India Ratings downgrades JSW Steel; Outlook negative

Company downgraded on deterioration of consolidated net leverage amid decline in fund flow from operations

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India Ratings has downgraded Sajjan Jindal-led JSW Steel in the view of deterioration in the company's consolidated net leverage amid decline in fund flow from operations interest coverage.

The company's consolidated earnings before interest, taxes, depreciation and amortisation (EBITDA) has fallen to Rs 4,957 per tonne in the year ended March from Rs 7,783 per tonne FY15 following a substantial decline in realisation due to import pressure and predatory pricing. The credit metrics were also affected by the debt-led capital expenditure incurred by the company during FY15-FY16 for capacity enhancement, said the report.

Meanwhile, the negative outlook reflects the risk of dilution in the protective measures undertaken by the government which could lead to a fall in company's realisation and further deterioration of its credit profile. The government in FY16 imposed a minimum import price (MIP) and a 20 percent safeguard duty on steel products. Post implementation of MIP, flat product (70 percent of company's sales) prices improved by about Rs 5,000 per tonne at end-June 2016.

The rating agency believes that better demand for steel in the domestic market and continuation of MIP will lead to a significant increase in JSW's sales volumes along with an increase in the average product realisation. The agency expects consolidated EBITDA to recover to the levels of Rs 7,500 per tonne from FY16's Rs 4,957. Although this will help improve consolidated net leverage, the credit metrics will remain stretched in terms of leverage.

The company has increased crude steel capacity by about 3.7 million tonne to 18 million in FY16. The agency however expects the company's capacity utilisation levels to come under pressure due to structural overcapacity. Agency expects incremental steel capacity to be 10-12 million tonne for FY17 compared to incremental consumption of 4-5 million-tonne in FY16. Thus, import substitution is important for the demand-supply equation to remain balanced. Though the import volume has substantially reduced post implementation of MIP, the domestic steel industry may remain vulnerable to imports due to a continuous decline in apparent consumption and capacity overhang in China.

JSW Steel lacks captive linkages for its key raw materials - iron ore and coking coal. The company is exposed to volatility in raw material prices (nearly 60 percent of its revenue), despite diversifying its procurement sources. JSWL imports its entire coking coal requirement while iron ore is procured from both domestic and international sources. The company intends to improve backward integration through the acquisition of raw material assets.

There are some strong sides to the business as well. The company has one of the lowest conversion costs compared to its peers globally, despite the absence of captive iron ore and coal linkages. This is primarily due to its manpower productivity and state-of-art manufacturing facilities. It also has a dominant market share in southern and western India. JSW's strategic partnership with JFE Steel Corporation (Japan) for technology has also provided a distinctive advantage to it.

The agency expects JSW's cash flow from operations to remain positive during FY17-FY18. The company has planned Rs 4,300 crore capital expenditure in FY17 of which Rs 1,500 crore is likely to be funded with debt. However, the agency does not expect the company to face a refinancing requirement for its debt maturities in FY17.