GuestPost ValuePick

Value Pick:A qualitative analysis of Tata Sponge

The guest post below is written by Krishnaraj Venkataraman, also known as Kimi.  Kimi has been an entrepreneur, and after selling his last business, now runs an investment partnerships that seeks to invest capital in undervalued securities in India.-Raoji


Benjamin Graham begins his seminal book Security Analysis with a quote by Horace, “Many shall be restored that now are fallen, and many shall fall that now are in honor”. With Indian politicians rushing to demonstrate the latter; investors such as me search for the former. One such candidate is Tata Sponge.

The rush to sell

Tata Sponge is a small and relatively obscure firm run in an obscure place making an obscure product called Sponge Iron. Experts have prognosticated a poor outlook for steel industry – the end user of sponge iron; raw material inputs like iron ore & coal and power are either not available or shockingly priced; steel scrap, a sponge iron substitute is available cheaper. It could get worse, and the industry as such is reeling under heavy debt and low capacity utilization – the business equivalent of a gas chamber. Some will surely not survive, and many others will be hurt badly.

Shareholders are petrified and are crowding to exit; and in that they are indifferent to the value of the stock. Who would want to hold when business is sure to decline in the next quarter and foggy after that?

However, the very act of such unrestrained selling pushes price far below levels indicated by good sense.

Characteristics of the business of Tata Sponge

Tata Sponge sources iron ore fully from the mine of its parent (at a discount to NMDC rates) and imports a good part of its coal needs, eliminating uncertainty of availability. It also generates its own power eliminating another source of availability uncertainty. (Makes you wonder if India is the only large economy where availability of any economic resource is the first consideration, and its cost is a distant second)

Tata Sponge operates its plant at near full capacity; and runs it well. For instance it tries to continuously minimize the coal and power needed to make a unit of sponge iron. Further the quality of sponge iron produced is consistent in its Iron content and weight – important consideration for customers. Operating a plant at full capacity allows its fixed costs to be spread over the largest possible quantity minimizing per unit costs of sponge iron – not to mention time and costs saved from rampant start-ups and shut-downs.

The advantages above add to a few vital points in margins where the selling price is out of control. However the trump card lies in its profitable power business. Tata Sponge uses waste heat from the sponge iron making process to generate power, 2/3rds of which at full capacity is sold to the local state electricity board. The marginal cost involved is about 30 – 40% of the price at which power is sold to the grid. These profits are independent of the sponge iron prices allowing the bottom-line to escape to an extent the cyclical nature of the sponge iron business.

Further Tata Sponge has turned a profit every year in the past since 1992, even under worse economic conditions than exists today.  In other words, it is reasonable to assume that Tata Sponge operationally should do OK under trying circumstances and quite good otherwise.

There’s another vital difference that separates the best from the rest especially during periods of high interest rates, viz., capital structure. Tata Sponge is practically debt free and none of its peers seen is. A debt free capital structure allows all the operational excellence to flow through to the bottom-line. This has added qualitative advantages as well – no covenant breach, no loan restructuring and no short term measures taken to meet loan liabilities.

The outcome is an economic performance that is far superior to the average Indian company; a Return on Equity of about 30% averaged over the last 20 years!

Comparing value with price for Tata Sponge

After a reading of the above one may conclude that Tata Sponge is more valuable alive than dead but the market seems to think the exact opposite. Not only that, the market thinks that Tata Sponge is worth even much less than its value as a closed shop. There cannot be any other conclusion reached when we find that it is changing hands at 68% of its Book Value as of 11 May 2013. This, even as it uses as it uses only about 30% of its Book Value for its core business; 25% on advances for a coal block allocated to it and the remaining 45% as cash and liquid assets.

Clearly a case of fallen honor that should be restored!


  1. Sources are Annual and Quarterly Reports and Industry numbers publicly available.
  2. Reasonable and practical assumptions have been made wherever necessary. Conclusions won’t be affected by minor changes in assumptions.
  3. We have long positions in the firm.
  4. Comments welcome at



21 replies on “Value Pick:A qualitative analysis of Tata Sponge”

thanks very good analysis and it is understood so simply by a lay person retired person like me Thankfully no jargon

God bless

Good analysis – thanks! There is no doubt that the stock is cheap. Any thoughts on why the dividend pay-out is low (only Rs.8 out of Rs.55 EPS). Also, do you know what they plan to do with the cash surplus of Rs.360 crore? Do you see any triggers or catalyst for the stock to go up? (i.e. for the “fallen honor to be restored”). Thanks again!

