Tata Steel Amalgamation – positive for group structure, neutral for value creation

The amalgamation may not add/create much value in terms of profitability except for the savings on royalty and regulatory costs, say analysts.

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Tata Steel Ltd, the country’s biggest steel producer, has announced the merger of seven of its subsidiaries with itself, excluding Neelachal Ispat Nigam Ltd (NINL), which it recently acquired.

The merger is a big positive for streamlining the overall group structure, enabling efficient utilisation of facilities and optimisation of procurement and working capital management, analysts said. However, they do not see any value addition or value creation for the time being due to the merger.

Tata Steel: Implication of amalgamation for shareholders

Possible Synergies

Post the merger, Tata Steel management expects a saving of around Rs 700–800 crore on a net present value (NPV) basis on royalty payments it currently has to make for iron ore supplies to these subsidiaries. However, these savings are dependent on the prices of iron ore in Odisha and Jharkhand where the mines are located.

According to a report from the research firm Motilal Oswal, “Tata is currently paying an additional royalty of 22.5 percent of IBM (Indian Bureau of Mines) prices for the quantum of iron ore supplied to Tata Steel Long Products (TSLP) and Tata Steel Mining Ltd (TSML)”. This is over and above the normal royalty paid to National Mineral Exploration Trust (NMET) and District Mineral Foundation (DMF) already paid for the iron ore dispatched from its mines. This normal royalty works out to 19.8 percent.

The group will also save on other regulatory costs like audits, filings/compliances under various Acts which are not only costly but also time-consuming, especially in cases where the size of operations does not justify the regulatory costs, said the Motilal Oswal report.

Merger of entities with Tata Steel will simplify management, help focus on business: CFO Koushik Chatterjee

Value Neutral

Analysts say the amalgamation may not add/create much value in terms of profitability except for the savings on royalty and regulatory costs. “We believe the merger is broadly value-neutral at the proposed swap ratios,” said a report from BOB Capital Markets. “While it will result in 2.2 percent dilution of Tata Steel’s shares, this would largely be offset by a lower share of the minority interest in earnings and modest cost savings of Rs 700 crore pre-tax mainly on account of additional royalty that is currently payable by Tata Steel on the sale of captive iron ore.”

Valuations

Post the announcement of the merger, the brokerages are not yet making any revisions to their estimates. They would like to wait for the completion of the merger and see how the synergies play out.

“We note that Tata Steel has been trying to merge TSLP and TTML, among other companies, for a while but had been unable to consummate the same and hence, we will wait for further clarity on the completion of these mergers,” said the Motilal Oswal report. The brokerage would also like to understand the timeline for the merger as the company has just made the announcement in this regard and would also seek greater clarity on the actual (and not NPV) synergy benefits that will accrue to the merged entity to evaluate the quantum of EPS accretion from this merger.

Jefferies, a global research firm, has a ‘hold’ rating on Tata Steel and has raised its target price from Rs 87 per share to Rs 95 per share on the back of lower price-to-book (PB) valuations and a better outlook on cash flows.

Motilal Oswal has a ‘neutral’ on the stock with a target price of Rs 106 per share as it estimates the stock trading at 4.3x EV/EBITDA for FY23 and 4.6x for FY24. In terms of price to book value (P/BV), it pegs the stock trading at 1.1x BV for FY23 and 1x for FY24. It expects Tata Steel to generate a return on equity (RoE) of 18.5 percent for FY23 and 14.4 percent in FY24 as compared to an RoE of 44.4 percent in FY22.

On the other hand, BOB Capital Markets has a ‘buy’ rating on the stock with a target price of Rs 140 a share on one-year forward EV/EBITDA multiple of 5.5x. “We continue to prefer defensive play in Tata Steel for its ability to generate sector-leading margins via better integration all the way to iron ore and for its focus on downstream and retail businesses to capture value-add,” it said in its report.

Tata Steel was trading at Rs 99.75, down 4.36 percent on the NSE at 13.48 pm on September 26.

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