Fitch Ratings-Singapore/Mumbai: Fitch Ratings has revised the Outlook on JSW Steel Limited's (JSWS) Long-Term Issuer Default Rating (IDR) to Stable from Negative and affirmed the rating at 'BB'. The agency has also affirmed JSWS's senior unsecured rating and the rating on its senior unsecured notes at 'BB'. A complete list of rating action is at the end of this commentary.
The Outlook revision reflects our view that robust profitability from improved industry fundamentals and a measured approach to capacity expansion will enable JSWS to deleverage steadily over the next few years. We estimate that the company's leverage will remain relatively high, with funds from operations (FFO) adjusted gross leverage at over 4.0x over the next two years, but risks are partly offset by JSWS's healthy EBITDAR margin, which should stay at over 20% to be well above the median for 'BB' rated steel companies. JSWS benefits from efficient operations that cater to structural demand growth in India amid the industry's better demand-supply balance following Chinese capacity cuts.
KEY RATING DRIVERS
Sustained Profitability: JSWS' standalone operations contribute over 90% of its consolidated EBITDA. Standalone steel sales volume was up by 5% yoy in the first nine months of the financial year ending March 2018 (FY18) and EBITDA per tonne (t) remained healthy, at around INR7,630/t (USD120/t). Domestic steel prices followed the rise in international prices with a lag, improving EBITDA/t to INR9,000/t in 3QFY18, from approximately INR6,300/t in 1QFY18. The company has sustained its healthy profitability since FY17, when average EBITDA/t on a standalone basis jumped by around 50% from the FY16 low, as pressure from imports reduced and fundamentals for the broader industry improved.
Improved Industry Fundamentals: China's hot-rolled steel-sheet spot prices have increased to USD650/t, from around USD450/t in April 2017, due to the improved demand/supply balance in the world's largest market and higher raw material costs. Chinese steel exports were down by around 30% in 2017, despite record steel output. China stated in February 2018 that it aims to meet its target of cutting steel capacity by 150 million t in 2018, two years earlier than planned. Fitch expects producers' margins to be largely sustained in 2018, although prices may moderate over the year.
India's steel demand is steady, at around 5% in 9MFY18, and the rate should be sustained in the near term due to government infrastructure spending, improved agriculture-sector income and an overall acceleration in economic activity. Robust international steel prices have rendered India's anti-dumping duties ineffective. However, risks to Indian steelmakers' margins are relatively lower due to regulatory protection should global steel prices trend downward.
Steady Execution, Spending Discipline: JSWS plans to invest around INR270 billion over FY18-FY21 on several projects, including steelmaking capacity expansion at its Dolvi plant by five million t per year by 2020, at a cost of INR150 billion. In addition, JSWS intends expand downstream facilities and revamp existing capacity. Projects that were announced in FY16 are proceeding as planned and are scheduled for completion in FY19. These include a pipe conveyor system for JSWS's key Vijayanagar plant to cut iron ore transportation costs, a tin plate mill and a 1.5 million t per year coke-oven plant. Successful completion should boost the company's sales volume and profitability.
JSWS is considering acquiring assets, including those under insolvency proceedings in India. The company has shown interest in three Indian assets, intending to keep a minority stake and ringfence itself from their liabilities. JSWS has a record of disciplined investment, which has at times meant it was not the highest bidder in competitive bids. We believe this alleviates risk to its leverage profile from its growth ambitions.
Robust Operational Profile: JSWS is India's largest steelmaker by sales volume. The company has a dominant market share in southern and western India, where its plants are located, supported by a rising share of value-added products. Its highly efficient operations are characterised by robust yields and low labour costs, which partly offset its lack of meaningful vertical integration. The company won mining rights for five iron ore mines in Karnataka in 2016. It has commenced production from one mine in February 2018 and aims to produce 4.7 million t of iron ore, or about 20% of the amount needed by its Vijayanagar plant, by FYE19. Captive iron-ore production should improve supply certainty for JSWS and reduce costs to some extent.
