Warren Buffet in his visit to India had spoken about the investment opportunities available in the metals space. With the spike in commodity prices over the past ten years, coupled with the rapid growth of India and China, Buffet was interested in dominant metal players with strong pricing power and subsequently, he invested $1 bn in POSCO, the South Korean steel giant. This recommendation is written partly as a result of the awe I have over Buffet and the inherent simplicity of the argument in favour of large integrated metal players holding captive ore reserves which act as a hedge from volatile fluctuations in commodity prices.
Tata Steel has fallen from a high of Rs 700 two years ago to the current price of Rs 300 (expected to fall further with the recent easing in Chinese growth numbers), reason for this being the perception that the European debt crisis would worsen the operating performance of Corus, a subsidiary of Tata Steel acquired for $ 12 bn during 2007-08.
Tata Steel India Tata Steel Europe Tata Steel Group
Total Income(2011-12) 37,000 82,000 137,000
PAT(2011-12) 6,700 (4,200) 5,000
Cap Utilization(2011-12) 105% 78%
Source: Tata Steel Annual Report 2011-12
All number in Rs Crs
As seen above, Tata Steel`s Indian operations are the key to its global ambitions. Corus with an annual steelmaking capacity of 18 mtpa (million tons per annum) has plants in UK and the Netherlands. The Netherlands facility with a capacity of 7.4 mtpa [4] (million tones per annum) is said to be one of the most efficient steel plants in the world[5]. The price paid for Corus has led many to believe that Tata Steel paid dearly to acquire an ailing, high cost, loss making company.
Why Corus
First, the global steel industry is facing a consolidation phase which began with the acquisition of Arcelor by Mittal Steels. The combined entity of Arcelor-Mittal has an annual capacity of 90 mtpa [7] or around 6% of the world`s total annual capacity[7]. China leads the world with a capacity of around 750 mtpa[8]. The steel market in China is so fragmented that it has close to 800 steel producers[9], 125 of whom are integrated[9] steel makers (steel makers with captive mines). For steelmakers to survive and continue having an element of pricing power, the industry needs to consolidate. Tata Steel`s acquisition of Corus took it from 65th [10] to nearly the 8th largest steel producer.
Second, the acquisition allowed Tata Steel, a low cost producer of basic steel to merge with Corus, which produces higher value added products and is a process technology owner.
The third and the most important reason for the acquisition is the history behind Corus. Corus was formed by the merger between British Steel Ltd and Hoogovens, a steelmaker based in Netherlands. Two top quality, efficient steel makers had been merged, with the result being a loss making behemoth on the brink of collapse(call it mismanagement). Moreover, Corus was handicapped by the fact that it did not hold any captive mines and was dependant on the highly volatile steel scrap market for its raw material. By 2005, the company had realized that a merger with a low cost steel producer which had access to captive mines was the only way to prevent bankruptcy. Subsequently, a bidding war erupted in 2006 over the control of Corus which included the Brazilian steelmaker CSN, Tata Steel and 2 Russian steel makers: Severstal and Evraz.
Tata Steel India
Coming to the Indian operations, Tata Steel India`s stunning profit margins are not simply the result of good management, goodwill and other most commonly assumed parameters. Rather, it is due to the low cost and high quality of iron ore that Tata has access to. At $ 150/ton of steel, Tata Steel`s cost of production is far lower compared to the $ 330/ton of other Indian steelmakers [11]. It is estimated that in India, iron ore bought in the spot market can be 5-15 times more expensive than captive ore[13]. Nearly 100% of Tata Steel`s iron ore requirement and 60% of its coal requirements[12] are sourced from captive mines (Indian operations). Such a level of vertical integration is impossible without Tata Steel`s vast history and heritage. Although it may not be possible for Tata to remake the Indian magic outside the country, we can be rest assured that the group`s vast footprint will enable it to secure mines and raw material sources in other parts of the world. Tata Steel`s ability to completely integrate its upstream and downstream operations are an important part of its strategy to revive Corus.
De-Leveraging
Tata Steel`s current debt of Rs 50,000 Crs[14](nearly Rs 60,000 Crs, 1.5 years back)will concern any investor. Tata Steel itself seems concerned and has begun to aggressively disinvest, restructure and infuse equity to bring down leverage.
