Saturday, September 26, 2009

Global Recession and Indian Response - 3: The Case of Tata Steel Limited

Global recession hit the world economies badly from mid-2008 onwards. The growth prospects of companies were adversely affected. As companies aimed to survive or remain profitable they instituted severe measures to close down or realign businesses and operations and implement severe cost compression measures. Jobs were lost and savings were wiped out while purchasing power crumbled and customer confidence wilted.

Indian economy too faced the adverse impact of the global recession with reduced GDP growth and heightened liquidity crisis. The fiscal year 2008-09 represented one of the most excruciating years for Corporate India. Different companies, of course, were affected by the economic recession differently and also responded to the evolving situation differently. Companies in the core engineering sector and those who made aggressive overseas investments in the previous years were particularly under severe pressure.

The author examines in a series of papers as to how different Indian companies withstood the ravages of recession in a more enduring manner than most overseas firms could.  This enquiry also results in an understanding of relevant business models and strategies as a subject of broader academic interest.

In the third paper of the series, the author examines how Tata Steel Limited (Tata Steel), fared in 2008-09. The conclusion that emerges from the study of Tata Steel (as from the earlier studies on Maruti Suzuki, India’s leading car manufacturing company and BHEL, India’s leading power and industrial equipment company – refer the other posts in this blog) is that Indian companies did acquit themselves rather creditably due to their intrinsic fundamentals and business management skills.  This, in turn, leads us to the interpretation that select Indian companies must set their sights higher and move on to higher trajectories of growth on a global canvas.

Tata Steel – A pioneering venture

Tata Steel Limited, Asia’s first integrated private sector company, is the world’s second most geographically diversified steel producer with major operations in India, Europe, South East Asia and rest of the world.  Listed as a Fortune 500 company with an annual crude steel capacity of around 31 million tones, the company has manufacturing units in 26 countries and a strong presence in 50 European and Asian markets.  Tata Steel India is the first integrated steel company in the world, outside of Japan, to be awarded the coveted Deming Application Prize 2008 for excellence in Total Quality Management.

Tata Steel was established as a private sector enterprise by the renowned nationalist and industrialist Mr Jamsetji Tata 102 years ago, laying the basic foundations of an engineering industry in the British occupied India.  The Company was a beacon of India’s enterprising spirit over a century of tumultuous national and international developments. Tata Steel caters to the core sectors of the Indian economy, viz., construction, automobiles, industry, defense and so on with its wide range of products. Tata Steel’s core competence lies in developing and manufacturing a wide range of steel products, steel tubes, bearings, wires and rods.  Tata Steel was a pioneer in developing high quality sheet steel and high precision steel tubes required for the new generation of automobiles in India. 

An exceptional chapter was written in Tata Steel’s century old history when in 2007 it acquired the Anglo-Dutch steel giant Corus Group Plc (Corus) for USD 12.11 billion in a landmark deal that placed India Inc in the global map. With the acquisition of Corus, Tata Steel’s capabilities extended to more value added products including those catering to European and American automobile and aerospace industries.

Prior to Corus acquisition in 2007, Tata Steel was a predominantly domestic oriented company with a production capacity of 7 MTPA.  With the integration of Corus, the capacity jumped up by 23 MTPA, making the Group the fifth largest steel producer in the world.  Current capacity stands at 31 MTPA.  Tata Steel also owns Jharia coal fields which meet the coal requirements of Tata Steel India.

A global business and operations model

Tata Steel represents a business model which derives sustainability through cost efficiency and growth through globalization.  The company’s domestic orientation, technological sophistication and cost leadership enabled it to continuously lead the Indian steel industry and withstand the recessionary cycles witnessed from time to time, including the global economic crisis of 2008-09.  With the Corus acquisition, in terms of capital deployment and sales the company is well-balanced.  Capital employed and revenues by geographies for Tata Steel, in that order are - India: 28% and 17%, UK:  32% and 34%, EU excluding UK: 26% and 30%, SE Asia: 12% and 12%, and Rest of the World: 3% and 6%.

