Jitendra Kumar GuptaMoneycontrol Research
European operations, which have been at the heart of Tata Steel's major problems, are now entering a more interesting phase wherein investors can hope for better profitability and reduced balance sheet risks.
Yesterday, Tata Steel announced its decision to form an equal JV with thyssenkrupp (Thyssen). Apart from thyssen's European operations, comprising about 11 million tonnes, the JV will operate Tata Steel's European operation thereby creating a combined total steel production capacity of close to 21 million tonnes.
Both the companies hope to leverage their synergies. Tata Steel Europe, for instance, is considered to be having a good hold on industrial steel whereas Thyssen is strong in the OEM segment.
From Tata Steel's perspective, it’s a big relief as it will not only diversify its risk in Europe, the combined entity will also have greater strength in terms of balance sheet and profitability. "When two organisations merge they have common functions like HR, procurement, legal, finance and many others. We will integrate and drive synergy, which will bring down the overall costs," Koushik Chatterjee, Group Executive Director, Tata Steel said, while addressing analysts ‘conference call late evening on Wednesday.
How would it benefit Tata Steel?
European operations sell close to 10 million tonnes of steel annually, which is about 42 percent of the total group volumes of 24 million tonnes. While the company had a huge operation in Europe, most of it was making losses. In FY16 Europe made an operating loss per tonne (EBIDTA per tonne) of USD 12.8 and in FY17 it reported EBIDTA per tonne of USD 66. As against this, Tata Steel India made an EBIDTA per tonne of USD 180 a tonne almost three times the operating profit of European operation.
Thankfully, with efforts to restructure European operations the company was able to bring down losses. Over the last couple of years, Tata Steel has sold three facilities in Europe as against 5 it originally had. Since they were making losses, selling them has made the company profitable. The remaining two facilities, in the UK and Netherlands, will be now part of the JV.
The management indicated that because of the common functions and other overheads, the JV would enjoy cost synergies of close to euros 400-600 million. This translates to an EBIDTA per tonne of about USD 24-36, which is almost 50 percent of the EBIDTA per tonne reported in FY17. That apart, the management is also expecting a slight improvement in the credit rating of the combined entity which will save them about 50 basis points in interest costs and improve their ability to service debt as cash flow improves.
What is more important is that a part of the debt of Tata Steel and pension liabilities of thyssen will be now part of the JV, whose ability to service them will be far superior to the existing European operations of Tata Steel. The capital structure of the JV would be done in such a manner that it can operate sustainably and generate a lot more cash which can be distributed through dividends. Once the JV starts to operate successfully, it can look for a separate listing or some other means of creating value.
Meanwhile, Tata Steel can hope to save more energy and resources for the domestic market. "We are looking to double the India capacity because we think that this is the market to be in. We are open to the organic and inorganic route for the expansion of Indian operations. We are working with Tata Sons looking for various ways to participate in opportunities that come in India inorganically," said Koushik Chatterjee in the analyst call.
With a resolution of the European problem, investors should not rule out Tata’s participation in buying out stressed steel assets in India, thereby paving the way for greater consolidation in the sector.
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