Steelmakers' robust margins in FY19 likely to moderate: Fitch Ratings

Fitch Ratings said on Thursday that healthy earnings before interest, tax, depreciation and amortisation (EBITDA) margins, which allowed Indian steelmakers like JSW Steel and Tata Steel to maintain stable leverage profiles in the past financial year 2018-19, are likely to moderate in the current one 2019-20.

However, a severe margin squeeze -- which could impact the companies' financial metrics and credit profiles materially -- is unlikely.

JSWS's consolidated reported EBITDA rose by 28 per cent in FY19, driven by a 34 per cent jump for standalone operations, which contributed more than 95 per cent of overall earnings. Standalone EBITDA growth mirrored the 33 per cent jump in EBITDA/tonne margin to around Rs 11,700.

 

The average FY19 EBITDA margin was affected by weaker prices in Q4 FY19 when the margin shrank to around Rs 10,100. Steel sales volume rose just one per cent in FY19 in the absence of any capacity increase.

JSWS's reported leverage -- consolidated net debt to EBITDA which is not adjusted for acceptances -- improved slightly to 2.4x in FY19 (FY18: 2.6x).

The company plans to spend a total of around Rs 32,000 crore in FY20 and FY21 to increase its steelmaking capacity to 24 million tonnes per annum (from 18 million tonnes per annum) and on several cost-saving and downstream projects.

"The latest spending plan is largely in line with our earlier expectations," said Fitch in a research paper adding that JSWS has yet to secure regulatory approvals for the acquisition of Bhushan Power and Steel, after which the company is likely to provide further details regarding the transaction structure.

TSL's reported consolidated EBITDA jumped around 40 per cent in FY19, mainly driven by higher margins for its existing operations in India and consolidation of earnings from Tata Steel BSL Limited (TSBSL) from late Q1 FY19.

The FY19 EBITDA/tonne margin for existing operations at Jamshedpur and Kalinganagar in India jumped to an average of above Rs 16,000 (FY18: around Rs 13,000), even as Q4 FY19 margins were materially lower at below Rs 14,000.

TSL improved TSBSL's profitability significantly after acquiring it in Q1 FY19, with EBITDA margin of close to Rs 9,400 per tonne for the financial year. The acquisition also drove a 33 per cent jump in TSL's steel sales volumes in India in FY19, making it the country's largest steelmaker in terms of sales volumes.

TSL's reported consolidated net debt-to-EBITDA leverage was around 3.2x in FY19, similar to FY18. The company expects capex in FY20 to remain largely flat year-on-year at around Rs 9,000 crore.

This includes around Rs 2,500 crore of capex for its European operations, which are unlikely to be transferred to the proposed joint venture with Thyssenkrupp based on the feedback received by the companies so far from the European Commission (EC).

The EC has set a provisional deadline of June 17 for its decision and Fitch awaits confirmation by the EC in order to resolve the rating watch on TSL's ratings.

The performance for Indian steelmakers came with the backdrop of relatively strong finished steel consumption growth of 7.5 per cent (6.8 million tonnes) during FY19, according to provisional official data. Imports increased by 4.7 per cent (0.4 million tonnes), much slower than what the market had feared last year in the wake of the imposition of steel import tariffs by the United States.

However, domestic flat-steel prices have followed the downward trend in global steel prices as the thresholds at which anti-dumping duties kick in are lower.

Global steel prices have corrected again in May in the absence of a resolution in trade disputes between the United States and China, after recovering since the start of the year. Business intelligence group CRU forecasts further price declines with slower industrial growth and weaker underlying demand for steel in multiple regions.

"As a result, steel prices will continue to be unable to properly reflect higher-priced iron ore. Fitch believes that margins for Indian steelmakers will shrink in FY20, from the FY19 highs. However, we do not anticipate an abrupt squeeze for the sector such as that seen in FY16 with restrained exports from China likely to be a key support for the global steel sector," it said.

Lower margins could result in some increase in the leverage ratios for JSWS and TSL in FY20. JSWS's increase is likely to be higher due to the significant rise in its capex as capacity expansion and other projects near completion.

"We do not expect JSWS's total adjusted debt-to-EBITDAR (earnings before interest, taxes, depreciation, amortisation, and restructuring or rent costs) ratio, after including acceptances, to exceed the negative rating sensitivity of 4x -- although risks remain," said Fitch.