1) Began with the sale of a Corus plant in Teeside for Rs 2500 Crs[15].
2) The bigger stake sale in Riversdale mining company for Rs 5000 Crs[16].
3) Hybrid perpetual securities (quasi equity/debt) worth Rs 2,250 Crs (11.7% interest) issued in the last couple of years.
4) 5.7 Cr shares allotted via Follow on public offer (FPO) at a price of Rs 610/share infusing Rs 3500 Crs of equity in Jan 2011.
5) 2.7 Crs shares allotted in 2010 and 2012 to Tata Sons Ltd on preferential basis on conversion of warrants at a price of Rs
594/share infusing Rs 1600 Crs of equity.
The cost of buying out Tata Steel works out to Rs 80,000 Crs (market cap of Rs 30,000 Crs and debt of Rs 50,000 Crs). Setting up a new global steel producer from scratch will take 5-6 years and entail a cost of Rs 55,000/ton[17]. With an annual capacity of 27 million tons(after commencement of 2.9 mtps Jamshedpur expansion expected in 2012-13), setting up something similar to Tata Steel will require a capex of Rs 150,000 Crs, leave alone the effort it would take to acquire mines, develop the brand, distribution channel and other attributes that takes to become the world`s 6th biggest steel maker. Clearly, stock markets overlook the above fact.
The market has factored in all the negatives related to the Corus acquisition. This is the reason Tata Steel is trading at a historical low of Rs 300. In the present scenario, while the markets are worried about the downside, the contrarian investor sees a good buying opportunity. Of all the 4 steelmakers who had bid for Corus, Tata Steel is the best poised to be able to take this acquisition through. The Tata group is the UK`s biggest employer and is in a better position to deal with the workforce and the government in UK and Europe. The very survival of Corus depends on the Tatas and it is obvious that the Corus workforce and European governments understand this (read the socialist French government`s assistance to Arcelor Mittal). Tata Steel is in an excellent position to turnaround a sick Corus and emerge as one of the world`s largest steel makers.
Disclosure: I have a vested interested in seeing this stock go up. I have bought some at Rs 350. Economic data from China are showing signs of softening. You can be rest assured the Tata Steel script will hit new lows from here in the medium term. As the same happens, request you to continue piling up a very long position in Tata Steel
Snippets from TS Annual Report 2011-12
– Cash and cash equivalents shown as Rs 3945 Crs for Tata Steel standalone. This does not include Tata Steel`s stake in Tata Power and Motors worth Rs 4,600 Crs
– A contingent liability to buyback all of NTT Docomo`s stake in Tata Teleservices could setback Tata Steel by nearly Rs 1000 Crs (at CMP of Tata tele)
REFERENCES
1) domain.com: Tata-Corus: Visionary deal or costly blunder?
3) http://www.tatanykshipping.com/tatasteelgroup.html
4) http://www.tatanykshipping.com/tatasteelgroup.html
5) domain.com: Corus acquisition will impact Chinese Steel market
7) http://www.arcelormittal.com/corporate/about.html
9) Did Tata Steel Overheat in Its Zeal to Win Corus?: India Knowledge@Wharton
(http://knowledge.wharton.upenn.edu/india/article.cfm?articleid=4158)
10) http://www.biztechreport.com/story/1459-indian-companies-acquisition-spree-overseas
11) Did Tata Steel Overheat in Its Zeal to Win Corus?: India Knowledge@Wharton
(http://knowledge.wharton.upenn.edu/india/article.cfm?articleid=4158)
13) http://businesstoday.intoday.in/story/tata-steels-raw-materials-need-lease-of-life/1/11903.html
14) Tata Steel Annual Report FY 2011-12
15) http://www.thehindubusinessline.com/companies/article1571479.ece
16) http://www.thehindubusinessline.com/companies/article2110379.ece?homepage=true
17) Did Tata Steel Overheat in Its Zeal to Win Corus?: India Knowledge@Wharton
(http://knowledge.wharton.upenn.edu/india/article.cfm?articleid=4158)
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