Tata Steel investment in UK steel capacity missed opportunity to cut exposure to high cost: Jefferies

Tata Steel share price touched a new 52-week high on Monday's trading session, following the announcement of a joint agreement between the company and the UK government

Tata Steel and the UK government have jointly announced a monumental agreement to invest £1.25 billion in electric arc furnace steelmaking at the Port Talbot site. Of this substantial project cost, Tata will commit 60 percent, or £750 million, while the UK government will provide 40 percent, equivalent to £500 million, in support. Pending the receipt of all necessary approvals, the project is expected to be commissioned in approximately 36 months.

Crucially, this agreement includes a grant from the UK Government of up to £500 million. The proposed project is poised to be a transformative step towards the decarbonization goals of the UK business, owing to the significantly lower carbon footprint associated with EAF-based plants compared to the existing blast furnace-based facility. Notably, the Port Talbot project is projected to reduce direct emissions by 50 million tonnes over a 10-year period. Furthermore, the undertaking will necessitate a comprehensive restructuring of Tata Steel's balance sheet, potentially leading to the elimination of current cash losses in the UK operations and non-cash impairment of legacy investments.

Tata has made it clear that it will engage in consultations with the unions regarding the proposed project, as it involves a potentially profound restructuring of the existing carbon-intensive steel-making facilities at Port Talbot, which could result in related cash outflows. The company aims to finalize the details and obtain necessary approvals over the next three months. Subsequently, it expects the new project to be commissioned over the following three years. Throughout this transitional period, Tata is committed to ensuring the uninterrupted supply of products to fulfill customer commitments, which may include the import of additional steel substrate to feed its downstream units.

Foreign brokerage firm Jefferies has issued a "Buy" rating on the stock with a target price of Rs 145. According to Jefferies, "Tata expects the new facility to yield £150-170 per tonne, equivalent to $185-210 per tonne, in higher spreads compared to the existing setup, thereby paving the way for decarbonization. On the flip side, the investment, in our view, represents a missed opportunity to reduce exposure to historically high-cost, low-margin geography."

Jefferies also highlighted, "The existing primary steel capacity at Port Talbot is nearing the end of its operational life, and a decision was imminent regarding whether to invest in a new plant or discontinue crude steel production at the facility." Furthermore, it emphasized that Tata's commitment of £750 million (approximately $930 million or Rs 6 per share) over an expected four-year period implies an annual cash outflow of around $230 million. Jefferies' current estimates indicate that Tata is positioned to generate free cash flow (post-interest payment) of $1.4-1.9 billion annually in FY25-26E. Despite the manageable overall cash outflow, Jefferies opined, "While the transition to a new EAF facility could enhance profitability and support decarbonization efforts, we view the decision to invest in UK-based steel-making as a missed opportunity to reduce exposure to historically high-cost, low-margin geography."

Tata Steel share price touched a new 52-week high on Monday's trading session, following the announcement of a joint agreement. Tata Steel stock price touched intraday high of Rs 134.85 and low of Rs 131.85. Tata Steel share price opened at Rs 134.75 apiece on BSE.

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