S&P Global Ratings revises Tata Steel outlook to stable on earnings rebound

Company's leverage remains high, limiting further rating upside from current 'B+'

S&P Global Ratings has revised outlook for Tata Steel to stable on the expectation that the company’s earnings would strengthen over the next 18 months and its key financial metrics would improve to levels appropriate for the current rating.

The stable outlook also assumes no major growth projects or asset divestments over the period, S&P Global Ratings said in its report today.

“We expect the company to sustain solid earnings over the next 12-18 months following a rebound in the second quarter of fiscal 2021 (year ending March 31, 2021), helped by a benign steel price environment and lower input costs,” it said.

A key driver of better near-term profitability for most steel producers is the sharp decline in coking coal prices, which are down about 30 per cent year on year, and are likely to remain soft at least for the next two quarters.

At the same time, we estimate domestic steel prices for Tata Steel's Indian operations will be higher in the second half of fiscal 2021, with a price increase of about Rs 3,000 per tonne already implemented in October 2020.

Weakness at the European operations has also been lower than previously expected, thanks to the company's earlier cost reduction initiatives as well as sizable government wage support (about £100 million received in the first half of 2020).

 

According to the revised base case, Tata Steel's ratio of funds from operations (FFO) to debt will increase to about 12 per cent in fiscal 2022, compared with our previous expectation of about six per cent.

The debt-to-EBITDA ratio will likely decline to less than 5x as of March 2022, from 6.7x as of March 2020.

Tata Steel's deleveraging is also supported by free operating cash flow, especially in fiscal 2021, where we see meaningful improvement in working capital.

“We forecast the company's EBITDA interest coverage will remain well above 2x--our previous downgrade trigger--in the next 12-18 months,” said the report.

Tata Steel has adequate headroom at the current rating but high leverage limits further upside.

Downside rating risk has reduced significantly owing to the expected improvement in the company's earnings. However, Tata Steel's leverage remains high, limiting further rating upside for now, said the report.

An upgrade to 'BB-' from ‘B+’ at present will require the company to further deleverage materially or grow its earnings well beyond our current base case.

Furthermore, operating risks remain high despite improved sentiment. Key risks include volatile steel prices due to the potential economic impact from renewed surges of Covid-19 infections and an increase in input prices, especially coking coal.

 

The current rating also does not assume any growth projects over the next two years or any material proceeds from asset sales. Tata Steel has initiated discussions with Sweden-based SSAB AB to potentially sell its Netherlands steel business and expects significant progress in the next six to nine months.

“We have not included the transaction in our base case given that it is still in the early stages. However, we view a sale as positive for Tata Steel's credit profile because it could result in meaningful deleveraging,” said S&P.

Tata Steel's adequate liquidity will continue to support the rating. “We expect the company to maintain adequate liquidity over the next 12-18 months, underpinned by a strong cash position, positive operating outlook, and manageable debt maturities,” it said,

As of September 30, 2020, Tata Steel had Rs 178 billion of cash and cash equivalent. In comparison, debt maturities over the next year were only about Rs 18 billion, apart from about Rs 130 billion of short-term debt.

“We also view the company's sound relationships with banks and its high standing in capital markets as supportive of its liquidity position,” said S&P.