Valuation of Tata Steel after the Corus

Acquisition

Overview

Tata steel is one of the largest private sector steel company. The company's products

include steel bearing rings, forgings, flanges, steel tubes, cold rolled strips , seamless

tubes and metallurgical machinery. The company’s strengths are its strong market

position , acquisition of corus and vertical integration . It faces considerable threat from

consolidation in steel industry , economic /industry downturn and environmental

regulations. The company has launched the Customer Value Management initiative with

the objective of creating complete understanding of customer problems and finding

solutions jointly. The company's Retail Value Management addresses the needs of

distributors, retailers and end consumers. The company has also launched India's first

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steel retail store – steel junction – for making steel shopping a happy and memorable

experience.

Group’s Expansion Plans :

Expansion Oversees

The group has been expanding its operations in countries like Vietnam , Singapore and

Africa. A Vietnam-based steel company, signed a memorandum of understanding

(MoU),with Tata Steel Group in steel making for a proposed steel complex with capacity

of 4.5 million tonnes per year.

Further,Tata Steel Global Holding in Singapore, signed a joint venture agreement with

Vietnam Steel Corporation and Vietnam Cement Industries Corporation for a steel

complex in Ha Tinh province in Vietnam. The company will have a stake of 65% in the

above project .Additionally, Tata Steel and Riversdale Mining, a company listed in

Australian Stock Exchange,entered into a MoU, whereby Tata Steel would become a

strategic investor in Riversdale's Mozambique Coal Project by acquiring a 35% stake in it

for a sum of AUD100 million $86.8 million.

Tata Steel and SODEMI (a state owned company for mineral development) entered into

joint venture agreement for the development of Mount Nimba Iron ore deposits in Ivory

Coast (West Africa).

the company is setting up High Carbon Ferro Chrome plant at Richards Bay, South Africa

with 134,500 tonne capacity in first phase . The business model of the plant includes

taking high quality Chrome Ore from India and elsewhere, convert it into Ferro Chrome

in Richards Bay, and exports the finished

product to various customer destinations.

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Tata Steel Group’s expansion in foreign countries would further increase the geographic

reach of its product and services.

Expansion in India

Tata Steel Group is also expanding its operations in India. In January 2008, Tata Steel

and Steel Authority of India (SAIL) signed an agreement to establish a 50:50 joint

venture company for coal mining in India. The joint venture would identify, acquire, and

develop coal blocks in India.

Also, Tata Steel signed a joint venture pact with Jasper Industries to establish a coal-

based power plant in the eastern state of Orissa, in June 2008.Jamshedpur works unit as

part of the INR140,000 million (approximately $3,477.6 million) brownfield expansion to

augment its production capacity to 10 million tonne in over two years.The group’s

expansion in India would help it to generate additional revenues.

Recommendation : Buy/Sell/Hold

As per our calculation, the company is valued somewhere between $456 and $489

( values derived by the ReoI and FCF Valuations respectively) . While in the last week, its

share price has been hovering between $480 and $520, we feel the stock is over-

priced. Thus, our recommendation is to sell stocks of Tata Steel . This is supported by a

mix of negative trends that the industry and firm in going through currently.

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KEY ASSUMPTIONS TAKEN FOR VALUATION

We have arrived at the valuation using the following assumptions :

1. According to data monitor report, April 2009, CAGR 18.6% growth forecasted for

Europe for the steel industry. Therefore, we have assumed peak growth in 2013.

After that the growth slows down linearly till it hits 6% in 2025 (GDP growth rate

in a mature economy). We have assumed terminal growth rate to be 4% due to

rising costs and competitive factors

2. For 2009-10, Tata Steel posted a 49.5% fall in consolidated profits. Sales and

profits tumbled because of the global economic crisis (contraction in demand

from the automotive and construction sectors). This is reflected in the NEGATIVE

COI in 2009-10. We are assuming that with slow down, tata Steel will decrease its

Net working capital by increasing liabilities.

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 3. Profit margins are derived from those of comparables companies in mature

economies

– Arcelor mittal – 8.36% , Nucor Steel – 7.74%

1. Profit margins & ATO have been considered at 2009 levels on a conservative

basis, assuming no increases or decreases.

