Tata Steel finally acknowledges its mistake

Tata Steel Ltd’s $1.6 billion write-down of goodwill and assets has received mixed reactions from analysts and investors. Some say the company should have written off a larger amount, others say the write down is in line with expectations and still others maintain the amount was larger than expected.

add_main_imageThis isn’t surprising. An impairment review is far from being exact. There is a lot of subjectivity involved, with variables such as the estimated value of brands and future demand and supply dynamics. From a stock-valuation perspective, however, the actual amount written off is almost irrelevant.

On the one hand, the lower book value will result in a higher price-to-book ratio. On the other, it will cause return ratios to rise. Given the direct relationship between the return on equity (RoE) of a company and its price-book valuation, equity investors are neutral to amount written down. Prior to the write down, the stock had a price-to-book value of around 0.67 times and RoE of around 8%. After the impairment, the price to book value will rise to around 0.84 times, backed by an increase in RoE to over 10%. NextMAds

Besides, the deterioration of the European steel market, which forced the write down was already well known and had been factored into valuations. As the head of research at a multinational brokerage points out, the impairment can be seen as an acknowledgement of the mistake the company made six years ago when it acquired Corus Plc.

What’s more, while the company’s Indian business is doing far better than its European operations, local demand has been relatively sluggish. To add to this, the company is on an capital-investment drive, which will result in increased debt. As things stand, there are hardly any reason for investors to buy the stock. It’s little wonder the scrip has continued to languish near its lowest level since the financial crisis for nearly two months now.