Lower Leverage, Improved FCF: We expect FFO adjusted gross leverage to moderate below 4.5x by FYE19 (FYE17: 4.9x, FYE16: 8.0x) due to sustained EBITDA strength from higher sales volume and better performance by subsidiaries. FCF is likely to be modesty positive over the next two years, despite capex pick-up in line with management guidance. We assume acquisition spending in FY19 and use equity method accounting for minority stakes in assets, with debt that does not have recourse to JSWS. A more aggressive inorganic growth strategy is a risk to our forecasts. We have also revised the sensitivities and moved to a gross leverage metric, as we believe this better captures JSWS's financial profile.
Senior Unsecured Rating: Around 60% of JSWS's consolidated debt, including acceptances, was secured as of 9MFY18, resulting in a secured debt/annualised EBITDA ratio of around 2.5x. This indicates the possibility of subordination and lower recoveries for unsecured debt, but further bespoke recovery analysis suggests above-average recovery prospects for senior unsecured creditors. Therefore, we have rated senior unsecured debt and notes at the same level as the IDR.
DERIVATION SUMMARY
JSWS can be compared with domestic peer, Tata Steel Limited (TSL, BB/Rating Watch Evolving), which is rated 'BB-' when excluding a one-notch uplift for potential parental support. TSL's standalone rating is based on a combination of robust operations in India and a much weaker operating profile in Europe. TSL plans to cut its European exposure with a proposed joint venture with thyssenkrupp AG (BB+/Rating Watch Positive), to which it will transfer its European flat-steel assets. However, to resolve the Rating Watch, Fitch awaits details on the joint venture after the signing of definitive agreements. Both TSL and JSWS have business-profile strengths in India, with vertical integration a key advantage for TSL and JSWS's key assets being a position as the market leader in steel sales and cost-efficient operations. The two companies also have a similar leverage outlook.
ArcelorMittal S.A. (BB+/Positive) is rated higher than JSWS, as it is larger and more diversified than JSWS and has lower leverage. However, notching differential is limited by ArcelorMittal's lower margin due to its global manufacturing facilities, including in locations with structurally high costs, such as Europe and the US.
KEY ASSUMPTIONS
Fitch's Key Assumptions within Our Rating Case for the Issuer
- Standalone sales volume compound annual growth rate of 6% over FY18-FY21 (FY17: 22%)
- Standalone EBITDA per t of around INR8,100 on average over FY18-FY21
- Cumulative capex, including acquisition spending, of around INR280 billion over FY18-FY21
- Average dividend pay-out of INR8 billion over FY18-21
RATING SENSITIVITIES
Developments that May, Individually or Collectively, Lead to Positive Rating Action
- FFO gross leverage below 3.5x on a sustained basis
- Sustained neutral or positive FCF
Developments that May, Individually or Collectively, Lead to Negative Rating Action
- FFO gross leverage above 4.5x for a sustained period
- Negative FCF for a sustained period
- Evidence of shift in focus on maintaining investment discipline
LIQUIDITY
Manageable Liquidity: JSWS reported cash and cash equivalents of around INR15 billion and debt of INR435 billion at end-2017. It also had available undrawn credit facilities (fund and non-fund based) of around INR115 billion and revenue and capital acceptances totalling around INR100 billion. We estimate short- and long-term debt due over the next 12 months at over INR100 billion, in addition to the acceptances. We expect JSWS to rely on refinancing, given its inadequate FCF generation, cash balance and undrawn credit facilities. However, the company's banking relationships and access to diverse funding sources, supported by improved industry fundamentals, should allow it to manage its liquidity needs.
FULL LIST OF RATING ACTIONS
JSW Steel Limited
- Long-Term IDR affirmed at 'BB'; Outlook revised to Stable from Negative
- Senior unsecured rating affirmed at 'BB'
- USD500 million 4.75% senior unsecured notes due 2019 affirmed at 'BB'
- USD500 million 5.25% senior unsecured notes due 2022 affirmed at 'BB'