2. Risk free rate at 8.4% source www.debtonnetindia.com at 22 april 2009.

3. Industry beta 1.53 -

http://pages.stern.nyu.edu/~adamodar/New_Home_Page/datafile/Betas.html

4. Market Risk premium for Indian Companies assumed at 9.23%

(http://pages.stern.nyu.edu/~adamodar/pdfiles/country/india.pdf)

5. Re is at 22.52% using formula Rf + B* Rm

6. Rd is taken at 8% since Tata steel’s new debt amounted to 8 Billion dollars due to

the CORUS acquisition. The same has been financed with Corus cash flows. This

new Debt generates 640 Million dollars in annual interest charges which works

out to be 8 & annual interest cost.

7. Calculations for WACC are shown in the excel model tab labeled WACC

8. Effective tax rate assumed to be 39.5% from P&L sheet.

Pricing Basis and Risks:

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Industry trends:

• Growing Sectors like Infrastructure, construction, automobiles and consumer

durables are increasing the demand for steel specially in developing countries.

We see that this demand is going to grow in the next few years.

• In August 2009, the index for basic metals has recorded growth rate of 8.5%. The

production has grown 7.6% compared to last year’s 6.6 .The investment demand

is strong and rising.. We find that there is subsequent rises in the in steel prices.

We can expect long steel prices too to go up. But the recent rupee appreciation

can dampen the pricing power of the players. The steel producers need to be

careful on dumping of steel in India, as this could take away benefits of strong

growth and pricing from steel players in domestic market.

• Increased Chinese production and resultant sluggish steel prices with falling net

realisations to adversely impact profitability.

• Overall steel sector outlook has dampened (also depicted by fall in market price),

due to prospects of further slowdown in profit growth amid declining steel prices

and rising iron ore & coal costs

• Other Industry threats are Rising interest rates , high cost of energy , cyclical

nature of steel industry and deficit infrastructure

• Big ticket investment by POSCO and Mittal could swallow the market (specifically

export)

Acquisition of Corus :

Its acquisition of corus in April 2007 has resulted in improvements in operating

efficiencies and reduction in cost , thus strengthening its position in the steel industry.

However, it had taken huge debt to finance corus acquisition . This could harm its

abilitiy to refinance itself for existing loans. Corus product range is concentrated on

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highly specalised requirement of aerospace, engineering , automotive and construction.

Its products are priced at a premium as compared to Tata Steel’s product.

• Since last year , corus growth has been slow. It is operating at a capacity of 80

percent and has reduced capacity by 30%. .The management has guided 2010

capacity utilization of 67-68% .

• The prices in Europe has bottomed but reduction in annual raw material prices

would help them maintain/increase their margins.

• The company expects staff cost of Corus to reduce in 2011 due to reduction in

number of workers. Currently Corus is not getting benefits of government scheme

to share 50% of the employee cost as some of other companies in this sector

majorly due to regulations in UK , given that Corus has huge employee base in UK

• The management expects Corus to turn EBITDA positive by third quarter of 2010.

This will depend on rate at which Europe recovers from the slowdown.

• Corus’ subdued performance was mainly on account of: i) unwillingness of the UK

government to support employee expenses (thereby placing European players at

an advantage, ii) higher energy costs still plaguing the company’s UK

operations . Also, higher priced coking coal inventory (in absence of new

contracts) and loss-making Teesside operations further subdued results

• With Corus acquisition, raw material selfsufficiency has decreased from 80% to

17%.

• Equity dilution from acquisition of Corus would reduce its earning per share.

• The estimated synergies will take time to materialize. Its integration to main

business group is still underway

• The cost of production per tonne of steel for Corus is very high on account of

inaccessibility raw material (iron ore and coal) and high labor costs. Tata Steel

has intended to reduce the cost by sourcing raw material from the source of

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 origin. The company is exposed to increase in raw material prices due to

acquisition.

• The deal values Corus at $751 per ton on EV basis, which is slightly higher than

Arcelor-Mittal deal, valued at $725 per ton. Though there is immense difference

in the profitability of both.

• Since Corus does not have any captive source of raw material , its profitability is

highly sensitive to prices of coal and iron ore. With nearly 90% of globally traded

iron ore concentrated in top 5 producers, there may be sharp jump in iron ore

prices.

• While rightsizing (dropping 5,000 employees) and restructuring operations are

masked as strategic initiatives to save costs, the measures echo Management’s

view on non-profitability of steelmaking in the UK.

Global Developments :

• Due to decline in cooking coal and iron ore costs by 60% and 33% , new contracts

have been negotiated globally which would help performance of TATA Steel.

