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Risk and Return-Part

Tata Steel faces various strategic, operating, financing, and legal risks as a global steel company. It has an enterprise risk management framework to take on certain risks and mitigate others. Its debt levels and returns on equity are high compared to peers, exposing vulnerabilities. While Tata Steel's stock outperformed the market in the past, it has underperformed recently. The company's weighted average cost of capital is higher than its returns on invested capital, indicating it is destroying value.

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85 views

Risk and Return-Part

Tata Steel faces various strategic, operating, financing, and legal risks as a global steel company. It has an enterprise risk management framework to take on certain risks and mitigate others. Its debt levels and returns on equity are high compared to peers, exposing vulnerabilities. While Tata Steel's stock outperformed the market in the past, it has underperformed recently. The company's weighted average cost of capital is higher than its returns on invested capital, indicating it is destroying value.

Uploaded by

qwertyzaz1989
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© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
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B3: Risk and return

What is the risk profile of your company?


As a global entity, Tata Steel is exposed to risks as well as opportunities in equal measure.
Recognising this, the Company has a robust Enterprise Risk Management (ERM) framework that
allows the organisation to take certain risks in order to be competitive and to mitigate other risks
to drive sustainable results.
Strategic risks

Macro environment and global steel over capacity impact operating markets:
Long term growth dependent on success of capacity expansion projects, restructuring.
Ensure that its plants are equipped with updated technologies in order to serve clients,
secure cost competitiveness and maintain R&D leadership

Operating risks

Supply chain disruptions could increase operating costs.


Balancing economic value as well as ecological and societal value
Increasing competition and customer expectation
Price volatility of raw materials
Growth projects and social license to operate

Financing risks

Adverse movements in credit rating and level of indebtedness could affect financial flexibility
Impairment of tangible and intangible assets
Financing for the Odisha project was a specific risk to the Company given the
volatility in the global financial markets and the availability of credit
Volatility in the currency markets can adversely affect the outcome of
commercial transactions and cause trading uncertainties

Legal risks

Regulatory environment & compliance


Legal proceedings

Performance profile of Investment in the company

The performance profile of the company is quite uneven. For the major part of
the last 15 years, Tata Steels share is doing better that Sensex/Nifty. An investor
having invested in Tata Steel on July, 2002 would have earned a whopping 1626
% return on selling it on April 2006. But since the later part of 2014, Tata Steels
stock has been underperforming the Sensex.

Risk in companys equity and debt

A sharp decline in steel demand in China has battered the finances of global
steel makers, exposing chinks in Tata Steel armour. With debt to equity ratio of
2.0, highest amongst its peers the company. At the end of FY15, its consolidated
debt was twice the equity (or net worth), and much higher than the industry
average of 70 per cent. At 10, the company's gearing ratio (debt to operating
profit) is also among the highest in the industry

Return on Equity or ROE tells company stockholders how effectually their money
is being utilized or reinvested. It is a useful ratio when analysing company
profitability or the management effectiveness given the capital invested by the
shareholders. ROE shows how efficiently a company utilizes investments to
generate income. Tata Steel return on equity is - 10.5% . Tata Steel is
rated below average in return on equity category among related companies.

Cost of Equity and Debt


Cost of Equity = Risk-Free Rate of Return + Beta of Asset * (Expected
Return of the Market - Risk-Free Rate of Return)
a) Based on 10-Year Treasury Constant Maturity Rate as the risk-free rate the
current risk-free rate is 2.05%..
b) Beta is the sensitivity of the expected excess asset returns to the expected
excess market returns. Tata Steel Ltd's beta is 1.22.
c) (Expected Return of the Market - Risk-Free Rate of Return) is also called
market premium. Market premium is 7.5%.
Cost of Equity = 2.05% + 1.22 * 7.5% = 11.2%
As of Mar. 2015, Tata Steel Ltd's interest expense (positive number) was
44307.9 Mil. Its total Book Value of Debt (D) is 688482.35 Mil.
Cost of Debt = 44307.9 / 688482.35 = 6.4356%.
WACC =

E / (E +
D)

= 0.2307

Cost of
Equity

* 11.2%

D / (E +
D)

+ 0.7693

Cost of
Debt

* 6.4356%

* (1 - Tax Rate)
* (1 -

-69.735%)
= 10.99%

As of today, Tata Steel Ltd's weighted average cost of capital is 10.99%. Tata
Steel Ltd's return on invested capital is -7.65%. Tata Steel Ltd earns returns that
do not match up to its cost of capital. It will destroy value as it grows.

