Usha Martin buy can push up earnings of Tata Steel

25 September 2018

Tata Steel’s likely acquisition of Usha Martin’s steel operations on a slump sale basis for Rs 4,300-4,700 crore is small, yet a good one. The buyout that includes Usha Martin’s captive iron ore mine and a power plant marginally increases debt on Tata Steel’s already leveraged balance sheet, but offers significant scope for earnings improvement.

Usha Martin’s EBIDTA per tonne in FY18 was around Rs 5,500. Peers with a similar set-up make much higher profits. For instance, EBIDTA per tonne for Jindal Steel & Power is Rs 10,600. This means that after the buyout by Tata Steel, Usha Martin’s steel division profits could improve sharply.

The acquisition of a million tonnes of steel capacity would include a captive 2.5 mtpa iron ore mine, which is 160 km away from the steel plant, and a 155-MW captive power plant. The company also has a coal mine that it won in the 2015 auctions. Analysts attribute low profitability to existing operational inefficiencies, and estimate an earnings upgrade in the next 18 to 24 months. The transaction could take 6 to 9 months.

At Rs 4,500 crore, the transaction can be valued at 6 to 6.5 EV by potential EBIDTA. Enterprise value is the market capitalization plus net debt. This would increase the net debt (from FY18 end) by 6 per cent, a limited impact for the Tatas. But once the earnings are upgraded, the acquired asset will be able to meet its own debt obligations.

For Tata Steel shareholders, the acquisitions of 1 mtpa steel capacity remains largely insignificant when compared with the overall size of the company. Tata Steel’s Indian capacity is 13 mtpa, which it plans to increase to 18 mtpa through expansion. What will be more important is the outcome on the Bhushan Power and Steel bidding, where Tata Steel is competing with JSW Steel and Liberty House.

This will decide the extent of leverage the company is willing to take. Its consolidated net debt (Rs 72,000 crore) to EBIDTA (Rs 21,890 crore) in FY18 was 3.3 and is expected to increase to 3.6. This is in the positive phase of the cycle. Bhushan’s acquisition could take the net debt to Rs 1.1 lakh crore and that may be considered a stretch by a section of the investors. On Monday, Tata Steel’s stock fell 2.8 per cent to Rs 607.7.