More upgrades for Tata Steel after pension deal

With the much-awaited Tata Steel UK pension scheme resolution getting cleared, investor sentiment has got a boost. 

For the company, which is working hard to make its European operations more profitable, resolving the British Steel Pension Scheme (BSPS) was critical for de-risking its future liabilities. Also, the scheme was seen as the main stumbling block for Tata Steel’s plan to strike a joint venture (JV) deal between its European operations and larger Europe-based peers such as Thyssenkrupp. 

Not surprisingly then, the news of BSPS resolution saw the Tata Steel stock soar to a high of Rs 692 (last seen in 2008) before closing at Rs 683.50 (up 3.3 per cent) on Tuesday.

The new pension scheme will have lower annual increases for pensioners in future, and therefore have an improved funding position, which significantly lowers the risk for the company, say analysts. Those at Edelweiss say it will significantly de-risk Tata Steel’s pension commitments, besides eliminating uncertainties surrounding deficit funding. Moreover, there now exists higher probability of further restructuring of Tata Steel Europe (TSE), including a JV with Thyssenkrupp’s Steel Europe division, which could lend further fillip to the stock. 

Analysts at Kotak Institutional Equities say the path to a JV appears to be clear now after the separation of BSPS from Tata Steel UK receiving an approval from the Pensions Regulator.

Although the company will pay GBP 550 million and issue shares equivalent to 33 per cent of economic equity stake in Tata Steel UK, to the BSPS trustee, this is still much lower than the potential deficit in the scheme, say analysts. 

The provisioning for the same may be seen in September quarter results, but the outgo was well expected and is factored in. Goutam Chakraborty at Emkay Global says the positive development in the form of settlement being expected too remains factored in the stock prices now, and it is the increased possibility of a JV that is being looked at.

A JV or partnership with a large player such as Thyssenkrupp, a leader in high-grade flat steel and value-added products and having sizable market share, can drive TSE’s growth. The company can focus on premium products rather than commoditised ones. The benefits on distribution and marketing channel can also help drive more benefits. Estimates peg the Ebitda (earnings before interest, tax, depreciation and amortisation) of the Europe business at $67 a tonne in FY17, compared with a loss in FY16. 

Given the expected gains, this metric can be much higher going ahead. The larger market share of the joint entity can help it command better pricing position as well, both with suppliers and its customers, leading to significant cost savings, including research and development (R&D) cost. Together, it is estimated that the combined revenues would be about $20 billion with an Ebitda of $1.5 billion, which is a significant number, says Rahul Agarwal, director, Wealth Discovery. Investec Capital sees $675 million synergy benefits accruing with the JV.

Further, analysts at Kotak Institutional Equities say they believe the JV with Thyssenkrupp can drive strong deleveraging for Tata Steel over the next few years. Not only some of the European debt can be pared in a trade-off between debt and equity for the JV, better cash flows in future can help reduce the debt faster. The consolidated net borrowings of Tata Steel is about Rs 83,000 crore at the end of FY17, according to Capitaline data.

Overall, the improved performance of TSE will have positive rub-off on Tata Steel’s consolidated financials as European operations and cash burns in the past had been diluting the strong Indian performance. Volume growth in India, driven by expanded Kalinganagar capacities, are already improving.

Analysts at Deutsche Bank, on Monday, had reiterated their positive view on Tata Steel, which is seen benefitting from volume growth (new Kalinganagar plant), rising steel prices, and resolution of the pension deficit issue. The potential venture with Thyssenkrupp could provide the company with a further value-creation opportunity, they said. 

Now with the JV path getting clearer, analysts have already started upping their stock price targets. Kotak Institutional Equities, while maintaining its positive stance, has revised its target price to Rs 715 from Rs 645 earlier, whereas analysts at Edelweiss maintained ‘buy’ rating with sum-of-the-parts’ based target price of Rs 720. 

It is expected that Thyssenkrupp might take a decision on the matter at their Board meeting later this month.

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