Wednesday, April 2, 2014

TATA Steel - Too much debt and relatively low efficiency

Over a 100 years old. Incredibly important to India's history. Flagship and value driver for the TATA group. Tremendous social contribution. Had the famous "hum ispat bhi banate hain" - "we also make steel" advertisement on TV. They are extremely ethical, systematic, and care for all stakeholders - suppliers, customers, employees and society. I can go on and on about this for hours. But lets see if after the 107 years of functioning this company deserves to be in the IGValue portfolio.

After the acquisition the company has been marred by debt. Efficiency overall is fairly low - they produce around 294 tons per employee per year whereas the global industry leader Nucor does 980 tons per employee per year and the industry average is 420 or so. And to top it all this is a number the annual report does not talk about - one has to derive it!

The India side of this company would have been a decently healthy company. There are plans to increase steel capacity in India by over 3x and the Indian per capita consumption of steel is only 60 Kgs/head/year compared to the global average of 215 Kgs/head/year.

1. How big is the moat?

Grade B moat

  • This company is a commodity producer and the only moat a commodity producer has is cost basis - the lowest cost producer survives.
  • Yes! It should come as a shocker. Before the acquisition of the Corus group their moat was massive. They were supposed to be the lowest cost producer of steel and their assets were extremely old and depreciated. The efficiency argument mentioned above was news to me as well.

2. Risks

  • Debt - The company is operating at over 4.5x debt to EBITDA (anything over 1x scares me). The only reason I believe this company will survive is because of the values, goodwill in society and the unbelievably great management capability of the TATA group. Anybody else and I would have said its headed for bankruptcy.
  • Low capacity utilization - Current utilization stands at 75% (Dec 2013). World steel consumption is unlikely to rise by more than 2% to 3% per year. The Indian steel consumption is also rising by a mere 0.5% per year. This further strengthens the point about the lowest cost producer surviving.

3. Financials

  • As expected Cash flow from operations is much higher than the net profits due to large depreciation and large interest component.
  • No ESOPs.
  • FX exposure seems to be well hedged and managed. The exposures are highly complex due to the global customer and manufacturing bases.
  • Inventories are high at an average of 19% of sales. Without the Corus assets the inventories are 14% of sales. 
  • Despite overall losses on a consolidated basis in FY2013 the company is still paying dividends which I find strange.
  • In FY2014 in the first 9 months the company has a PAT of 2.5 K Crores which is a healthy sign

4. Soft Factors

  • The biggest shareholder is TATA Sons at 29.75%. Total promoter group holding is 31.35%
    • 23% owned by insurance companies
    • FIIs hold 13.8%
    • Individuals hold 22.39% - this is expected as every retail investor seems to want to be invested in TATA Steel
  • This company is supposed to be the model for corporate governance
    • Transparency in the reporting is excellent
  • Director shareholding in the company is very low - not a good sign

5. Pricing

  • Given the very high financial leverage, efficiency concerns and the slow industry growth I would say this is not a value investment at this point. Given the strength of the TATA group and their stellar management capability I hope this company recovers not just for the investors but for society as well.
Note: A company of the size of TATA steel cannot be done justice to in a small note.


No comments:

Post a Comment