Jitendra Kumar Gupta Moneycontrol Research
The pressing need to resolve stressed assets in the steel industry has opened up an opportunity for bigger players with balance sheet strength.
Tata Steel, which recently concluded the acquisition of Bhushan Steel, is acquiring Usha Martin’s steel assets. While it is a relatively smaller-sized buy -- one million tonne capacity compared to 5 million tonnes in the case of Bhushan Steel, it could be value accretive given the valuation and synergies that Tata Steel will enjoy with this acquisition.
Moreover, given the size of the acquisition, its impact on the financial leverage of Tata Steel would be negligible. Rather we would await the result of the ongoing acquisition process of Bhushan Power, which if acquired would have a much larger impact on financial leverage of Tata Steel.
Synergies of the deal
Usha Martin’s steel assets which are valued at around Rs 4,300-4,700 crore has an integrated operation with the rolling mills and captive iron ore mines.
Usha Martin’s problems started with its expansion and diversification, which led to pressure on the balance sheet as cash flow from these new businesses was not enough to service its debt.
While the overall industry slowdown was responsible, it also impacted its core profit-making steel business which enjoyed unique advantages such as the manufacturing of value-added products.
Interestingly, Usha Martin’s steel division earned earnings before interest, depreciation, tax and amortisation (EBITDA) of Rs 5,500 per tonne in FY18, far lower than the EBITDA commanded by peers in the region of about Rs 10,000-11,000 a tonne.
During the peak of the cycle, these assets reported EBITDA of about Rs 500 crore against a current run rate of about Rs 340 crore. Thus, it is quite obvious that with the acquisition, Tata Steel would use its brand (Tata Tiscon in long products) and drive other operating efficiencies possibly through higher capacity utilisation, at about 71 percent currently, to increase profitability.
An attractive asset
Even at 90 percent capacity utilisation and assuming a 50 percent improvement in current EBITDA per tonne to about Rs 8,250 per tonne over the next two years, it can potentially generate operating profits of about Rs 740 crore. Based on the potential operating profits, valuations work out to about 5.8-6.3 times on the basis of enterprise value to operating profits, which is quite reasonable. Pre-tax return on capital works out to close to 16-17 percent on a constant basis. Moreover, valuation should also be looked at from the fact that these are operational assets. Creating similar assets would have definitely cost more today and could possibly take 3-4 years to build.
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