Jefferies Criticizes Tata Steel's UK Investment for Failing to Reduce High-Cost Exposure

19 Sep, 2023

Jefferies Criticizes Tata Steel's UK Investment for Failing to Reduce High-Cost Exposure

Tata Steel and the UK government have unveiled a significant partnership to invest £1.25 billion in electric arc furnace (EAF) steel production at the Port Talbot site. In this substantial project, Tata Steel will contribute 60% (£750 million), while the UK government will provide the remaining 40% (£500 million) pending approval. The project aims to be operational in approximately 36 months.

An essential aspect of this agreement is a grant of up to £500 million from the UK government. This ambitious project aligns with the UK's decarbonization objectives, as EAF-based plants have a considerably lower carbon footprint compared to conventional blast furnace facilities. The Port Talbot project is anticipated to reduce direct emissions by 50 million tonnes over a decade. Additionally, the project will lead to a comprehensive restructuring of Tata Steel's balance sheet, potentially eliminating current cash losses in its UK operations and addressing non-cash impairments from previous investments.

Tata Steel has emphasized its commitment to consult with labor unions due to the potentially transformative nature of this project, which may involve significant changes to the carbon-intensive steel-making processes at Port Talbot. The company intends to finalize project details and obtain approvals within the next three months, with commissioning expected over the subsequent three years. Throughout this transition, Tata Steel is determined to ensure a continuous supply of products, which may involve importing additional steel substrate for its downstream units.

Foreign brokerage firm Jefferies has issued a "Buy" rating for Tata Steel stock, setting a target price of Rs 145. Jefferies sees the new facility as yielding higher spreads of £150-170 per tonne ($185-210 per tonne) compared to the existing setup, facilitating decarbonization. However, Jefferies also notes that the investment represents a missed opportunity to reduce exposure to historically high-cost, low-margin regions.

Jefferies further highlights that the existing primary steel capacity at Port Talbot is nearing the end of its operational life, and a decision was imminent regarding whether to invest in a new plant or discontinue crude steel production at the facility. Tata's commitment of £750 million over an expected four-year period implies an annual cash outflow of around $230 million. Jefferies' estimates suggest that Tata is poised to generate free cash flow (post-interest payment) of $1.4-1.9 billion annually in FY25-26E. Despite the manageable overall cash outflow, Jefferies maintains its view that while the transition to a new EAF facility could enhance profitability and support decarbonization efforts, investing in UK-based steel-making represents a missed opportunity to reduce exposure to historically high-cost, low-margin regions.

Following the announcement of the joint agreement, Tata Steel's share price reached a new 52-week high during Monday's trading session, touching an intraday high of Rs 134.85 and a low of Rs 131.85. The stock opened at Rs 134.75 per share on BSE.

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