The December quarter consolidated results of Tata Steel Ltd has beaten market expectations by a wide margin. Analysts polled by Bloomberg had estimated a median loss of Rs470 crore. Instead, the company reported a profit of Rs814 crore. Not surprisingly, the Tata Steel stock rose 6% after the results were announced on Friday. There is near consensus among fund managers that Tata Steel is a stock to avoid at current levels of about Rs170, and a large number of short positions have been built on the anticipation of weak results and because of concerns about the company’s high leverage. The unexpected profit may lead investors to cover these short positions and cause the company’s shares to rise.
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According to Tata Steel, the better-than-expected performance is largely a result of the cost efficiencies it had managed to derive at Corus Group Plc. But some analysts differ. They point out that the firm’s European business has also profited from forex hedges and sales contracts it had entered into at higher prices in preceding quarters.
Unexpected performance: Tata Steel’s Jamshedpur facility. The firm reported a profit of Rs814 crore for the December quarter.
Because Corus operates in different geographies, it hedges its foreign currency exposures. Last quarter’s operational results include gains on these hedges. Besides, it is interesting to note that Corus’ sales realization stood at a high $1,250 (Rs63,375) per tonne last quarter, compared with $1,137 per tonne in the preceding two quarters. This at a time when steel prices nosedived across the world. The only possible explanation is that at least some of the deliveries of 4.3 million tonnes last quarter were under medium- or long-term contracts, the prices of which were determined before steel prices plunged.
The company did well to report an operating margin of 7 percentage points despite an inventory write-down of Rs1,700 crore, thanks to cost savings. Still, last quarter’s performance is not sustainable. Realizations will be much lower and aligned with the current market price of around $650 per tonne. Meanwhile, the operating environment for Corus continues to be challenging, with volumes expected to be 40% lower on a year-on-year basis in the first two quarters of the current calendar year. In the December quarter, its volumes fell by 23%. Lower utilization brings forth the challenge of higher fixed costs for every tonne of production, but the management is confident of extracting savings even in this environment. Thanks to the downturn, Corus has been able to shed some of its flab both in terms of employees and non-core assets.
Thankfully for the company, its Indian operations are doing well. Volumes are expected to grow 50% in the March quarter, compared with the December quarter, thanks to the commissioning of a new plant. While realizations have fallen even in the domestic market, Tata Steel’s costs are low because of captive resources and the higher volumes will result in higher cash flows. Another positive for the company is that no large debt repayments are due in the next two years.
But there’s little doubt that the next couple of years of operations will be tough for the company, and this is the reason the company’s shares trade at a large discount to its book value of about Rs300 per share.
Graphics by Paras Jain / Mint
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