The turnover of the Tata Steel Group increased by 12% in 2008-09 to Rs 1,473,290 million (USD 30.7 billion; USD 1 = Rs 48). Acquisition of Corus contributed to the significantly enhanced turnover profile of the company.  Stand-alone turnover of the company, Tata Steel India, at Rs 246,240 million was just 16.6% of the Group’s consolidated turnover.  That said, globalization, and in particular the expensive Corus acquisition, took a significant toll on the profitability of the company.  On a standalone basis, the Earnings Before Interest, Taxes and Depreciation (EBITDA) was Rs 90,980 million in 2008-09, compared to Rs 80,810 million of 2007-08, representing an increase of 12.6%, even in a year of recession.  Profit before Taxes (PBT) increased by 10.3% to Rs 73,156 million, while Profit after Taxes (PAT) increased by 11% to Rs 52017 million.  On a consolidated basis, however, EBITDA in 2008-09 was flat at Rs 176,103 million compared to Rs 177,105 million in 2007-08.  Consolidated PBT registered a sharp fall of 59% to Rs 67, 432 million in 2008-09 while consolidated PAT also plummeted by 40% to Rs 49,509 million.

The disparity in the demand profiles of different global markets was evident in terms of Tata Steel’s performance.  The Indian steel division reported an increase of 10% in finished steel production and sales during 2008-09 to 5.231 MTPA while the European finished steel production in 2008-09 dropped by 20% to 16 MTPA.  Sundry debtors at  Rs 6359.8 million were higher by 17% on a standalone basis.  As a percentage of sales, however, the standalone sundry debtors as a percentage of turnover declined marginally from 2.7% in 2007-08 to 2.6%, reflecting the company’s prudent sales and collection policies.  On a consolidated basis too, management of sales and collections reflected prudential principles even in a year of recession.  Consolidated sundry debtors, in fact, declined by 30% to Rs 130,316 million and as a percentage to consolidated sales declined sharply from 14.2% in 2007-08 to 8.8% in 2008-09.  The domestic collection practices were more robust than those of the overseas operations but the progressive discipline that was witnessed in 2008-09 would augur well for the future.

The standalone manpower costs of Tata Steel India increased by a whopping 26.9%, from Rs 18,160 million to Rs 23,060 million in 2008-09.  The consolidated manpower costs, however, increased at a lower rate of 6.4% from, Rs 169,000 million to Rs 179, 750 million, reflecting cost cuts in the overseas operations.  On a standalone basis, turnover to employee ratio (on rupee base) was 10.5 in 2008-09, compared to 10.8 in 2007-08.  This stable turnover to employee cost ratio, despite the 27% increase in employee costs, reflects the high degree of efficiencies achieved in the Indian operations in terms of non-employee costs and also improvements in conversion efficiencies. On a consolidated basis, the value added ratio was 8.2 in 2008-09, compared to 7.8 in 2007-08.  These marginal improvements reflect an effort to optimize employee costs and conversion efficiencies on a global basis.

Manufacture of steel and value added steel products for automobile, infrastructure and industrial sectors is an investment-intensive endeavor. The need for ensuring raw material security through ownership of mines puts an additional pressure.    The fixed assets of the company increased by 8% during 2008-09 to Rs 453,056 million, reflecting a continued asset augmentation policy.  Substantial portion of the fixed assets represent overseas assets in 2:1 ratio (overseas : domestic).  Sales to assets ratio of the standalone operations was 1.7:1 while that of overseas operations was 4:1.  It would appear that the domestic assets need to be sweated much more through enhanced operations on a stand-alone basis. This insight, coupled with the geographical distribution of capital employed and revenue generated brought out earlier, appears contrarian to the general perception that Tata Steel’s domestic operations are one of the lowest cost operations, globally.  New investments in green field and brown field projects in India which have potential to add capacity and turnover and enhance input security could change the profile favorably in future.

The acquisition logic and challenge

Tata Steel’s acquisition driven strategy to leapfrog into global steel arena is a path- breaking one for the Indian industry. After taking 100 years to reach a 7 MTPA capacity, Tata Steel in one sweep quadrupled capacity and derived 65% of its sales from Europe. Tata Steel became the fifth largest producer of steel in the world, up from fifty-sixth position.  Access to some sophisticated technologies and products has also been part of the bargain. The potential benefits of the Corus deal were widely appreciated. Most experts were of the opinion that the acquisition did make strategic sense. Some analysts had doubts about the outcome and effects on Tata Steel’s performance.  They pointed out that Corus’ EBIDTA (earning before interest, tax depreciation and amortization) at 8 % was much lower than that of Tata Steel which was at 30% in the financial year 2006-07.  Whether the price paid of USD 12.1 billion was worth the leap into the Top 5 global league is a matter that will be answered by the company’s performance in a few years. The comment from the chairman of Tata Steel and a few opinions from some industry experts are instructive.

