After stoking hopes of a long-term commodity supercycle, Tata Steel’s Q3FY22 quarterly performance indicates the various steps the company is taking to adapt to rising costs, invest for future growth, and reduce its carbon footprint.

Although consolidated revenues in Q3FY22 rose marginally QoQ to Rs 60,783 crore, it was the near 50% YoY rise that has set the base for future revenue expectations.

One way to look at this is that due to flat volumes on a YoY and QoQ basis, the company also posted flat revenues on a sequential basis. The other way to look at this, however, is the falling delivery volumes for Tata Steel. Sometime after Q4FY21, the company’s production volumes peaked, and so did deliveries of steel products to customers. There was a surge in steel delivered to customers in Q2FY22, but this fell again in Q3FY22.

High input costs to put pressure on realisations

In the earnings call, Tata Steel’s management pointed to the rising cost of coking coal as one-factor impacting margins. The company did sew up a few price hikes in November and December 2021 that will kick into gear in 2022, which could help improve realisations.

But the company’s management noted that it has seen a Rs 3,500 per tonne impact on realisations already in Q4FY22. This will hurt its margins and EBITDA per tonne further. Still, in YoY terms, Tata Steel’s consolidated EBITDA in Q3FY22 is double that of Q3FY22. That shows what a profitable journey the last 12 months have been for Tata Steel.

Capacity expansion and cutting debt, judiciously

Investors should note here that Tata Steel has been cutting debt aggressively and has now brought down its net debt to EBITDA ratio to below 1 at the end of December 31, 2021, and net debt to equity ratio to 0.68. But is Tata Steel being conservative in investing in capacity expansion to pay off debt while also allocating cash flows for capex?

The company says that it is focused on balancing growth with deleveraging, which means it will not disavow growth just because it is focused on cutting debt. This can be seen in the recent acquisition of Nilachal Ispat by the company’s subsidiary Tata Steel Long Products. Although Tata Steel Long Products does not have the balance sheet strength to fund the expansion plan of nearly 4X its current one million tonnes per annum volume, the funds will be raised on Tata Steel’s balance sheet strength. The company plans to structure this debt to make sure Tata Steel Long Products uses it for expanding Nilachal Ispat’s capacity at its integrated steel plant.

Decarbonisation throws a twist into capex plans

Although Tata Steel’s management says that the company has tied up supplies of iron ore till 2030 (or the foreseeable future), it expects additional capex spending to shift its manufacturing process away from fossil fuel-fired furnaces. In this, it has experimented with coal bed methane in Europe, which is the first time ever in the industry, according to the management.

CEO and Managing Director T.V. Narendran noted that while the company is committed to decarbonising its production process, the steel manufacturer cannot bear the whole burden of transitioning to “green steel”. The company will invest to bring down the carbon intensity of its manufacturing process, but the customer and the government also have to contribute to the transition. The management pointed out that in Europe, there are subsidy programmes that are helping steelmakers to share the burden of transition to green steel. And customers will also have to pay more for green steel.

In India, the transition to less carbon intensity is dependent on how quickly India is able to spread its gas pipelines into eastern states. The infrastructure to enable switching to natural gas or hydrogen to fire up a furnace is still not available, despite the government’s recent announcement for a program to boost hydrogen production for industrial use. But the Centre is investing through PSUs to expand the natural gas grid in eastern India. This could also help India advance towards the 2070 target of the country being net carbon neutral.

That means steel companies will essentially have to retrofit their existing plants and plan new capacity additions to be able to run on so-called green fuel. This is akin to developing a new steel plant for existing plants that have a long useful life.

Demand headwinds persist, but exports also dip

One of the main industries Tata Steel supplies steel to is the auto industry, and it has been impacted severely in Europe and in India because of the ongoing semiconductor shortage pervading through various industries. This affected the company’s European businesses’ performance. Although the company will be able to recover higher prices in Europe, volumes are already back to pre-Covid levels.

The fall in realisations in exports is also something that contributed to the management’s comment about falling realisation, which could affect the company’s margins going forward. If we add into this China’s various measures to control runaway steel prices, and then curbs of production of steel to cut carbon emissions, it’s a very hazy scenario to assess where coking coal and steel prices are headed.