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Hitting Where It Hurts

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Having posted dismal results — a 89 per cent fall in profits — in the second quarter, India's largest steel producer is gearing up for harsher times to come. The quarter ending December (Q3) is expected to be ‘difficult', said Tata Steel Europe's (TSE) CEO Karl-Ulrich Kohler last week after the Q2 results were out.

While waning demand for steel and rising costs of raw materials (coking coal and iron ore) have hit Tata Steel hard, the depreciating rupee also ate into its profits. Steel sales in Europe have thinned down since June on fears that Greece and other euro-zone countries may default on debt.

TSE, which produces about two-thirds of Tata Steel's total steel and buys all the required raw material from outside, faced a 40 per cent increase in coal prices and 30 per cent rise in iron ore. The 14 per cent surge in the price of hot-rolled coil steel was not enough to power the bottom line.

According to Niraj Shah, analyst, Fortune Equity Brokers India, the European uncertainty is likely to continue and this may force the company to shutter or suspend more units there. "Indian operations may be the saving grace, but even here, the shine is off as consumption growth has almost stagnated," says Shah.

The rupee depreciation has also lowered the earnings of Indian commodity players. It has affected Tata Steel's exposure to foreign-currency convertible bonds by Rs 150 crore, says group chief financial officer Koushik Chatterjee. The rupee depreciated 8.7 per cent in the three months ended September, the biggest quarterly drop since 1992.

Since the Tatas acquired Tata Steel Europe (then Corus) in 2007, the steelmaker has been haunted by the costs of iron ore and coking coal. So the then managing director (now the vice-chairman) B. Muthuraman set a target for sourcing half of the raw materials from captive mines. But the acquisition or development of mines has been delayed because of the financial crises. Now, the company is developing some of its mines in Mozambique, Canada, South Africa and Cote d'Ivoire and looking to acquire mines.

Analysts estimate that the European entity could save up to 60 per cent of input costs, translating into a cost reduction of $120 a tonne of steel, if it could achieve full self-sufficiency in raw materials. "Since the company is looking for only 50 per cent raw material security, the overall input cost reduction will be 30 per cent, or $60 a tonne of steel," says an analyst.

Tata Steel managing director H.M. Nerurkar expects that raw material prices to come down. The spot indication in the past two to three weeks is that they are coming down, he says. On the Indian steel market, Nerurkar says, "Both prices and demand will be steady."

The slowdown in steel prices has softened the raw material spot prices, too. That is a helping hand for Tata Steel. However, it is time for the company to tighten the belt.

(This story was published in Businessworld Issue Dated 28-11-2011)