Commenting on the acquisition, Mr Ratan Tata, chairman, Tata & Sons, said, “Together (with Corus), we are a well balanced company, strategically well placed to compete at the leading edge of a rapidly changing global steel industry.”

Mr Vivek Gupta, Managing Director, AT Kearney (India) said, “The financials for this deal (require) high performance levels, perfect post-deal execution and sustained high steel prices.  It is a risky game and will be okay for Tata as long as the economy is growing and no major bumps occur.  If (these bumps) do occur, they can become a challenge, and I am reminded of the high leverage days of the mid-1980s.”

Mr S Mukherji, Managing Director, ICICI Securities said, “Indian steel companies are on a consolidation mode.  The Tata-Corus deal has set many records.  So far, the only $1 billion-plus deal was done by ONGC, and it’s the first milestone for India Inc, with the Tata deal crossing $10 billion mark.  It’s a landmark deal since an Indian company has taken over an international company three times its size.”

Stressing on the synergies that could arise from this acquisition, Phanish Puram, Professor of Strategic and International Management, London Business School said, “The Tata-Corus deal is different because it links low-cost Indian production and raw materials and growth markets to high-margin markets and high technology in the West.”

On the face of it, the multi-pronged strategy adopted by the company to integrate global assets, enhance raw material security, expand the low cost manufacturing base in India and diversify into logistics could take the company into an era of superior cost and supply chain dynamics. The company is setting up new green field projects in Orissa, Chhattisgarh and Jharkhand states, which are rich in natural resources.  In addition, the company has shown remarkable openness to form 50:50 joint ventures with other domestic and global corporations.  BlueScope Steel, Australia (for coated steel and building products), Larsen & Toubro, India (for deep water port in Orissa), NYK Line, Japan (for shipping bulk cargo), Riversdale Mining, Australia (for coking coal), co-investment with Vale, Nippon Steel, JFE and POSCO (for coal mining in Australia), SAIL, India (for acquisition of coal blocks), New Millennium Capital, Canada (for iron ore) and Al Bahaja Group, Oman (for limestone) are some of the joint venture partners.  These multi-pronged initiatives should strengthen Tata Steel significantly in the years to come.

Six strategic drivers

The success of Tata Steel’s acquisition strategy depends on six primary components: cultural exchange, capital structure stabilization, asset integration, value chain optimization, cost leadership and technological differentiation.  These are also essential to cope with the pressure caused by the acquisition in a period of intense global recession.  The leadership of Tata Steel, headed by Mr Ratan Tata, chairman and Mr B Muthuraman, managing director acted with alacrity from the date of acquisition to put in place a framework that meets the six strategic criteria. 

In one of the first acts, post-Corus acquisition, Tata Steel’s leadership team was expanded to include senior leaders from the Corus group.  The leadership team of Tata Steel continuously engaged the Corus team during the pre- and post-/acquisition phases to ensure mutual acceptance and cultural integration.  To smoothen the integration process, a 3-member Group Corporate Centre and a 6 member Group Corporate Function Team was created with representation from Tata Steel Europe (erstwhile Corus).  The senior management team was also expanded to a total of 23, including 5 senior representatives from Tata Steel Europe.  The integration of decision making and operational review and allotment of key functions such as Group strategy to erstwhile Corus executives helped in smoother cultural and corporate integration.  The two Corus executives were also a part of the five member team which constantly interacted with various stakeholders to address their concerns about the recessionary environment and Tata Steel’s response to the crisis and strategy.  Whether the representation for Tata Steel Europe in the leadership team is adequate or additional skills need to be leveraged could be debated further.

The second critical concern relates to capital structure stabilization.  The equity and debt resources had to be significantly expanded (with more debt than equity) to fund and manage the Corus acquisition.  The gross debt in the Tata Steel Group rose dramatically to USD 10.54 billion in March 2008 essentially because of the Corus acquisition while it increased further to USD 11.78 billion by end March 2009 to fund the growth projects in India and to provide adequate liquidity buffer in the recessionary times.  During 2008-09, the debt instruments were restructured for better terms and the foreign currency term debt in Tata Steel India was hedged into rupees to manage payment pressures and exchange volatility respectively.  The debt-equity ratio which increased from a low of 0.06 in 2005-06 to 1.99 in 2007-08 was contained at 1.65 in 2008-09.  Considering that the company operated at similar high debt-equity levels in the past but managed to improve the situation to a zero debt level eventually, one may expect the company to be successful once again, provided a few other concerns are effectively addressed, as below.

