Ravi Ananthanarayanan
Tata Steel's profitability will improve after the sale of a majority stake in its South East Asian steel business, an underperformer in its portfolio.
In FY18, the SE Asia region contributed to 7.2% of consolidated sales but its contribution to Ebitda was only 2%. The division has been facing a tough time, partly due to competition from cheap Chinese imports. Its performance had improved consequent to restructuring but it still pulls down overall performance.
Compared to Tata Steel's consolidated Ebitda/tonne of Rs 10,231 in FY18, the SE Asia division managed to deliver only a seventeenth of that, at Rs 1740/tonne. It remained at nearly the same level in the September quarter, falling by 17% over a year ago.
Notionally, if this division had not been around in the September quarter, Tata Steel's Ebitda margin would have increased by 1.2 percentage points over a year ago to 21.9%.
Surprisingly, Tata Steel has not sold its entire stake. Instead, it will sell a 70% stake in the SE Asia subsidiaries to HBIS of China. The buyer's identity confirms that the Chinese still find this market to be financially viable, perhaps because of their proximity to the market.
Tata Steel will get $327 million (Rs 2,321 crore) for a 70 percent stake, which values the business at Rs 3,315 crore. Also, Rs 960 crore in loans sitting in the two SE Asia subsidiaries should also move out of its consolidated balance-sheet.
The valuation seems fair to Tata Steel. The SE Asia business’s has been valued at an enterprise value/Ebitda of 7.6times and 0.3times its sales, based on FY18 numbers. Tata Steel itself trades at 5.5times and 0.4 times respectively.
If the valuations are reasonable despite the poor performance, that could be explained by the surprise 30% that Tata Steel is retaining in the business. That can work two ways. One, HBIS is giving a leeway on valuation but only for a 70% stake, which gives it management control but lowers its immediate cash outflow. If the business does not do well, then Tata Steel’s residual stake may not fetch the same valuation.
But the second and more cheery scenario for Tata Steel is if the business does much better under HBIS. Then, valuations could improve and Tata Steel will be able to sell its residual 30% stake to HBIS at a higher valuation.
The immediate benefit for Tata Steel is improved profitability after the SE Asia business exits the portfolio (can take 3-4 months to be executed). While its revenues will decline, it frees up some capital and management’s attention too. The European business is set to go into a joint venture with Thyssenkrupp AG and now with the SE Asian business out, the management can focus most of its attention on growing its presence in the Indian steel market.
Tata Steel's shares were down despite this announcement but that can be attributed more to metal stocks falling. The BSE Metals Index was down by much more than Tata Steel was, at the time of writing this.
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