The Steel Authority of India's dramatic turnaround in the last two years has forced the market to change the rankings in the steel sector.
In April last year, Tata Steel was at the top of the market cap league among steel companies with a market capitalisation of Rs 4,988 crore (Rs 49.88 billion), 33 per cent more than that of the Steel Authority of India.
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But thanks to Steel Authority of India's turnaround, the roles reversed and by the end of 2003, its market cap was about 30 per cent more than that of Tata Steel.
Tata Steel has now regained some lost ground. On the last count, the Steel Authority of India's market cap was about 13 per cent more than that of Tata Steel. But it cannot be said the market now prefers Steel Authority of India over Tata Steel.
True, in the past year or so, Steel Authority of India's market price rose faster than Tata Steel's, but that was to accommodate the rapid improvement in financials.
In fact, Tata Steel still enjoys a considerable premium, both in terms of the price-earnings ratio and market cap/sales. Its PE based on FY04 earnings is 8.5, compared with 6.7 for the Steel Authority of India.
Further, its market cap is 1.4 times its FY04 sales, while the Steel Authority of India's market value is just 0.77 times its FY04 sales. The reasons for this are obvious. First, Tata Steel's vertical integration from mines to value-added products gives it a much better cost structure.
For instance, its cost of iron ore is estimated at $7-9 per tonne, compared with a spot price in the region of $45-50. Besides, it sources 60 per cent of its coking coal requirements from its captive mines.
Also, it enters into long-term contracts for the remainder. This gives it a clear advantage, especially as coal shortage has hit many other players, including the Steel Authority of India.
In Q1 FY04, the Steel Authority of India had to contend with a lower production level due to a shortage of coal, as it relies on third party sources like Bharat Coal as well as on imports from Australia to meet its needs. In addition, only around 50 per cent of these coal purchases are made using long-term contracts.
What is more, Tata Steel has a better product mix, with value-added products making up for around 20 per cent of the total production. On the marketing side, Tata Steel sells around 15 per cent of its output on spot and monthly basis, compared with around 50-55 per cent for the public sector giant.
Although this limits Tata Steel's ability to take full advantage of a surge in steel prices, it also ensures that its earnings do not taper sharply in case there is a reversal in the commodity cycle.
This, coupled with its better cost structure, helped it post an operating margin of 32.7 per cent in FY04, higher than the Steel Authority of India's operating margin of 26.1 per cent (adjusted for a one-off wage settlement bill).
Thanks to a much lower interest cost (1.1 per cent of sales, compared with 4.1 per cent for the Steel Authority of India), Tata Steel's PBT margins, at 27 per cent, are almost 10 percentage points more than that of the Steel Authority of India.
The Steel Authority of India's market cap may have caught up with that of Tata Steel's, but in terms of quality of earnings and operational efficiency, it still has a lot of catching up to do.
To be fair to the Steel Authority of India, it has done a lot in the recent past. From a loss of Rs 1,700 crore (Rs 17 billion) in FY02, it has posted a profit of Rs 2,510 crore (Rs 25.1 billion) in FY04. Its manpower has been reduced by 17.5 per cent in the last five years and debt has been halved compared with the five-year-ago level.