Will drop in steel prices spoil party?
T Surendar
[ 2 Feb, 2007 0127hrs ISTTIMES NEWS NETWORK ]
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MUMBAI: Consider the facts. In the last eighteen months, global prices of steel have come off their top.
On the other hand, valuation of steel assets have been increasing rapidly after a wave of global consolidation in the last decade by players like Mittal Steel and Arcelor.
Tata Steel paid a substantial premium over the last big deal in the steel sector to acquire Anglo-Dutch company Corus.
Now, what will happen if global prices of steel were to weaken?
For over a year now, analysts have been saying that the steel price cycle has held out for far too long and prices of the commodity will soften after China slow downs its consumption, post-2008 Olympics.
In mid-2005, when the Chinese government decided to clampdown on steel imports to cool off the volatile market, steel prices tumbled and affected even Tata Steel's profitability.
Now, a recent report by Mumbai-based broking firm First Global has recommended investors to "sell"Tata Steel shares, branding it a long-term underperformer. The report argues that should steel prices fall $50-75 by next year, Corus will end up making a loss.
Tata Steel officials, for their part, say that they have factored several scenarios into the price they have finally paid for Corus. Say Koushik Chatterjee, vice president (finance) of Tata Steel: "We have taken into account possible steel price changes, geographical and product mix possibilities and funding alternatives while bidding for the deal. We are optimistic we can extract benefits from the acquisition in different scenarios."
The First Global report says that in cyclical industries, whether it is shipping or steel, the time to buy assets in when the cycle is at a low, when assets are unloved, distressed.
In the last decade, that was how L N Mittal built his steel empire. Also, the type of businesses to be leveraged to the hilt, are the ones with steady and predictable, if unexciting cash flows.
The report points out that in the Tata-Corus deal, both these basic tenets have been turned in their head. "The deal combines high business risk with high financial risk."
Says First Global's Devina Mehra: "If you look at Tata Steel's ten year earnings data, it is all over the place. Even five years ago, it was struggling to make a decent return on equity. When their earnings are linked so much to steel prices, we feel that they have over stretched themselves."
As recently as 2002, when steel prices had hit a global low, Tata Steel's profit margin had fallen below 5%.
When Mittal Steel was picking up global assets, Tata Steel did not even want to invest in a large expansion plan fearing a drop in earnings.
Tata Steel plans to fund its Corus acquisition by raising debt through a newly-formed, wholly-owned subsidiary.
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