Standard & Poor's Ratings Services said today that it had lowered its long-term corporate credit rating on India-based steelmaker Tata Steel to 'BB-' from 'BB'. The outlook is stable. ''We also lowered our issue rating on the company's guaranteed senior unsecured notes to 'BB-' from 'BB'. ABJA Investment Co. Pte issued the notes,'' it said.
''We downgraded Tata Steel because we expect the company's weak cash flows and compressed profitability to keep its leverage high over the next 12-18 months," said Standard & Poor's credit analyst Vishal Kulkarni. ''We lowered our assessment of Tata Steel's financial risk profile to highly leveraged from aggressive to reflect the company's weakened cash flow leverage ratios. Subdued demand and low steel prices have kept operating performance weak at Tata Steel's India and European operations. We expect the company's operating performance to improve, but only gradually, beginning in fiscal 2017 (year ending March 31, 2017).''
Profitability at Tata Steel's backward integrated India operations has suffered by the more than 40% fall in the average selling prices of steel in the domestic market over the past 18 months. EBITDA per ton declined to about Indian rupee (INR) 8,500 in the quarter ended Sept. 30, 2015, from Rs 15,000 in the previous quarter. The India operations contribute a significant part of the consolidated group EBITDA. Steel prices have come down globally in line with the decline in iron ore and coking coal prices. In addition, demand is likely to stay subdued and production volumes should remain largely stable.
Exports from countries in Asia and Eastern Europe with excess capacity have further contributed to lower prices in India and Europe. Steel imports, priced competitively, increased to about 10% of domestic demand In India in fiscal 2015, further pushing down domestic prices and the profitability of local steel producers.
The India operations also faced some regulatory challenges in fiscal 2015, which we believe Tata Steel has largely addressed. Disruptions in the mining of iron ore, coal, and ferro chrome increased raw material costs and lowered EBITDA in the past 12-15 months. ''We expect the resumption of mining to partly help restore profitability. However, profitability is unlikely to revert to the historical highs (of about Rs 13,000-Rs 15,000 a ton) over the next two years, given the steep fall in steel prices,'' the rating agency said.
Tata Steel's new steel facility in the state of Odisha in India has been delayed and will now come on-stream in the last quarter of fiscal 2016, more than a year later than we had previously expected. This delay has pushed back the potential improvement in the company's financial ratios. Even with incremental production from Odisha and possibly higher margins in India, Tata Steel's ratio of funds from operations (FFO) to debt will still remain below 10% over the next two years.
S&P expects the company's debt to remain high and free operating cash flows to remain negative until fiscal 2018, the report stated.
Tata Steel's European operations continue to face tough operating conditions.
Volumes were slightly low as demand remained sluggish and imports increased. Fixed costs stayed high at certain facilities and currency movements were unfavorable for profitability. "In our view, Tata Steel's intent to restructure its weaker operations in Europe could usher in operating stability and better margins. However, downside risks remain for European operations due to competitively priced imports, high costs, anemic demand, and potential delays in meaningful restructuring."
S&P said, "In our view, any significant improvement in steel demand in India is tied to several factors. These include the implementation of various infrastructure projects and restarting the capital expenditure cycle to enable job creation, which could result in growth in both housing and auto demand. The Indian government's steps in this direction, although well intentioned, could take some time to result in real demand growth. While global steel capacity utilization remains at less than 70%, low raw material prices help marginal producers in maintaining their production levels, causing a supply glut. Therefore, an improvement in prices will be only gradual and imports will likely remain competitive."
''We expect Tata Steel's financial risk profile to approach the stronger end of the highly leveraged category over the next two years. The gradual recovery in profitability at the India operations and stability at the European operations will support the improvement in financial ratios. Also, when compared with peers, Tata Steel is at the upper end for the rating. We therefore assign a positive score to Tata Steel in our comparable rating analysis,'' it said.
''The stable outlook reflects our expectation that Tata Steel's operating performance will gradually recover over the next 12-15 months,'' said Kulkarni. A gradual improvement in profitability at the India operations as mining operations revert to pre-disruption levels and demand and steel prices pick up from current lows should support the recovery in the company's financial ratios. The stable outlook also envisages the additional production from the new Odisha facility and stable operating performance in Europe over the next 12 months to improve the company's currently weak EBITDA interest coverage to 2.0x in fiscal 2017.
Further the rating agency said, "We could lower the rating if the improvement in Tata Steel's operating performance is weaker than we anticipated, such that we expect EBITDA interest coverage to remain below 2.0x for a prolonged period. EBITDA per ton stagnating below Rs 8,000 at the India operations will likely result in such weakness in operating and financial metrics.
Rating upside is unlikely over the next 12 months because we expect the improvement in Tata Steel's operating and financial performance to come only gradually. Nevertheless, we could upgrade the company if the FFO-to-debt ratio stabilizes near 15%. This could happen if EBITDA per ton at the India operations reaches Rs 15,000 sustainably; strategic fund raising could further help swifter deleveraging."