The third important concern is with reference to asset integration.  With Corus acquisition, the assets of Corus accounted for more than thrice the asset base of the original Tata Steel.  Clearly therefore integration of asset base, with implications in terms of paring down of overlapping assets and divesting obsolete assets and building up of required, niche assets in a major challenge.  While several actions were underway at Corus from 2003 to optimize assets, the economic crisis and the acquisition provided a major push to implement a much more aggressive asset restructuring at Corus plants.  Closure of 4 plants, mothballing of 2 plants out of the 15 plants of Corus group was a primary action.  In addition, enhancement of efficiencies and reduction of overheads were taken up at each unit to enhance asset competitiveness.

The fourth plank of the strategy relates to value chain integration.  One of the premises of Corus acquisition was that Tata Steel India would be in a position to provide low cost, high quality crude steel to Tata Steel Europe for conversion into value added products.  This would emerge from a global product-market portfolio plan and integrated supply chain management.  This apart, ensuring raw material security is an essential component of strategy from risk management and value chain perspectives.  Raw material self-sufficiency of the Group reduced to 25% of the requirements post Corus acquisition.  While the current plans envisage enhancement in material sufficiency to 50%, a more aggressive mining and minerals strategy could be required to ensure value chain economics and achieve requisite production assurance.  In addition, tighter integration of the various overseas ventures in the end-product space would be essential for more optimal matching of production and sales profiles across the globe.

Cost leadership is the fifth essential requirement for Tata Steel to enhance its global competitiveness.  Focusing essentially on the high cost, high asset European operations, the Group has taken up “Weathering the Storm” and “Fit for the Future” programs to ensure cost competitiveness in an environment of changed realities.  These comprise a host of measures for asset restructuring, manpower rationalization, overhead review and efficiency enhancement.  Together these programs are believed to have resulted in more than USD 1.2 billion in cash savings to the group during the year.  Durable increases in cost economics would, however, occur only when technology driven cost savings are achieved.  These would relate to better quality of input raw materials, better combustion and conversion efficiencies, energy-efficient operations, reduction of carbon footprint and tighter inventory control through global supply chain management.  Initiatives of continuous improvement in shop floor, logistics and commercial operations need to be combined with break-through initiatives in process and product technologies, for which a more comprehensive plan probably needs to be still developed.

While Tata Steel could be seen have already covered a significant ground on the above five issues, the strategy on the sixth dimension of technological differentiation is still somewhat abstract.  The technological equity enjoyed by Tata Steel’s products relate to their robust specifications and high quality with reasonable costing, together providing considerable value to the customer.  This, however, cannot be the same as a clear technological differentiation in terms of first-in-class products for the market place.  Tata Steel spends only Rs 415.9 million on R&D, which account for just 0.17% of the company’s total turnover.  Clearly, Tata Steel needs to take a quantum jump in R&D expenditure to undertake fundamental research in new material technologies, new coating technologies, nano-functional materials and fluids and material characterization technologies (to name a few areas) in order to ensure a truly differentiated technological position.

In addition, industry specific research needs to be undertaken to dovetail or even proactively lead product development in other industries through first-in-class or best-in-class steel technologies.  Achieving technological leadership through enhanced R&D effort and commitment of requisite resources is a strategic lever that must be put in place by Tata Steel as soon as possible. 

In sum, Tata Steel has accomplished an incredible feat by catapulting itself into the global steel arena as a Top 5 steel producer through the Corus acquisition.  The sustainability of this strategy has been tested by the global economic recession that hit the steel industry suddenly and adversely in 2008.  It is clear that Tata Steel’s strategic initiatives for cultural integration, capital stabilization, asset integration, value chain optimization and cost leadership are firmly in place and have helped the company weather the storm.  Reinforcement of these strategic initiatives with the sixth essential component of technological differentiation based on higher R&D effort would help Tata Steel achieve an unassailable position in the global steel industry.

Posted by Dr CB Rao on September 26, 2009

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