Tata Steel Q4 profitability soars but risks emerge from weak raw material prices
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Tata Steel Ltd’s March quarter performance will send investor expectations high, what with consolidated Ebitda (earnings before interest, tax, depreciation and amortization) rising by 91.4% sequentially and by 3.2 times over a year ago. While its performance was better than the Street’s expectations, a change in market circumstances poses a risk that should not be ignored.
Higher output was one reason for better performance, as operating leverage improved (costs don’t increase in the same proportion as sales), but higher steel prices were also an important reason. Steel realizations, on an average, rose by 8% sequentially along with higher volumes, contributing to revenue rising by 21.6% sequentially. Global steel prices have been increasing on the back of an improving economic outlook, and due to rising iron ore and coking coal prices. Since raw materials account for 35% of sales, even a sharp sequential increase of 33% in raw material costs and 21% from a year ago did not eat into margins.
Another highlight was that all regions did well. India has always been a strong performer but even Europe delivered this quarter, with deliveries increasing sequentially and Ebitda/tonne doubling (see chart above). Rising prices and the restructuring of its UK business appear to be working for Tata Steel.
Now, the company reported a loss of Rs1,168 crore but this was mainly due to charges related to the closure of its British Steel Pension Scheme and a few other exceptional items such as the restructuring of its UK operations. If one excludes that, its profit was Rs3,352 crore against Rs301 crore in the December quarter.
There are some developing risks that investors need to keep an eye on. Domestic steel demand is still a cause for some concern, apart from the automotive segment, which is doing well. In April, India’s steel consumption was up by only 3.4% but production was up by 8.7%; exports rose by 142% to ensure the market remained balanced.
That makes companies such as Tata Steel reliant on exports for their surplus output. A weak rupee is one risk. The dollar-rupee exchange rate is Rs64, 5% lower than in early-January, meaning steel firms will earn that much less for every dollar of exports. A bigger worry is a fall in the price of inputs. China’s imported iron ore price (Qingdao port) is at $61/tonne, down from a high of $94.9 in the March quarter. Coking coal prices have been falling recently too. Typically, if these raw materials settle at lower levels, global steel prices come under pressure.
Now, the government may be able to support domestic prices to an extent but there is no such support in the international market. That is a risk both for exports from India and for its European business. While Tata Steel’s volumes may still increase, a fall in steel prices can damage its margins and that is the main risk to watch out for. The share has been trading lower compared to its April-levels, perhaps reflecting this concern.