• TATA Steel has successfully negotiated with its lenders on the debt covenants

and the lenders have unanimously agreed on the freezing of covenants till March

2010 and would be relaxed thereafter. We believe this is a positive development

for Tata Steel.

• Shipments and average steel selling price are expected to be higher in fourth

quarter than in third quarter . However, its operating environment remains

challenging .Real demand from Europe and US has not yet recovered.Its India

operations will benefit by strong volume growth , robust demand in India and

better pricing environment.

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 • Slowdown in the steel cycle is a key risk . With the acquisition of Corus, tata steel

is financially and operationally leveraged than its counter parts. Also, the global

steel cycle is currently dependent on China for its fortunes. Any major policy

change will have an impact in global steel and iron ore industry. Demand has

significantly weakened due to economic down cycle triggered by financial crisis.

Earnings are under pressure due to poor shipments and high input cost ,which will

continue to pain steel companies.

• Whole sector has witnessed higher cost of production due to higher iron ore and

coking coal prices. The cost is relatively high in overseas operation than domestic

operation.

• Long steel prices have been relatively more volatile than flat steel due to higher

sensitivity to construction . The prices have remain low due to lower construction

activity.

• European steel production witnessed severe decline of 40% for last seven months

and according to us Europe will take more to recover.

Financial Outlook :

• Expansion in Jamshedpur and Raw material Linkage

Tata Steel is expanding capacity by 2.9 mn tpa by FY12 at a Capex of USD 3 bn .

FY10 capex is 30 bn , out of which 15 bn has been already spent. 50 bn capex

will be spent in FY11 and the rest in FY12

Tata Steel has taken 35% stake in high value benga coal project. The total capex

of project is USD 450 mn for developing mining capacity of 7-10 mn tpa. These

are some major investments in Tata Steel’s

Books for coming 2 years.

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 • The company is evaluating its debt profile and restricting high cost debt . This

would reduce interest cost from FY11 onwards . The company has a liquid cash of

61 bn which could be used to reduce debt

Recently ,Tata steel underwent a restructuring by converting bonds worth $870

mn for new convertible bonds. This reduced its overall debt liability and increased

the maturity of its existing debt while benefiting investors by giving them an

annual coupon . The company reported one time charge of restructuring ,

impairment and disposal. If debt to equity ratio decreases for tata steel , they

would lose their tax leverage , wacc will increase . Our valuation is sensitive to

wacc , hence it will change with change in wacc.

• Tata Steel’s profit declined in FY09 due to huge decline in net realization although

its sales volume increased. Also, interest cost surged 60%. These factors led to

decline in profits.

• The Greenfield projects announced by the company may take more time to

commence production than company’s estimate.

Ratio Analyses

Current Ratio = Current Assets/Current Liabilities

Presently, TATA STEEL has a current ratio of 0.81. A current ratio of 2:1 is always

considered as optimum means that there is a 50 % safety margin in terms of assets to

cover its current liabilities. However this doesn’t mean higher current ratio is good. It

may signify higher unused cash,

inventory which again may result in inventory carrying cost.

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Debt/Equity Ratio:

As per Appendix 7 attached, TATA Steel has a D/E =1.7. A firm has two options when

going for expansion one is raising debt and other going for public issue. Generally very

high debt is not

preferred by the investors because it signifies the risk and high form of equity has

threat of hostile bid and acquisition. Tatas have decreasing trend till 2006 and it has

gone up in the year 2007 shows it has borrowed some money for investments. Thus ,

basically after the acquisistion of Corus , the Steel Makers are in a position of heavy

debt.

Asset Turnover Ratio: Gross Income/Net Operating Assets

The Tata Steel Group has a healthy Asset Turnover Ratio of 2.2 in 2009 and 1.93 in

2008. For future projections, the ATO has been taken to be steady throughout at an

average value of 2.

REFERENCES

1. www.capitaline.com
2. http://www.sharetradingtips.com/blog/wp-
content/uploads/2008/06/financia_ratio_analysis_of_jindal_steel_with_tata_steel.p
df
3. http://www.etintelligence.com/etig/login/home.jsp

5. ISI Emerging Markets

4. Datamonitor

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APPENDIX 1 – BALANCE SHEET

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APPENDIX 2 – PROFIT & Loss Statement

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APPENDIX 3 – REFORULATED BALANCE SHEET

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APPENDIX 4 – REFORULATED P&L

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APPENDIX 5 – RATIO ANALYSIS

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APPENDIX 6- VALUATION

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APPENDIX 7 – WACC

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