Restructuring of Tata Steel's European operations is crucial for company's consolidated financial health, S&P Global Ratings said today.
"The recent improvement in profitability at Tata Steel Ltd is in line with our expectations and supports the company's credit quality. However, we believe restructuring of Tata Steel's European operations will be a key to an improvement in the company's consolidated financial health and ratings," the ratings agency said.
This is given the company's large debt, low margins and volatile profitability, especially in the UK.
"We attribute Tata Steel's improved profitability in India in the third quarter of the fiscal year ending March 31, 2017, to stronger global steel prices, aided by better demand than we expected in stimulus-driven Chinese markets and optimism on the new US administration's infrastructure spending proposals," it said.
S&P Global Ratings credit analyst Vishal Kulkarni said, "We expect the improving profitability trend, especially in India, to continue in the quarter ending March 2017 despite some headwinds in India, where short-term demand could get disrupted due to slower construction following demonetisation."
The Indian government's protectionist measures for the domestic steel industry also continue to support the Indian steel market, in our view, it said adding these measures have lowered steel imports in here, helping domestic steelmakers, including Tata Steel, to generate better profitability per tonne, despite steep rises in prices of raw materials such as coking coal.
"We believe that Tata Steel's India operations can deliver more than Rs 10,000 average EBITDA per ton for fiscal 2017. The company's India EBITDA per tonne improved to more than INR 11,332 in the third quarter of fiscal 2017, from about Rs 628 in the previous quarter," S&P said.
Talking about the Tata Steel's new capacity at the Kalinganagar industrial zone in India, it said it is also ramping up well, producing 1.5 million tonnes of steel in fiscal 2017, which is higher than 1.3 million tonnes expected.
Profitability at Tata Steel's Europe operations will continue to be volatile, given it is a function of raw material prices and currency movements.
Europe EBITDA of USD 50 per tonne for the nine months ending December 2017 is a turnaround from negative EBITDA during the same period last year, and is in line with our expectation.
It said in line with our forecast of EBITDA per tonne at Rs 10,000-11,000 in India and USD 40-USD 45 in Europe over next two years, "we expect Tata Steel's ratio of funds from operations (FFO) to debt to improve to about 12 per cent, and EBITDA interest coverage to be around 2.0x over the next one to two years," the Rating agency said.
The ratings agency further said this is a marked
improvement from a negative EBITDA in fiscal 2016. These ratios support our stable outlook on the ratings of Tata Steel.
"We would raise our rating if the FFO-to-debt ratio can reach 15 per cent sustainably. In our view, improving profitability and declining capital expenditure (with no new material expansion underway) will support Tata Steel's financial ratios. Still the improvement is from weak levels and is in line with expectations for the ratings," it said.
The improvement in Tata Steel's profitability in the third quarter of fiscal year 2016-2017 coincides with the company's restructuring efforts to bolster the operational health of its European businesses.
Over the past one to two years, Tata Steel has sold off a number of relatively small assets in Europe to reduce cash losses, while its debt remained largely unchanged.
Meanwhile, the company's proposed changes to the pension scheme for its UK operations has been approved by the workers.
The rating agency said the proposal still needs approval of other stakeholders, such as the trustees, and the regulators. The financial implications, if any, for Tata Steel from the changes will be clear once it is finalised.
Tata Steel is also considering joint ventures with other steel makers in Europe, which, when transacted, could bolster the company's financial metrics over next two to three years, it said.
Completion of these intended strategic measures -- asset sales, pension-scheme overhaul, and joint ventures -- would be supportive of credit quality, it said.
