Fitch Ratings has revised the Outlook on India-based Tata Steel Limited (TSL) and Tata Steel UK Holdings Limited (TSUKH) to Negative from Stable. Fitch has affirmed TSL's Long-Term Foreign Currency Issuer Default Rating (FC IDR) at 'BB+' and its National Long-Term Rating at 'Fitch AA(ind)'. TSUKH's FC IDR has been affirmed at 'B+'. A list additional rating actions is provided at the end of this commentary.
The Outlook revision reflects Fitch's view that profitability pressures will remain for TSL and TSUKH given the challenging short-term outlook for the global steel market. In FY12 (year end March), consolidated EBITDA margins fell to 9.3% (FY11: 13.5%) driven by the challenging operating environment. Thus, net financial leverage (net debt/ operating EBITDAR) increased to 4.27x (FY11: 3.25x), beyond Fitch's negative rating guideline of 4x. Leverage is likely to remain around the current levels during FY13 before improving in FY14 on the back of volume growth in Indian operations and an improvement in operations at TSUKH.
In FY12, TSUKH's performance deteriorated with the entity recording operating losses in two quarters. The company reported a fall in EBITDA margins to around 2% in FY12 from around 6% in FY11. Fitch notes that TSUKH has taken various initiatives to improve its profitability, like improving operational efficiencies, upgrading facilities & technology and rationalising capacities, focusing on a higher value-added product mix and improving supply chain management. Fitch however expects TSUKH's profitability to remain volatile due to fluctuations in raw material prices and the prevailing weak steel markets in Europe.
Fitch expects the steel demand in India to be impacted in the near term due to the slowing demand growth in various end-user industries. Also, TSL is likely to drive only partial benefit from its additional 2.9mtpa brownfield capacity during FY13, with full benefits expected to accrue from FY14. While TSL's Indian operations will continue to benefit from raw material integration, any significant and sustained drop in steel prices may have a negative impact on the performance of the consolidated entity.
Fitch continues to take a consolidated view of TSL in line with its Parent and Subsidiary Rating Linkage methodology, with TSUKH's ratings benefiting from potential parental support. TSL's ratings continue to benefit from one-notch of uplift derived from Fitch's assessment of potential support from the Tata group due to the former's strategic importance to the group.
The ratings continue to benefit from the strong liquidity of TSL and TSUKH with consolidated cash and bank balances of USD2,398m and access to undrawn lines of USD961m as at end-March 2012. Also, the limited repayments at TSUKH in the next three years also support liquidity.
WHAT COULD TRIGGER A RATING ACTION?
Negative: Future developments that may, individually or collectively, lead to negative rating action include:
Positive: The current Rating Outlook is Negative. As a result, Fitch's sensitivities do not currently anticipate developments with a material likelihood, individually or collectively, of leading to a rating upgrade. However, strong profitability supported an improvement in steel markets resulting in net financial leverage improving to below 4x levels may result in the Outlook being revised to Stable.
Rating actions on debt instruments are as follows:
Secured bank facilities aggregating around GBP3.6bn affirmed at Long-Term 'BB-' with a recovery rating of 'RR3'.