Tata Steel (FPO) - Avoid

Tata Steel FPO

Tata Steel, India’s largest steelmaker and one of the flagship companies of Tata Group is coming up with its follow-on public offer (FPO). The company will be issuing 5.7 crore equity shares of face value of Rs 10 each in the price range of Rs 594 - Rs 610 per equity share. This will constitute 5.94 per cent of fully diluted post-issue paid-up capital of the company. Through this issue the company intends to raise between Rs 3385 crore and Rs 3477 crore at the lower and upper price band respectively.

Tata Steel is a vertically integrated steel company with a production capacity of 27.2 million tones per annum (mtpa) and has its operations spread in 26 counties. But majority of the company’s operations spread in two geographical areas that are Europe and India accounting for 62.9 per cent and 28.8 per cent of its business respectively at the end of FY10.  The money raised through the FPO will be primarily used to expand their manufacturing capacity at the Jamshedpur plant. This will help the company to augment its capacity by 3 mtpa, taking its total capacity in Jamshedpur to nearly 9 mtpa by the end of February 2012. Part of the proceeds will also go towards deleveraging its balance sheet as the company will repay debts worth Rs 1000 crore from the proceeds. This will help the company in part to reach its long-term debt-equity target of 1:1, which currently stands at 1:1.5 with a total debt of Rs 56000 crore on a consolidated basis as at the end of September 30, 2010.

Financial Performance and Valuation

For the financial year 2010, the company’s net sales declined by 30.5 per cent on a yearly basis, primarily due to a drop in sales of its European operation. Sales in Europe were down 40 per cent. It is worth noting that currently European markets account for 46.4 per cent of its net sales while the Indian market accounts for 26.2 per cent of its sales. While total sales dropped by 29.5 per cent, the total cost was down by just 27 per cent during FY10, leading to a loss. The company posted a net loss of Rs 2014 crore in FY10. Though the situation has improved since then in regard to its Indian operations, its largest market, Europe is still not out of the woods. This has affected the sales volume of the company on a consolidated basis. It declined marginally during the last quarter (September 2010). There was a little improvement on the pricing front which helped the company to offset the decline in volumes. The main worry is not what has happened in the past but what could happen in future. In the December quarter too (according to the RHP), the sales volume has declined marginally. The company lacked pricing power during the December quarter and this will result in a rather flat topline for the December quarter. Add to this the increased cost of materials and margins will surely come under pressure affecting the bottomline performance of the company as well. All this will surely impact the stock price.

In terms of valuation, the company’s last twelve months' earning is discounting the offer price by 8.48 times and 8.71 times to its fully diluted equity capital. This is available at a slight discount to other major players like SAIL that is trading at 12 times. This is probably because SAIL’s major revenue comes from the domestic market which is in a much better shape than the international market. But apart from the valuation what is also important to note is that the current offering of Tata Steel is available at just four per cent and seven per cent discount to its CMP of Rs 633. We feel that in such volatile market condition this is not a very huge arbitrage opportunity providing a comfortable cushion to investors, in case the share price goes down – a scenario which could well materialise considering that performance of steel companies is likely to be hampered by higher input costs. This is also what results of SAIL have been suggesting. Moreover, we feel that the situation in the commodity market whether it is raw material or finished products is not stable and hence we suggest our readers to avoid the issue currently and a better opportunity will appear in the next few quarters to enter the counter.