Capital Structure:

From
Year

To
Year

Class
Of
Share

Authorize
d Capital

Issued
Capital

Paid Up
Shares
(Nos)

Paid
Up
Face
Value

Paid
Up
Capital

2014

2015

Equity
Share

2,100.00

972.1

97121543
9

10

971.22

2013

2014

Equity
Share

2,100.00

972.1

97121540
5

10

971.22

2012

2013

Equity
Share

2,100.00

972.1

97121522
9

10

971.22

2012

Equity
Share

972.1

97121445
0

10

971.21

2010

2011

Equity
Share

2,100.00

960.1

95921445
0

10

959.21

2009

2010

Equity
Share

1,750.00

888.1

88721419
6

10

887.21

2008

2009

Equity
Share

1,750.00

731.4

73059247
1

10

730.59

2007

2008

Equity
Share

1,750.00

731.4

73058432
0

10

730.58

2006

2007

Equity
Share

1,750.00

581.1

58047285
6

10

580.47

2006

Equity
Share

554.1

55347285
6

10

553.47

2004

2005

Equity
Share

600

554.1

55347285
6

10

553.47

2003

2004

Equity
Share

440

368.4

36777190
1

10

367.77

2002

2003

Equity
Share

440

368.4

36777190
1

10

367.77

2001

2002

Equity
Share

440

368.4

36777190
1

10

367.77

2001

Equity
Share

368.4

36777190
1

10

367.77

1999

2000

Equity
Share

440

368.4

36777188
0

10

367.77

1998

1999

Equity
Share

440

368.4

36777151
2

10

367.77

1997

1998

Equity
Share

440

368.4

36813740
5

10

368.14

1996

1997

Equity
Share

440

368.4

36813656
8

10

368.14

2011

2005

2000

2,100.00

600

440

1995

1996

Equity
Share

440

368.4

36815208
5

10

368.15

The pressure on steel realisations and cost increases for Indias operations led to
a sharp 24 per cent year-over-year decline in Ebitda in FY2015 to Rs 10,100
crore. This pushed Tata Steels leverage to 6.8 times, breaching the downward
rating trigger.

Beta values of Tata Steel

Daily One
Month
Range
1.73
2.29
379.94
223.88

Long
Term
Beta *

Period
Beta
Mean
Standard
Deviation

13.88%

Daily Three
Month
Range

3.43%

Weekly
Weekly - Two
One Year
Year
Range
Range
1.93
0.865
1.23
246.41
343.19 389.87
3.24%

4.35%

5.16%

Fortnightl
y - Two
Monthly - Two
Year
Year Range
Range
1.11
1.48
389.48
389.5
6.95%

Bottom up beta of Tata Steel


To calculate the bottom-up beta for Tata Steel, the industry average of the
financial and operating leverage has to be considered.

12.04%

Unlevered Industry beta


Average regression beta = 1.16
Average debt-equity ratio = 1.77
Average effective tax-rate = 9.75%
Un-leveraged beta = Regression beta/ {1+ (1-tax-rate)*debt-equity ratio}
Un-leveraged beta = 1.16/ 1 + (1-.0.0975)*1.77 = 0.44
The above results in the effect of the financial leverage being eliminated.
However the effect of operating leverage also needs to be addressed.
Business beta = Unlevered beta/ {1+ (fixed to variable-ratio)}
Business beta = 0.44/ {1+ (0.13)} = 0.38
The figure of 0.38 purely reflects the risk of operating in the steel industry
without taking into consideration leverage of any sort. This number forms the
base from which Tata Steels beta will be calculated. As Tata Steel operations are
levered (both operationally and financially), the business beta has to be adjusted
to capture this difference.

Unlevered beta of Tata Steel (adjusted for its operating leverage)


Business beta = 0.38
Fixed/variable cost ratio = 0.32
Unlevered Beta of Tata Steel = 0.38 * (1+0.32) = 0.50

If Tata Steel had borrowed no money and the whole company was funded entirely
by equity, then the beta of the stock would be 0.50. However, the company has
a proportion of debt for which its beta needs to be adjusted

Levered Beta of Tata Steel (adjusted for its financial leverage)


Unlevered beta = 0.50
Debt-equity ratio = 0.4
Effective Tax rate = 30.66%
Levered beta = Unlevered beta * {1+ (1 - effective tax rate) * debt-equity ratio}
(1-tax rate is used in the formula as interest payments are tax deductible).
Levered beta of Tata Steel = 0.50 * {1+ (1-0.30)*0.4} = 0.64
The bottom-up beta for Tata Steel which captures the nature of the business in
which it operates, its operating leverage and the financial leverage works out to
be 0.64.

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