The two companies' operating results for FY2016 while weak, were in line with our revised expectations in February at the time of the ratings downgrade.
Tata Steel reported consolidated revenue of INR1,172 billion and consolidated underlying EBITDA of INR79 billion, down 16% and 39% respectively from a year ago. Although, the results for the quarter ended March 2016 (QE3/2016) showed a substantial improvement over the previous trailing quarter with consolidated revenue and EBITDA of INR295 billion and INR23 billion, an increase of 5% and 171% respectively. The improvement in the operating performance was a result of the general uptick in global steel prices in February and March, after an all-time dip in January.
"We estimate consolidated adjusted leverage of 8.7x at March 2016, slightly below the peak of 9.0x at December 2015. Looking ahead into FY2017 we expect leverage to correct towards 6.5x-7.5x," says Kaustubh Chaubal, a Moody's Vice President and Senior Analyst.
Tata Steel's reported gross debt of INR862 billion at March 2016 rose by only INR55 billion from March 2015 debt levels, despite capital expenditure of INR115 billion and weak operations during the year.
"The proposed sale of the long products business to Greybull Capital (unrated) and the company's intention to sell its UK business are credit positive, although there is no immediate impact on our ratings or outlook," adds Chaubal, who is also the Lead Analyst for Tata Steel and TSUKH.
"The divestment of the loss making operations will reduce the drag on the European business' profitability which has been under strain for a while; although much is unknown about the divestment contours including debt and pension liabilities to be transferred, which in particular will drive the impact, if any, on the ratings and outlook on Tata Steel and TSUKH," continues Chaubal.
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Tata Steel's India (TSI) business revenues and underlying EBITDA of INR382 billion and INR74 billion were down 9% and 27% from last year. EBITDA/tonne of INR7,744 for the full year was down 33%, although for QE3/2016 was higher by INR1,563 over the previous trailing quarter and represented price increases effected in February and March.
Tata Steel's European operations reported revenue of INR674 billion and underlying EBITDA loss of INR6 billion, down 16% and 115% respectively for fiscal 2016. Steel prices in Europe also remained weak with cheaper imports from China and Russia. Tata Steel's European operations registered a sharp 115% drop in its EBITDA/tonne to negative INR439 in FY2016.
In our view, continuing protectionist measures are imperative especially as global steel over supply prevails, exerting pressure on prices globally.
In India, we see the extension of the safeguard duty for three years until 2019 from an initial 200 day period, the imposition of an minimum import price (MIP) on some 173 grades of steel imports (in its current form until early August 2016), and a possible antidumping duty, as a reflection of continuing support for the ailing steel sector.
In Europe, we expect the European Union's (EU) anti-dumping duties on steel imports from China and Russia to provide some support to steel prices.
Increase in TSI's production with the commissioning of 3 million tonnes per annum (3mtpa) greenfield expansion at Kalinganagar which started commercial production in May 2016, a higher proportion of value added products in its product basket, and the expected completion of the restructuring of Tata Steel Europe will drive earnings expansion for Tata Steel and TSUKH and lead the path towards leverage correction.
We will watch out for the progress on the UK business divestments; clarity on divestment of liabilities including pensions and erasing the negative EBITDA impact of the UK facilities on TSUKH's credit metrics would be critical for any change in outlook to the TSUKH ratings. Credit metrics that would support such an action include adjusted leverage trending towards 7.0x and EBIT/interest coverage of at least 1.0x on a sustained basis.
As to a change in our outlook on Tata Steel to stable, other than the improvement in its operating and credit metrics as a result of the divestment of the lossmaking UK operations, we would need to see: (1) domestic steel prices continuing on their recovery path, or, on the back of an increase in steel volumes -- Tata Steel shows a substantial improvement in profitability, with consolidated EBITDA/tonne in the INR6,000-7,000 range; and (2) the company's free cash flow turns positive on a sustained basis.
Adjusted consolidated leverage trending towards 4.5x -- 5.0x would constitute a leading indicator for a change in Tata Steel's outlook to stable.
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