Tata Steel Ltd’s profits before tax and exceptional items for the March quarter were up 48%, although the volume of steel sold was higher by a mere 0.4%. Revenues for the steel business increased 22.8%. Those numbers sum up the story: Higher steel prices have boosted profits.
The stock has moved up sharply in the last couple of months, shaking off concerns about equity dilution as a result of the Corus acquisition. After the initial dismay at the extent of the dilution, investors were relieved it would be staggered over three years and they veered round to the view that everything would be fine for Tata Steel, provided steel prices remained firm.
So far, the optimists have been right. Tata Steel has increased prices by 7-8% in May. The management says it expects prices to remain high in the second half of the year in most markets. But about a month ago, at the time of unveiling Corus’ 2006 results, Philippe Varin, the Corus CEO, said: “Looking ahead, the market outlook for 2007 is positive.” But he immediately qualified that by pointing out, “…it is not yet clear whether this improving trend will continue through the second half of the year.”
The concern is the usual one, of higher Chinese exports. Those who believe that prices may decline say China’s steel output is up 21% in the first four months of 2007 and that additional capacity is expected to come on stream this year. The opposite camp cites the Chinese government’s decision to introduce a licensing policy for exports as evidence that it wants to discourage them. The long-awaited global slowdown and rupee appreciation will also have a bearing on prices.
The management says that there has been a steep rise in freight rates, especially in the past two months, although that cost has been offset to some extent by lower coal prices. Operating margins were about 200 basis points lower than in the December quarter. But taking Tata Steel’s price hike in May and Corus’ 5-10% price increase in April, the current quarter should be good for both Tata Steel and Corus.
In addition to acquiring Whyte & Mackay, Vijay Mallya also seems to have acquired a magic charm against the winner’s curse. While companies that have made big acquisitions have seen their stocks plummet as investors fret about whether the deal will hurt earnings, the United Spirits stock has soared. And why not? The enterprise valuation of £595 million (Rs4,819.5 crore) turned out not only lower than expected but below the valuations paid for comparable Scotch whisky asset deals. It will add to earnings within a year of acquisition. It gives United Spirits access to premium Scotch brands and an inventory valued at £380 million.
Analysts point out that Whyte & Mackay has tied up with large Scotch players for selling a part of its bulk Scotch, which will ensure stability in earnings for the next few years. It will be United Spirits a weapon to battle the likes of Diageo, which had 25% volume growth in India in the six months to December 2006. The company will be able to combine its newly acquired Scotch assets with its distribution network to tap the rapidly growing premium scotch market in India.
With Scotch demand growing by 10% worldwide and over 20% in emerging markets, and with supply limited and bulk Scotch prices up 80-120% since August last year, the market is convinced that this is an acquisition with a difference.