Why Usha Martin Is A Small But An Important Bet For Tata Steel

Tata Steel Ltd. agreed to buy smaller peer Usha Martin Ltd. for up to Rs 4,700 crore as it looks to double its capacity by 2022.

The steel arm of the salt-to-software Tata Group will acquire the 1-million-tonne-per-annum business in an all-cash deal, it informed exchanges over the weekend. That will take Tata Steel’s total capacity to more than 19 MTPA.

This is Tata Steel’s second acquisition this year after it successfully bid for Bhushan Steel Ltd.’s business during insolvency resolution. To be sure, the Usha Martin buyout is a small one. Yet, JPMorgan said it takes pressure off Tata Steel to aggressively bid for the second Bhushan twin in the insolvency court: Bhushan Power & Steel Ltd.

Tata Steel is betting on growing demand in the domestic market, having offloaded assets in the U.K.—a legacy of its troubled Corus buyout—and combined its European business with the steel arm of Germany’s Thyssenkrupp AG.

The steelmaker will add 6.5 MPTA capacity through the two deals— Bhushan Steel and Usha Martin. They complement its 5 MTPA expansion at Kalinganagar, Odisha unit and 1.5 MTPA de-bottlenecking at Jamshedpur. That sets it on course to hit the targeted 26 MTPA by March 2022.

The Usha Martin acquisition, subject to regulatory and government approvals that could take six to nine months, will help Tata Steel build capabilities in long products and expand its portfolio.

Impact On Tata Steel’s Financials

Usha Martin, in its annual report for the last financial year, valued its steel business at Rs 5,245 crore—a significant premium to the company’s enterprise value of Rs 4,300-4,700 crore. Still, the buyout wouldn’t weigh on the balance sheet of Tata Steel and could be paid for from its one quarter operating income.

This would add just 6 percent to the company’s net debt on consolidated basis.

What Usha Martin Brings

Usha Martin’s Jamshedpur unit is an integrated plant, backed by:

• A captive iron ore supply.
• 0.4 kilotonne-a-year coke oven.
• 1.2 million tonnes pellets.
• 0.8 million tonne sinter plant.
• 0.6 million blast furnace.
• 0.6 million direct reduced iron.
• 64-megawatt captive thermal power plant.

The plant has 1-million-tonne billet capacity and 0.8-million-tonne finished steel capacity. It’s located close to Tata Steel’s facilities in Jamshedpur.

Valuations

Tata Steel’s Usha Martin deal is cheaper than its Bhushan Steel acquisition. It’s paying $596-653 a tonne compared with $941 a tonne for Bhushan Steel, according to data compiled by BloombergQuint. To be sure, Tata Steel can scale up capacity at the Bhushan Steel plant, which led to higher valuations.

Most brokerages said the Usha Martin acquisition will help Tata Steel:

JPMorgan

• ‘Overweight’ rating with price target of Rs 980-implying an upside of 57 percent.
• Usha Martin acquisition at an attractive valuation.
• EV/Ebitda of 7x implies operating income of Rs 4,900-6,400 crore.
• Acquisition done at the right time, addresses gap in long-product portfolio.
• The deal removes an overhang over the possibility of aggressive bidding for Bhushan Power & Steel.

Macquarie

• At the annualised margins based on the first-quarter of 2018-19, the deal valued at 6.5 times the EV-to-Ebitda. (That compares with the industry average of 6 times, according to Bloomberg.)
• Higher utilisation (at 75-80%) and cost efficiency are low hanging fruits to expand margins.
• The deal would add just 2 percent to Tata Steel’s consolidated Ebitda.
• It would add 5 percent to debt and should be 1 percent earnings-per-share accretive in FY20E.
• Higher utilisation (at 75-80 percent) and cost efficiency are low-hanging fruits to expand margins.

CLSA

• Retain ‘Buy’ with a target price of Rs 855—a potential upside of 36 percent.
• Acquisition small but reasonably priced.
• Usha Martin’s steel business adds just 0.5 percent to Tata’s Steel’s India volumes.
• Expect the transaction to be largely earnings and value neutral for Tata Steel.

HSBC

• Reiterate ‘Buy’ with a price target of Rs 890, implying an upside of 42 percent.
• The deal reinforces Tata Steel’s strategy to focus on its domestic business.
• View it as marginally positive at $625 enterprise value per tonne, and 6.6 times enterprise value to Ebitda
• Marginally positive, but too small to move the needle.