Moody's has also affirmed Tata Steel's Ba3 corporate family rating (CFR) and TSUKH's B3 CFR. At the same time, Moody's has withdrawn the B3-PD probability of default rating for TSUKH.
RATINGS RATIONALE
"The change in the ratings outlook to stable from negative reflects our expectation that the benign operating environment and recovery in the financial performance of TSUKH and Tata Steel over the last few quarters will continue over a longer term, leading to a sustained improvement in its credit metrics," says Kaustubh Chaubal, a Moody's Vice President and Senior Analyst.
Tata Steel's consolidated adjusted leverage -- as indicated by adjusted debt/reported EBITDA -- stood at an estimated 4.7x at end-September 2017, down from 8.9x in March 2016.
Strong growth prospects -- in particular, in its key operating markets of India, Europe and South East Asia -- with apparent steel consumption (production + imports -- exports) slated to grow, amid capacity removals in China, augur well for Tata Steel.
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Moody's expects China's steel production capacity to continue to decline with the government's implementation of supply-side reforms and environmental protection measures that have forced the closure of inefficient mills and prompted consolidation in the industry, leading to a decline in Chinese exports and supporting regional steel prices.
As for demand, Moody's expects India's steel consumption to grow in the mid-single digits in 2017 and 2018, on the back of economic activity with expected GDP growth in the 7.3% - 7.5% area. Moreover, implementation of the goods and services tax (GST) in July will help the organized sector, and strong brand recall players, such as Tata Steel, will be major beneficiaries.
In Europe -- by far Tata Steel's second largest market by volume with expected annual shipments of 10 million tonnes (mt) in the fiscal year ending March 2018 (FY2018) -- sustained demand from key user industries, such as automotive, construction and capital goods, will lead apparent steel consumption to grow by an estimated 2% in calendar 2017 and by 1.5% in 2018.
As a result, consolidated EBITDA/tonne will average INR7,500 -- 7,900 in FY2018, higher than the stable outlook trigger of INR7,000. Moreover with half the sales volumes from the higher profitable Tata Steel India (TSI) business -- that generates EBITDA/tonne in the INR10,000 - INR12,000 range, up from ~ 40% in FY2016 -- will drive a meaningful improvement in consolidated earnings. Absent any large capital expenditure and investment needs, free cash flow generation will improve and allow deleveraging.
Following Tata Steel's signing of the memorandum of understanding (MoU) with thyssenkrupp AG (Ba2 developing) in September, Moody's expects Tata Steel to enter into a definitive agreement for a joint venture (JV) of its European business by March 2018 and the consummation of the JV by March 2019. The transaction is at an early stage with signing and possible closing subject to due diligence and approvals from respective shareholders and antitrust authorities.
The change in the ratings outlook to stable rests on Moody's view that Tata Steel will maintain a cautious approach when evaluating expansions or potential acquisitions. Large debt-funded investments, if any, that slow the pace of leverage correction could weigh on the ratings. That said, given the significant improvement in operating and financial metrics, there is sufficient headroom under the ratings.
In light of the significant improvement in operating and credit metrics, upward ratings pressure is likely to build over the next 12-18 months. Tata Steel's ratings could be upgraded if adjusted debt/EBITDA improves towards 4.0x -- 4.5x and EBIT/interest coverage improves to 3.0x.
A downgrade is unlikely, given the return of the outlook to stable today. That said, downward pressure could build if there is any reversal in the trajectory for leverage correction, as a result of a sudden shift in industry conditions, or if the company undertakes overtly aggressive investments or acquisitions. Adjusted leverage exceeding 5.0x -- 5.5x on a sustained basis could be a leading indicator of a downgrade.
Sustained improvements in TSUKH's credit metrics, such that adjusted debt/EBITDA remains below 6.5x, will support an upgrade of the corporate family rating.
We do not anticipate any downward pressure on the company's fundamental credit quality. Any revision in our support assumptions from Tata Steel could pressure the ratings.
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