"The outlook change to positive from stable reflects ArcelorMittal's strengthening credit profile on the back of improved market conditions, successful efforts to reduce debt and expectations that its free cash flow will turn positive in 2017-18," says Gianmarco Migliavacca, a Moody's Vice President -- Senior Credit Officer and lead analyst for ArcelorMittal.
The positive outlook incorporates Moody's revised forecast for adjusted gross debt/EBITDA, which should reduce to a level below 3x by end-2017 and into 2018. It also reflects the rating agency's expectation that free cash flow will become materially positive in Q4 2017 and into 2018, even after assuming a modest negative initial impact on credit metrics and cash flows from the acquisition of Ilva, which Moody's assumes will be completed during H1 2018.
RATINGS RATIONALE
The outlook change to positive from stable is driven by the projected improvement of ArcelorMittal's key credit metrics and free cash flow towards levels more commensurate with a Baa3 rated company.
The rating agency's expectation of a stronger financial profile for the company is underpinned by the assumption of more supportive operating conditions across all the main markets in which the company operates. Steel spreads are projected to remain at healthy levels in 2018 and 2019 and broadly in line with 2017, which is consistent with Moody's current stable outlook on the steel sector across all regions including China.
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The structural rebalancing of steel demand and supply taking place in China should also support industry fundamentals elsewhere, considering that China accounts for more than 50% of global steel consumption and production.
Under the assumption of a stable demand environment for the main underlying steel end-markets, and of ongoing actions to reduce costs and improve productivity according to the company's multi-year 'Action 2020' plan, Moody's expects a further improvement in ArcelorMittal's adjusted EBITDA in 2018-19 towards a range of $8.6 billion to $9 billion, from a level of $8.5 billion estimated for 2017 and from a much lower level of $6.2bn in 2016.
At the same time, Moody's anticipates further reduction of the adjusted gross debt towards $22 billion by year-end 2019, from $23.8 billion anticipated by end-2017, following the voluntary prepayment of $1.25 billion notes via a public cash tender offer completed in October 2017. As a result, the projected adjusted gross debt/EBITDA should be positioned at around 2.5x in 2018-19 from 2.8x estimated by the end of December 2017.
The positive outlook also reflects Moody's expectation of a positive Free Cash Flow (FCF) of around $1.1bn in 2017, assuming a large working capital inflow in Q4 2017, partly offsetting material outflows in previous quarters, and a much higher FCF in 2018-19 in excess of $2 billion. The sustainably higher FCF is underpinned by higher projected EBITDA and a normalisation of working capital assuming steel and raw material prices are more stable, after their significant increase during 2017. The higher projected cash flows from operations should accommodate capex of around $3.7 billion annually in both 2018 and 2019. The higher projected capex vs $2.9bn expected in 2016 includes investments of around $500 million per annum Moody's assumes will be required to turnaround Ilva in Italy, assuming the acquisition is closed by April 2018, and around $350 million per annum to expand production and improve productivity in Mexico.
Positive FCF and large committed credit facilities should strengthen the company's liquidity position, which Moody's considers as good. Healthy liquidity provides meaningful headroom to support the company's financial profile ahead of the next cyclical downturn, in case of unexpected underperformance within a single region, or during the execution of the Ilva turnaround plan.
The affirmation of the CFR is underpinned by Moody's view that ArcelorMittal's rating is solidly positioned at Ba1, reflecting the company's (1) strong market position in the global steel industry; (2) strong geographical and product diversification; (3) partial vertical integration into iron ore and coking coal, which mitigates the company's exposure to increases in raw material prices; (4) improving adjusted gross debt/EBITDA towards 3x or below 3.9x in 2016; and (5) good liquidity profile.
At the same time, the rating still reflects (1) a history of low profitability, negative or marginally positive FCF and high leverage in the past five years, and only a limited track record of higher EBIT margin and lower leverage from 2017, with an adjusted EBIT margin and gross leverage of 8.3% and 3.1x respectively for the 12 months to September 2017; (2) moderate to high execution risk to completely turnaround Ilva after its acquisition, which is expected to close in the H1 2018; and (3) exposure to highly cyclical end-user markets.
WHAT COULD CHANGE THE RATING UP/DOWN
Moody's could upgrade the ratings if (1) Moody's adjusted leverage were to trend below 3.0x on a sustainable basis; (2) ArcelorMittal's profitability were to improve with its Moody's adjusted EBIT margin to increase to levels around 8% or above; (3) the company's cash from operation minus dividend (CFO-div) /debt were to move towards 25%; and (4) the company maintains positive FCF on a sustainable basis.
Moody's could downgrade the rating if (1) ArcelorMittal's profitability falls with its Moody's-adjusted EBIT dropping below 6%; (2) the company's Moody's-adjusted leverage remains consistently above 4.0x debt/EBITDA; (3) its (CFO-div) /debt decreases below 15%; (4) it pursues M&A activity resulting in higher leverage; and (5) the company generates negative free cash flow over multiple years.
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