The consolidated March quarter results of Tata Steel Ltd were way below Street expectations, and the culprit, just like in the December quarter, was a poor show by Corus.
The European company’s operations were severely impacted in the second half of the year due to a surge in Chinese steel imports to the region. Acquired by Tata Steel in April 2007, Corus accounts for 72.5% of the firm’s consolidated revenues. Chinese imports rose to 55 million tonnes (mt) last year, from 33mt in 2006 and nil in 2005. This led to an excess supply situation in the European market, due to which Corus has had to correct its inventory position.
STEELY SHOW (Graphic)
This had impacted performance in the December quarter severely, when operating profit margin of Tata Steel’s overseas subsidiaries had fallen to 6.9%, from 9.8% in the September quarter and 11.8% in the June quarter. Corus accounts for about 88% of the overseas subsidiaries’ total profit, and hence almost single-handedly determines the performance of Tata Steel’s overseas operations.
The March quarter results don’t provide any respite— the operating profit margin of overseas subsidiaries has dropped marginally to 6.7%, despite price increases and a respite in Chinese imports from the early part of this year. But some analysts feel that some of the impact of excess stocks was expected to spill over to the March quarter. Even then, the reported profit is lower than estimates. Its earnings per share looks impressive at Rs177.2, but note that more than one-third of that came from exceptional gains related to a reduced liability on employee benefit schemes owing to rising bond yields.
Core operations could well be under strain this year. Corus’ chief executive Phillipe Varin says that he expects demand in Europe to grow by around 1-2%. The construction sector in Europe has witnessed a slowdown, while there continues to be demand from the consumer sector. Meanwhile, raw material costs continue to pose major problems. Last year, although Corus raised prices a number of times, it was barely able to cover the increase in costs. Much of the increase in profit last year came from an increase in volumes. If volumes remain muted this year, profit growth may come under pressure. But Varin points out that he expects a profit increase of $600 million (Rs2,562 crore) this year, which essentially implies a growth of about 30%.
One factor that may work in the company’s favour is that Chinese imports came off a bit from early this year. Another is that price increases so far this fiscal have been robust—the price of hot-rolled coils would have increased by nearly 50% when the company takes a second price increase on 1 July.
Tata Steel’s Indian operations have reported good numbers, with operating margin continuing to hover around 42%. Since the company has nearly full raw material security for its domestic operations, higher commodity prices are hardly affecting it.
Last year, however, higher prices paid for imported coal did erode profitability by a bit. Going forward, much depends on the company’s ability to tie up long-term raw material resources at reasonable costs for its global operations.
Equally important is its ability to pass through all the increase in costs in the interim. Corus’ price increases so far this year hold the promise that this should largely happen— hence the outperformance of the stock since late March. Future direction of the stock, too, would depend on moves in this regard.
Fed’s decision and commodity prices
The US Federal Reserve’s decision to keep rates on hold is being widely seen as an admission that it’s unsure of which direction monetary policy should take.
The US central bank faces a big dilemma—if it cuts rates, it stokes inflation; if it hikes them, the economy, already weak, will go into a tailspin; and if it holds rates, rate hikes by other central banks such as the European Central Bank will weaken the dollar, which could lead to higher commodity prices and more inflation.
In fact, the immediate reaction?to?the?Fed’s?decision to hold rates has been a strengthening of the Asian currencies and a knee-jerk rise in prices of commodities such as copper. In other words, Ben Bernanke’s attempt to talk the dollar up is unlikely to work.
But, while the Fed has kept its policy rate unchanged, the Reserve Bank of India (RBI) has raised its rate. Shouldn’t this widening differential between Indian and US policy rates strengthen the rupee?
“It would, in normal times,” says A. Prasanna, economist with ICICI Securities Ltd. “But these are not normal times. The perception of India has changed adversely because of the impact of high oil prices on the fiscal and current account deficits and the changes in the interest rate are unlikely to matter for the rupee.”
He adds that the only reason why the rupee hasn’t depreciated further is because of the central bank’s support, a point buttressed by the fact that RBI’s foreign exchange reserves came down by $5 billion (Rs21,350 crore today) in the week to 13 June. In short, the single most important focus for the Indian economy now is high oil prices.
And now that the Fed has not tightened the rates and the dollar has weakened, that could lead to higher crude prices, which will certainly not help matters.
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