such as the one with Thyssenkrupp


Tata Steel’s fortunes have changed dramatically in the past year. Graphic: Subrata Jana/Mint
Tata Steel’s fortunes have changed dramatically in the past year. Graphic: Subrata Jana/Mint

Tata Steel Ltd’s shares have doubled in value in the past year, thanks to an improvement in market conditions and prospects of a cut in exposure to the loss-making European business.

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The company’s December quarter results may cause some more cheer among investors. Reported operating profit was far higher than Street expectations, thanks largely to an unusual jump in the profits of its India business.

Earnings before interest, tax, depreciation and amortization of the India business rose by as much as 70% quarter-on-quarter to Rs3,393 crore, thanks to both better volumes and realizations. But as pointed out in this column last month, the jump in sales last quarter could well be due to one-off factors, and the performance may not sustain going forward.

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According to analysts, sales in the December quarter were aided by advance purchases ahead of an expected price hike in January, as well as some dealers stocking up using demonetized currency. If underlying steel demand hasn’t improved as much, the increase in inventory levels may well hurt going forward. As such, it makes sense to wait and watch for signs of improvement in underlying demand before jumping to conclusions just based on last quarter’s results.

The European operations reported a sharp decline in profit as expected, thanks to higher raw material and energy costs as well as due to a planned yearly maintenance stop. In the near term, the profitability of the business depends on how prices of coking coal move.

More importantly, though, investors will be keen to see a lasting solution to the European problem through an M&A (mergers and acquisitions) deal, such as the one being discussed with ThyssenKrupp AG. The latter has said that Tata Steel must fix its pension deficits before merger talks can be taken forward. If the deal doesn’t materialize, investors will be clearly disappointed. After all, one of the reasons the company’s shares have done well in the past year is because of prospects of cutting losses in Europe through M&A deals.

The silver lining, of course, is that price realizations have improved, and the Indian business has been doing far better than it has done in years.

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