Industrials

Chris Bryant is a Bloomberg Gadfly columnist covering industrial companies. He previously worked for the Financial Times.

Tata's decision to put its U.K. steel assets up for sale means the rather dull subject of pensions is set to become a red-hot issue for Europe's steel industry. How so?

As if weak European steel demand and China's rampant steel exports weren't enough of a problem for the sector, the low interest-rate environment has made funding workers' retirements much more costly. Steelmakers have large legacy workforces so are among those worst affected. 

Potential Partners?
ThyssenKrupp's shares gained this week on hopes Tata's U.K. sale will trigger consolidation
Source: Bloomberg

Even if Tata manages to offload its U.K. steel business, it can't simply walk away from its obligations to a pension plan that has more than 130,000 members.

The regulator has a lot of power to go after so-called connected parties, which in this case may well include Tata Steel Europe and even the parent company in Mumbai, according to John Ralfe, an independent pensions consultant. To cut its ties, Tata may still have to inject about 2 billion pounds into the pension plan ($2.9 billion), Ralfe estimates.

That's a large sum for the Indian steelmaker as its balance sheet is already straining under more than $11 billion of net debt, as Gadfly has noted.

Pensions may also prove a barrier to finding a home for Tata's steel assets because potential partners have issues of their own. An obvious example here is ThyssenKrupp. 

An idea that's gained ground among analysts is that the company hive off its steel businesses in Europe, perhaps by pursuing combinations with some of Tata's European operations. And investors have long favored a separation of ThyssenKrupp's European steel business from its elevator and component units because the latter tend to generate better margins but suffer from a conglomerate discount.

Technology Trumps Steel
ThyssenKrupp makes more money with elevators than it does selling steel
Source: Company presentation (fiscal 2014/2015)

Management have been making more positive noises about European steel consolidation of late. Still, investors shouldn't pin their hopes on the company quickly exiting steel altogether.

Obligations related to Thyssenkrupp's defined benefit pension plans totaled more than 9.7 billion euros ($11 billion) at the end of September, of which two thirds are wholly unfunded. Almost all of that portion is related to Germany, where there is no mandatory funding level and the plan is underpinned by cashflows from ThyssenKrupp's operations.

Pension Pain
ThyssenKrupp has a large unfunded pension liability that could complicate industry consolidation
Source: Annual report

Given the steel unit's weak profitability, spinning it off would therefore present huge balance sheet challenges. The company has 4.4 billion euros in net debt and the ratio of that to its equity is an uncomfortable 130 percent. 

In view of these pension obstacles, investors who celebrated Tata's announcement by sending both companies' shares up more than 6 percent on Wednesday should perhaps be a little more sober.

This column does not necessarily reflect the opinion of Bloomberg LP and its owners.

To contact the author of this story:
Chris Bryant in Frankfurt at cbryant32@bloomberg.net

To contact the editor responsible for this story:
Jennifer Ryan at jryan13@bloomberg.net