In different circumstances, Tata Steel Ltd’s shareholders could have settled down for a smooth ride for the next few years. An improving outlook for its domestic business, healthy cash flows and the impending transfer of its European steel business to a joint venture all promise a leaner balance sheet and a more profitable Tata Steel.

It does have an expansion plan with an investment of Rs23,500 crore over four years, which it can fund with existing cash flows, a rights issue and some debt. But a number of distressed steel assets that are up for sale have caught its fancy. If it doesn’t bid, it may see its domestic or global rivals gobble them up and grow their share in the Indian market. While an improved outlook for steel has helped Tata Steel’s performance improve, unfortunately, it has also raised valuations for these distressed assets.

Tata Steel’s December quarter results were better than expected, with its revenue increasing by 3% sequentially while its Ebitda rose by 21%. The company saw its input costs decline, chiefly due to lower coking coal costs in India and improved coke consumption rates. This made up for a seasonally weak quarter in Europe. Tata Steel’s presentation showed India being chiefly responsible for the increase in Ebitda, since Europe reported a decline (see chart). A decline in interest costs and a relatively flat depreciation saw its profit before tax and before exceptional items increase by 47% sequentially.

What about the outlook? The global price outlook for steel remains steady, as China appears to be sticking to its commitment of cutting down on polluting steel capacity. That has lent support to prices by curbing supply and prices have also been helped by the increase in iron ore prices. The company expects India to remain a net exporter of steel, and steel prices to sustain. In Europe, demand is expected to improve but imports may continue to put pressure on prices.

Its results illustrate how important the domestic market remains for Tata Steel. In bidding for distressed assets, the objective must be to acquire at an attractive valuation and then turn it around through operational and financial restructuring. Initially, the risks will be of overpaying, of additional investments required and any hidden obstacles.

Tata Steel’s results confirm that its financials are looking healthier than ever. Investors will be hoping it knows what it is doing, by putting that at risk to snap up some of the distressed steel assets on offer. Investors will wait to see if it indeed is a successful bidder for any of the large assets, and the investment logic for the bid. It could put some pressure on valuations initially, as any such large acquisition will strain its performance and balance sheet. Eventually, the focus will shift back to a healthier domestic demand situation and whether China continues to keep steel production under check.