Dear Wilfred:

Thanks for your comments. I am glad you found it jargon free .

Dear Paddy:

I think the dividend payout is low to accumulate capital. This capital will fund Capex plans for adding a steel plant and developing the Coal block. I guess that is what they intend to do with most of the cash.

Also another point that often gets overlooked is that there is a frictional cost by way of taxes of 17% whenever dividend is paid – that discourages increased dividend payouts.

No idea how honor will be restored 🙂

Thanks for all your comments

I too agree with Mr.Wilfred, No Jargon simplicity and easy to understand to a layman.Your analysis is really very very deep and also
very clear .
Although the steel ind is passing through the bad patch , that may be only the Hitch or SEBI’s declaration of ILLIQUID stock may hamper the
price, else very good for long term.

God Bless you

Good Analysis. At today’s market pr ice of 250 per share the market cap of the company is 385 cr while the company had cash of about 360 cr as on March 31,2013. That means the business which generated PAT of about 85 cr last year, Cash flow from operations of about 111cr, free cash flows (operating cash flows-capex) of 99 crs!!!!. Further in context all of valuation PE-5.2x (TTM), Price/Book of 0.6x, is debt free, last year RoE was about 14% that was because of high cash component on balance sheet which must be earning 4-5% post tax……

Just wanted to check if I am making mistake at 02/08 price of 236 per share the stock is being valued at cash per share on balance sheet? As on 31/03 the company had 361 cr of cash (234 cr of cash and 126 cr of current investment) divided by 1.54 cr shares? Am I making a major mistake?

Disclaimer- I have a position in the stock

@Nitin – I think you are correct. I am long on the stock as well and hope it falls more without much reason actually 🙂

Hi Kimi,

Nice connecting with you. Just saw an announcement to stock exchange that Ruanne, Caniff and Goldfard Inc have increased their stake by 1%. I believe this is part of Sequoia fund of US known to be good value investors.,_Cunniff_%26_Goldfarb.

However I am worried about one thing in this stock … what are the triggers for it climb? You have any opinion on that?

Also don’t you think this would be a good time for the management to go for a buy back I mean you increase value for shareholders?

Hey Nitin:

Sorry, I came here after a while so not sure if my response will be relevant still. Why don’t you write to me on my email and we can continue from there?

I really do not know or bother too much about the trigger. I also think chances of a buyback are less because the firm is in an industry which will generally be in need of capital.

I too saw RCG buy shares of TSIL but that has no bearing on my assessment.



Nice hearing from you. Hope you and your investments are doing well.

I want to write back to you but don’t have your email….


Excellent analysis of a hidden gem. What o you think of the sharp upward move recently? Do they have any major customer other than Tata Steel? Any reason why Tata Steel may want to acquire this company, which will need further debt in its books? Should one exit at Rs 400?

Thanks for an outstanding report. One of the best ‘value’ analyses I have seen. Do you think some day steel companies will make do without sponge iron or use a better substitute? Also,is the company likely to be sold by Tata group?

Dilip Mehta P.S. Will welcome looking at similar in-depth reports on other companies. Could we chat? My contact no. is (0) 99800 18722.

Dear Mr. Mehta,

First of all my apologies for not replying for many days…was really pre-occupied. In my limited knowledge as long as significant capacity of induction and electric arc furnace plants in India…sponge iron would continue to be in demand. Ofcourse cyclicality associated with steel would remain. I don’t think with kind of efficiency of operations, natural resources (coal mine) and synergies with Tata Steel this company would be sold by Tatas. Infact merger with Tata Steel could be a possibility. Tata Steel recently hiked stake to over 51%.

My number is 9810543689. I will be traveling and will call you once I am back.Would definitely want to hear your views on various value investing ideas.


Thanks , Nitin, for an excellent response.
Do you have similar reports for some other value picks?

Hi Karthikraja,

Is that question for me? I understand that there are more than one Nitin’s on the forum.


Excellent analysis, which was made a couple of years back when the stock price was Rs 200+. At the CMP of around 600, does it hold good, particularly, due to the industry being in dire straits ?

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