Tata Sponge Q3 Review: Cost pressures hurt earning; Usha Martin integration key factor to watch

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Jitendra Kumar GuptaMoneycontrol Research

Tata Sponge’s stock tumbled over 5 percent to Rs 774 a share on January 14 after the company reported a drop in profits both on the quarter-on-quarter (QoQ) as well as on year-on-year (YoY) over the weekend. Tata Sponge, which is operating at over 115 percent capacity utilisation is striving for volume growth. And now, it faces twin pressures of falling steel prices and higher raw material costs on its profitability.

Q3FY19 analysis: Key positives

During the quarter ended December 2018, it reported 22 percent growth in sales to Rs 261 crore, largely a reflection of higher sponge iron prices YoY. During the quarter, sponge iron was trading at about Rs 22,000 a tonne as against Rs 19,000-20,000 a tonne in the quarter ending December 2017. That apart, a marginal benefit might have also kicked in because of the debottlenecking of the existing capacity to increase volumes.

Key negatives

Despite strong growth in sales and better utilisation, it was surprising to see pressure on profitability. During the quarter, the company reported 37 percent YoY decline in operating profits (EBITDA) to Rs 30.4 crore. Moreover, margins dropped by a whopping 1080 basis points to 11.6 percent.

Falling profitability is a result of higher iron ore and coal prices. During the quarter, the cost of material consumed jumped 47 percent to Rs 192 crore. The benchmark NMDC iron ore lumps (6-40 mm) were priced at around Rs 4,200-4,500 a tonne in December quarter 2017, which rose to around Rs 5,000-5,500 a tonne in December 2018 quarter.

Notably, net profit was down 25.6 percent to Rs 27 crore due to costs despite lower interest and depreciation.

Other observations

The other notable development was the reshuffling of the board in the light of impending integration of recently-acquired company Usha Martin. Tata Sponge’s Chairman AM Mishra will be now replaced by TV Narendran, who has rich experience, currently working as global CEO and MD of Tata Steel.

Outlook

Sponge iron prices have fallen in the recent months and further pressure is building up because of soft international steel prices led by lower demand in China and few other markets. While raw material prices are also taking note of the same, the correction in final product prices is faster than raw materials, thereby putting pressure on earnings.

While the recent correction in its share price reflects some of these concerns and the stock is currently trading at an optically reasonable valuation of 9-10 times its annualised earnings, we would still avoid the stock, till concerns on commodity prices fully play out.

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