ArcelorMittal's acquisition of Essar Steel is a risk for domestic steel producers, as the global giant gets a ready asset in one of the largest and fastest growing markets for steel in the world
The biggest steel producer in the world, ArcelorMittal has acquired a prized Indian steel asset, giving it access to one of the largest and fastest growing markets for steel globally. Domestic steelmakers are likely look at this entrant warily. They have fat profit margins in the domestic market relative to what global steelmakers earn, and a hungry entrant could sacrifice some of that in the quest for market share and volume growth.
Essar Steel was indeed operationally among the top flat steel companies in India. But with a parent company possessing the financial muscle, scale and technological capabilities of ArcelorMittal, the balance shifts.
In 2018, ArcelorMittal notched up revenues of $76billion while Tata Steel’s annualised FY19 revenues amount to $23billion and JSW Steel $12billion. Of course, both Indian steel companies are giants in the domestic market, and also have steel operations overseas, the comparison is just to illustrate the difference in global scale. In volume terms, in 2017, ArcelorMittal’s steel output was 97million tonnes, compared to Tata Steel’s 25million tonnes and JSW’s 16.1million tonnes, according to the World Steel Association.
In this light, consider ArcelorMittal’s resolution plan for Essar Steel. It has set up a joint venture in which it owns 60% and global steel major Nippon Steel and Sumitomo Metal Corporation (third-largest in the world) will hold the rest. It has already tied up debt lines of $7billion (Rs49000crore), of which $1billion has been utilised to pay off debts of related parties for ArcelorMittal to become eligible to bid for Essar Steel.
These arrangements having been put in place should allow ArcelorMittal to fund the transaction, without losing much time.
ArcelorMittal is to pay Rs42000crore to Essar Steel’s lenders, and another Rs8000crore will be invested directly into Essar Steel, to support operations, improve output and profitability.
While Essar Steel’s nameplate capacity is close to 10million tonnes, its actual production is about 5million tonnes of flat steel. Flat steel is the more lucrative segment compared to long steel products. In flat stee, value-addition yields even better margins, if the company can supply to sectors such as automobiles and consumer durables.
As part of the resolution plan, ArcelorMittal will also invest Rs18697crore in two stages, spread over six years. In the first phase, it will take up finished steel output to 6.5million tonnes, by completing ongoing projects, invest in operations and quality, to increase share of value-added products, especially of automotive steel. In the second phase, it plans to increase production to 8.5million tonnes by the end of 2024. Longer term, it wants steel output to increase further to 12-15million tonnes.
Lastly, the JV will also attempt to buy out ancillary assets such as a slurry pipeline and port facilities that are linked to Essar Steel’s operations but not owned by it. That will secure all it needs to run the Essar Steel plant efficiently.
Immediately, the market situation may not change much, as Essar’s steel plant is a running plant and in FY18 it sold 80% of output in the domestic market. But this is a company that has been operating under several financial constraints. That will end after ArcelorMittal takes over. As the resolution plan is implemented, output will step up further. The fight will not be as much for overall market share, as it will be for a higher share of the market for value added products. The ArcelorMittal-Nippon combine could bring their global strengths and supplier relationships to play in the domestic market.This is the chief risk for Indian steelmakers for whom the domestic steel market is a cash cow. The profitability in the domestic market is several notches higher than the global market. In the December 2018 quarter, for example, ArcelorMittal had an Ebitda/tonne of $96/tonne (steel division: $79/tonne) while Tata Steel’s was $146/tonne. In the nine months ended December, JSW’s figure was $184/tonne. That shows the risk that domestic companies face, if ArcelorMittal decides to indulge in some price-driven competition to grab share, even as its investment plans will expand the capacity of Essar Steel. Life is about to get interesting for steel companies in India.