What Essar Steel Brings To The Table For ArcelorMittal

ArcelorMittal emerged as preferred bidder for Essar Steel. BloombergQuint looks at what it gets and the challenges it will face.

Molten steel is poured at a steel factory in Hisar, Haryana, India. (Photographer: Udit Kulshrestha/Bloomberg)
Molten steel is poured at a steel factory in Hisar, Haryana, India. (Photographer: Udit Kulshrestha/Bloomberg)

ArcelorMittal emerged as the preferred bidder for Essar Steel Ltd., bringing billionaire Lakshmi Mittal a step closer to taking control of one of India’s largest insolvent companies.

Essar Steel, India’s third-largest steelmaker, has the sole integrated steel mill in the western region with an annual capacity of 10 million tonnes a year, according to data compiled by BloombergQuint. “A big capacity, locational advantage and a diversified product portfolio within flat products makes Essar Steel an attractive bet,” said Jayanta Roy, senior vice-president at ICRA.

BloombergQuint looks at what ArcelorMittal gets and the challenges it will face:

Hazira Unit: Large Capacity, Locational Advantage

Essar Steel runs a gas-based 10 MTPA fully integrated facility at Hazira, Gujarat. It also has processing and distribution centres in Hazira, Pune, Chennai, Indore, Bhuj, Delhi-National Capital Region, Kolkata, besides three overseas locations, according to its website.

Since it’s a fully-integrated plant—raw material to finished products— that helps the company save costs. Moreover, access to a dedicated port ensures easy movement of raw material and finished goods. That also reduces the cost of expansion for any potential acquirer, according to Rakesh Arora of Go India Advisors.

The Hazira facility is the only plant in the world to have three crucial iron-making technologies at a single location—blast furnace, direct reduced iron or midrex, and corex or smelting reduction process. It has the world’s largest direct reduced ironmaking plant with a capacity of 6.8 MTPA. The unit is fed by slurry pipelines carrying iron ore from Essar Steel’s mines to its pellet plants.

Product Mix

The company produces flat steel products, including slabs, hot-rolled and cold-rolled coils, plates, galvanised products and pipes, among others, that are used from automobiles, construction to warships. These higher-margin value-added products constitute the entire portfolio of Essar Steel. Flat steel products form 74 percent of JSW Steel’s and 72 percent of Tata Steel’s portfolio.

Captive Iron Ore Supply

Essar Steel won a 99.6-million-tonne Ghoraburhani-Sagasahi iron ore block in Odisha—ensuring better profitability when prices of the steelmaking raw material are higher globally and at home. Over the last six months, domestic iron ore prices increased 40-45 percent.

To be sure, Goldman Sachs said any fall in domestic iron ore prices will benefit partially integrated steelmakers like JSW Steel.

Slurry Pipelines

Essar Steel’s Paradip and Vizag pellet plants are linked to iron ore mines through 253-km and 267-km slurry pipelines from Dabuna to Paradip (Odisha) and Kirandul to Vizag (Andhra Pradesh). These lines transport the beneficiated iron ore slurry to the pellet plants and then export it to the steel plant at Hazira.

Typically, the slurry is transported from mines to port through railways or trucks. Slurry pipelines are environment friendly and cheaper than the other modes of transportation.

The Challenges

Committed Natural Gas Supply

Nearly 70 percent of Essar Steel’s production is through direct reduced iron-making technique. Direct reduced iron, or sponge iron, is created when iron ore is reduced to metallic iron using natural gas or coal. A disruption in the committed gas supply for the company will lower its capacity utilisation.

“Essar Steel requires 6 million standard cubic metres per day of natural gas as feedstock for the steelmaking,” according to rating agency Crisil.

In 2016-17, it used 2.23 mmscmd for functioning at 55 percent of its capacity, Rahul Prithiani, director at Crisil Research, said. While the acquirer can import gas through the port in absence of domestic availability, he said, this can eat into its cost of production.

Higher Cost Of Production

Essar Steel’s realisation per tonne is higher than JSW Steel’s but lower than that of Tata Steel Ltd., according to Crisil. But its Ebitda per tonne is significantly lower because of account of higher cost of production due to greater energy and logistics costs, according to Crisil’s Prithiani.

The acquirer may face challenges to efficiently manage the plant given its past financial performance compared to peers JSW Steel and Tata Steel, according to data provided rating agency Crisil.

Non-Cooperation From Essar Port

Essar Steel’s port facilities are run by Essar Port—the country’s second-largest private port company with a total capacity of 110 MTPA. Located on the western coast, the port is used to import iron ore, pellets, limestone and other dry bulk cargos, and export finished products.

Essar Port is also a creditor to Essar Steel and is required to take a haircut for its exposure to the insolvent company. So, if the port operator decides not to extend full its cooperation, the acquirer may face some trouble.

Ongoing Litigation On Odisha Slurry Pipeline

In 2015, Essar Steel sold its holding in Odisha Slurry Pipeline Infrastructure to Srei Infrastructure, a transaction which was objected by banks who challenged it in the court. The Reserve Bank of India was also against the move. Lenders had moved both the Calcutta High Court and the National Company Law Tribunal with a plea to reverse a sale and leaseback last year. Again, in February 2018, lenders to Odisha Slurry Pipeline moved the Delhi High Court seeking a stay on the sale of a 70 percent stake in the pipeline. Hence, a lack of ownership of slurry lines or a delay in judgement on the ongoing litigation may be an operational risk for the company.

Also, any disruption in slurry pipelines as seen during the Maoist attack on Essar Steel’s Kirandul-Vizag line in October 2011 can add to the operational costs.

Employee Costs

Clearance of dues to employees, statutory liabilities and any additional expenditure by the successful bidder to turn around Essar Steel’s operations will pose a challenge, according to Abhizer Diwanji, partner and national leader-financial services at EY India.